Friday, November 21, 1997


The Daily Dow
by Robert Sheard

LEXINGTON, KY. (Nov. 21, 1997) -- Looking at the number of stocks held in some mutual funds can give the individual investor reason to pause and wonder just how many stocks one really needs to balance diversification with strong growth. Surely when Fidelity Magellan held some 1,400 different stocks under Peter Lynch's management, it wasn't because there were 1,400 great bargains out there.

But the individual investor doesn't have the problem of having to find parking places for many billions of dollars (and even if he did, I still think 1,400 stocks is a bit absurd), so just how many stocks are really necessary?

In other words, is it safe to put your whole portfolio in four stocks, Foolish though they may be?

The answer, as usual, is "it depends." If you're just starting out in stocks and investing a couple thousand dollars, it probably doesn't make much sense from a transaction-cost perspective to invest in any more than four stocks. Commissions on a relatively small portfolio can become prohibitive if you cut the pie into too many slices, even at deep-discount rates.

But a very concentrated portfolio does carry with it a measure of risk associated with each individual stock. While the Dow stocks are favored because of their historical stability, there's nothing to say that tomorrow one of them can't get struck by lightning and short out. With a portfolio invested in only four stocks, you have 25% of your net worth exposed to that danger in each stock. If one of the four gets sliced in half overnight, you've just watched 12.5% of your total portfolio disappear. That hurts.

If you're just starting out and it only represents a couple of hundred dollars, it's a risk that's probably worth taking. But if you're talking about a portfolio of some size, where commission costs don't prevent you from diversifying further, it's not really a great risk.

So think of the Foolish Four (or the Beating the Dow Five or whatever) as a starting point and a core for your portfolio. As you add money to your account and the balance grows, consider expanding the number of holdings to ten, fifteen, even twenty if you like. Some studies show that all of the important portfolio diversification takes place in your first 16 stocks (assuming they represent a range of industries).

If you want to stay with the low-maintenance Dow stocks, perhaps augment them with other large-cap high yielders. Or start to do some research into growth stocks to complement the Dow Dividend Approach.

By the time you have fifteen stocks, the damage done if one were to get sliced in half is reduced to an overall portfolio loss of only 3.33%. Quite a bit easier to sleep at night than with a risk of 12.5% on a four-stock portfolio, don't you think?

So if you're just getting started, go ahead and stick with the Foolish Four for a while. But you might want to start picking up other Foolish finds as you add each thousand or so to your account. By the time you have $10,000 in your portfolio, you'll be holding a ten-stock Foolish portfolio you can feel comfortable with -- and you'll still keep commissions reasonable if you're using a deep-discount broker. Even if you have twenty trades a year on your ten-stock portfolio (which isn't likely with these somewhat stable approaches), the commissions of $160 to $200 only represent 1.6% to 2.0% of your total portfolio. And those percentages will keep shrinking as your portfolio grows.

Start with the Dow as your core, and then branch out to flesh out a fully Foolish portfolio. Have a great weekend!

TODAY'S NUMBERS
Stock  Change   Last
--------------------
T    +1  1/16  55.69
GM   +   1/2   62.06
CHV  +   1/2   84.56
MMM  -   1/4   96.75

           
                  Day   Month    Year
        FOOL-4   +1.02%   6.65%  27.48%
        DJIA     +0.70%   5.90%  22.22%
        S&P 500  +0.43%   5.30%  30.02%
        NASDAQ   -0.36%   1.70%  25.54%

    Rec'd   #  Security     In At       Now    Change

   1/2/97  479 AT&T          41.75     55.69    33.38%
   1/2/97  153 Chevron       65.00     84.56    30.10%
   1/2/97  120 3M            83.00     96.75    16.57%
   1/2/97  179 Gen. Motor    55.75     62.06    11.32%


    Rec'd   #  Security     In At     Value    Change

   1/2/97  479 AT&T       19998.25  26674.31  $6676.06
   1/2/97  153 Chevron     9945.00  12938.06  $2993.06
   1/2/97  120 3M          9960.00  11610.00  $1650.00
   1/2/97  179 Gen. Motor  9979.25  11109.19  $1129.94


                             CASH   $1409.35
                            TOTAL  $63740.91