The Daily Dow
Monday, August 4, 1997
by Robert Sheard
LEXINGTON, KY. (August 4, 1997) -- Now that both the House of Representatives and the Senate have passed the budget and tax-cut bills, and President Clinton is likely to sign them into law tomorrow, let's look at how the establishment of a new holding period for capital gains might affect the Dow strategies.
First of all, if you choose to continue with the Dow approaches as we've always done, updating after a year (and a day), nothing will change for you. The maximum capital-gains tax rate is still going to be 28%. So if you're quite content with that rate and the annual updates, nothing need change.
If you'd like to take advantage of the new lower rate of 20%, however, you need to hold your stocks at least 18 months. But is this Foolish with the Dow approaches? If Lawrence S. Pratt has anything to say about it, yes it is.
Pratt published a study called "Toward an Optimal Stock Selection Strategy" in the June 1995 edition of the Economic Education Bulletin (Volume 35, Number 6), which is published by the American Institute for Economic Research in Great Barrington, Massachusetts (01230).
Pratt's study tested holding periods from 1 to 36 months for the Dow stocks in combinations from 1 to 30 stocks (ranked by dividend yield). The study covered the twenty years from December 1974 to December 1994.
What Pratt found is that the optimal holding period for the Dow stocks ranged from 16 to 19 months, depending on how many stocks of the 30 one includes. For the ten stocks we're concerned with -- the top ten yielders -- the optimal holding period was 18 to 19 months, with an annualized return of 18.05% for both periods. Contrast that with the 12-month holding period return of 17.25% for the top ten yielders. For different numbers of stocks up to ten, the optimal holding period ranged consistently from 17 to 19 months.
Given these data, then, the new 18-month holding period required for the lowest capital-gains tax rate (20%) should not hurt the Dow approaches at all. In fact, it should boost the returns because it extends our traditional annual holding period right to the point where Pratt found the optimal holding period sits. Plus it reduces trading costs and qualifies all gains for a much lower tax rate.
In the coming months we'll undoubtedly re-test the Foolish Four returns with 18-month holding periods to get precise numbers using our dual screen of high yield and low price, but Pratt's research is convincing enough that I have little doubt the returns will be even better than what we're now used to quoting. In the meantime, his numbers are convincing enough to me that I have no qualms about suggesting an 18-month holding period from here on out for the Dow approaches. According to his study, it's simply a better holding period anyway.
For another aspect of the new tax laws (Individual Retirement Accounts),
see tonight's Foolish
Workshop
report.
(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. ________________________________
Stock Change Last -------------------- T + 3/16 37.44 GM -1 3/4 62.69 CHV + 7/8 79.50 MMM + 15/16 95.19
Day Month Year
FOOL-4 +0.04% 1.04% 7.01%
DJIA +0.05% -0.29% 27.14%
S&P 500 +0.33% -0.42% 28.29%
NASDAQ +0.70% 0.73% 24.35%
Rec'd # Security In At Now Change
1/2/97 153 Chevron 65.00 79.50 22.31%
1/2/97 120 3M 83.00 95.19 14.68%
1/2/97 179 Gen. Motor 55.75 62.69 12.44%
1/2/97 479 AT&T 41.75 37.44 -10.33%
Rec'd # Security In At Value Change
1/2/97 153 Chevron 9945.00 12163.50 $2218.50
1/2/97 120 3M 9960.00 11422.50 $1462.50
1/2/97 179 Gen. Motor 9979.25 11221.06 $1241.81
1/2/97 479 AT&T 19998.25 17932.56 -$2065.69
CASH $767.60
TOTAL $53507.23