The Daily Dow
Wednesday, September 10, 1997
by Robert Sheard
LEXINGTON, KY. (Sept. 10, 1997) -- One of our goals as long-term investors is to minimize taxes and trading costs. As one reader asked this week, what about a strategy where one bought the current Foolish Four stocks through Dividend Reinvestment Plans every time one added money to the market and then simply held them forever?
In the short run, I believe such an approach would be fine. Your new money would always be going into the favored positions, your trading costs are minimized by using DRPs, and you delay taxes for many years by holding each stock indefinitely.
There's a problem with such an approach, though, that over many years would render the approach less effective than the standard Dow Approach. All stocks go through phases or cycles where they're more or less attractive in terms of potential growth. If you buy a stock and hold it forever, you hold through all phases, good and bad. That brings the annualized returns on such a stock to a middle ground over many years. For example, over the last ten years, the average return for the current 30 individual Dow components has been 14.77%.
The Dow Approach, however, is designed to buy a stock when it's at its least attractive part of the cycle and then to hold it only until it recovers significantly. Then one would sell the stock to reinvest those funds into another stock that's currently out of favor. In other words, it's a forced discipline, making you "buy low and sell high." By only holding stocks during part of their normal life cycle (while they're recovering), you can boost your overall portfolio returns five or six percentage points per year on average. Over a couple of decades, that advantage can make a monumental difference to your total portfolio. For example, $10,000 at 14.77% for 20 years grows to $157,000. At 22.91% (the historical return for the Foolish Four since 1971), the same $10,000 grows to $619,000. That's a difference of nearly 300%.
This doesn't account for taxes, however. Taxing the Foolish Four at 20% would reduce that $619,000 to $290,000 if you're not using a tax-deferred or tax-free IRA. On the buy-and-hold forever portfolio, the taxes would be deferred to the end of the 20 years and would then be levied at 18%. That would reduce the $157,000 total to $130,000. The 123% difference is still amazing, even after taxes.
These tax figures don't account for periodic additions, of course, but the point is, even after taxes, updating one's Dow portfolio periodically to hold the current Dow Approach stocks is a better long-term alternative than simply buying and holding forever. Don't get me wrong; even buying all 30 Dow stocks and sitting on them forever would be better than letting the vast majority of mutual funds control your investments, but the other alternatives available through the Dow Approach variations are even better.
(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 +1 3/8 42.06 GM + 1/4 67.31 CHV - 1/2 81.13 MMM -2 1/8 90.06
Day Month Year
FOOL-4 +0.66% 6.55% 12.85%
DJIA -1.69% 1.27% 19.71%
S&P 500 -1.56% 2.17% 24.07%
NASDAQ -1.02% 3.28% 26.97%
Rec'd # Security In At Now Change
1/2/97 153 Chevron 65.00 81.13 24.81%
1/2/97 179 Gen. Motor 55.75 67.31 20.74%
1/2/97 120 3M 83.00 90.06 8.51%
1/2/97 479 AT&T 41.75 42.06 0.75%
Rec'd # Security In At Value Change
1/2/97 153 Chevron 9945.00 12412.13 $2467.13
1/2/97 179 Gen. Motor 9979.25 12048.94 $2069.69
1/2/97 120 3M 9960.00 10807.50 $847.50
1/2/97 479 AT&T 19998.25 20147.94 $149.69
CASH $1009.44
TOTAL $56425.94