The Daily Dow
Friday, October 3, 1997
by Robert Sheard

LEXINGTON, KY. (Oct. 3, 1997) -- It comes as no surprise that one of the most frequent questions in the Dow message folder asks what effect the new capital gains tax rules will have on our beloved Dow Approaches. While the jury is still out, the possibilities look promising.

Our research staff is building a history using the eighteen-month holding period now required to get the lower 20% tax rate. In the meantime, we do have some preliminary research that can help us decide what to do.

First, though, let's look at the hurdles the Dow Approach faces. Since 1971, the Foolish Four approach has produced an annualized return of 22.91%. At the old maximum long-term capital gains tax rate of 28%, that represents an after-tax return of 16.50%. This tax rate is still in effect, of course, for all stocks held at least a year but less than eighteen months.

To get the same after-tax return with the new lower rate of 20% for stocks held at least eighteen months, the Foolish Four model would only have to achieve a return before taxes of 20.63% -- two and a quarter percentage points lower than its historical return on a twelve-month cycle. So as long as the eighteen-month holding period doesn't slice more than 2.28 percentage points off of the pre-tax annualized return, the longer holding period gives us a net advantage.

For high-yield Dow stocks, the good news from one study we've discussed in the past suggests that eighteen months is a better holding period than twelve months anyway. In fact, eighteen or nineteen months appears to be the optimal holding period for these stocks. (For a summary of Lawrence Pratt's study, see my August 4 Foolish Four column.)

Are you struggling with the decision of whether to extend your Dow portfolio holding period? The research we have now seems to point to an advantage in both before- and after-tax returns for the longer cycle. Of course, I'll feature the results of our own historical test whenever our staff completes it. If you're skeptical about the longer holding period, however, it's nice to know that the worst-case scenario is right where we were before the tax reform (a maximum rate of 28% for stocks held at least a year). Fool on!

(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. ________________________________


1997 Foolish Four Model
Stock  Change   Last
--------------------
T    -   3/8   43.25
GM   -   3/8   67.81
CHV  +1  3/8   85.88
MMM  -   3/16  94.94

           Day   Month    Year
                  Day   Month   Year
        FOOL-4   -0.10%   0.81%  17.11%
        DJIA     +0.14%   1.17%  24.66%
        S&P 500  +0.48%   1.87%  30.28%
        NASDAQ   +0.79%   1.79%  32.90%

    Rec'd   #  Security     In At       Now    Change
   1/2/97  153 Chevron       65.00     85.88    32.12%
   1/2/97  179 Gen. Motor    55.75     67.81    21.64%
   1/2/97  120 3M            83.00     94.94    14.38%
   1/2/97  479 AT&T          41.75     43.25     3.59%


    Rec'd   #  Security     In At     Value    Change
   1/2/97  153 Chevron     9945.00  13138.88  $3193.88
   1/2/97  179 Gen. Motor  9979.25  12138.44  $2159.19
   1/2/97  120 3M          9960.00  11392.50  $1432.50
   1/2/97  479 AT&T       19998.25  20716.75   $718.50


                             CASH   $1167.51
                            TOTAL  $58554.07