CASE STUDY INFLATION CONSIDERATIONS FOR STOCK AND BOND INVESTMENTS Background The savings and investments that an individual maintains should have some balance between equity (corporate stocks that rely on market growth and dividend income) and fixed-income investments (bonds that pay dividends to the purchaser and a guaranteed amount upon maturity). When inflation is moderately high. bonds offer a low return relative to stocks because the potential for market growth is not present with bonds. Additionally, the forces of inflation make the dividends worth less in future years because for most bonds there is no inflation adjustment made in the amount the dividend pays as time passes. However, bonds do offer a steady income that may be important to an individual, and they serve to preserve the principal invested in the bond because the face value is returned at maturity. Information Earl is an engineer who wants a predictable flow of money for travel and vacations. He has a collection of stocks in his retirement portfolio, but no bonds. He has accumulated a total of $50.000 of his own funds in low-yielding savings abcounts and wants to improve his long-term return from this nonretirement program "nest egg." He can choose additional stocks or bonds, but has decided to not split the $50,000 between the two forms of investments. There are two choices he has outlined, with the best estimates he can make at this time. He assumes the effects of federal and state income taxes will be the same for both forms of investment Stock purchase. Stocks purchased through a mutual fund would pay an estimated 2% per year dividend and appreciate in value at 5% per year. Bond purchase: If he purchased a bond, he would have a predictable income of 5% per year and the S50.000 face value after the 12-year maturity period