Wednesday, December 31, 1997


The Daily Dow
by Robert Sheard

LEXINGTON, KY. (Dec. 31, 1997) -- Yesterday, I followed up on David Gardner's announcement that we're officially revising the Foolish Four strategy to adopt my Unemotional Value four-stock approach, but a number of readers have written me since yesterday evening asking why we didn't go whole hog and opt for the UV two-stock approach. After all, the UV2 has an astounding return since 1961 of 21.54% annually and the highest Sharpe Ratio of the variations we've been tracking, even beating the heretofore much-vaunted one-stock PPP approach.

Some confusion exists, however, about what exactly the Sharpe Ratio measures. It is not a measure of pure risk. What the Sharpe Ratio measures is how well a given strategy has compensated its users for taking on the risk associated with such a strategy. And in that regard, yes, the UV2 has done very well in the 37 years we have data for it.

But that doesn't alter the fact that such an approach still necessitates one taking on a very high per-stock risk. Let's look at it the easy way. Half of your money is in a single stock, the other half in another stock. If either of those two stocks implodes, your entire portfolio is going to take a massive hit. Let's say one of the stocks gets cut in half. Hey, it happens even with large stocks. Look at 3Com <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COMS)") else Response.Write("(Nasdaq: COMS)") end if %> this year. The result of that single stock's disaster means your entire portfolio loses 25%. To me, that's not investing -- it's gambling. So even though the numbers look good for the UV2, it's not a complete portfolio strategy and always carries a big risk.

The way I see even the Foolish Four is as a starting point, a core around which you'll add new layers as your portfolio grows. The Gardners hold twelve stocks or so in their Fool Portfolio, four of which are Foolish Four choices. I like anywhere from fifteen to twenty total stocks. So the Foolish Four is the beginning for us. If you're getting into the stock market from scratch, begin with the Foolish Four, of course, but don't consider it your only strategy once your portfolio reaches $5,000 to $10,000.

With deep-discount brokers charging such low fees today, one can easily take a $1,000 position in any stock and not give up too much to commissions. (Buying and selling a single stock each year at $8 a trade only costs 1.6% of that initial $1,000 stake.) So one plan would be to put your first $4,000 in the Foolish Four and then with each additional $1,000, add a new stock to your portfolio. Whether the additional stocks are more Dow choices, or growth stocks using other strategies, is up to your personal goals and comfort level.

Eventually using a plan like this, you'll build your portfolio up to ten or twenty stocks by the time you've saved and invested $10,000 to $20,000. From there, it's simply a matter of maintenance with your new money and growing portfolio.

Don't get me wrong; I think the Foolish Four is a marvelous strategy, although it scares me when I hear the mainstream media extolling its virtues (heh heh). But it's only a starting place. I'll always cringe when I hear of someone using a very concentrated approach like this (even with four stocks) for an entire large portfolio. There's simply no need to take on such a high risk, despite the historic stability and returns for these variations.

Set up your Foolish Four core and then add layers of other stocks. And your goal for these additional stocks is to surpass even the returns your Foolish Four core achieves. I wish you all a very Foolish and Happy New Year!

TODAY'S NUMBERS
Stock  Change   Last
--------------------
T    -1  5/16  61.25
GM   -  11/16  60.63
CHV  -1  1/16  77.00
MMM  -  15/16  82.06


           
                   Day   Month    Year
        FOOL-4   -1.58%   1.57%  28.06%
        DJIA     -0.10%   1.09%  22.64%
        S&P 500  -0.04%   1.57%  31.01%
        NASDAQ   +0.31%  -1.89%  21.64%

    Rec'd   #  Security     In At       Now    Change

   1/2/97  479 AT&T          41.75     61.25    46.71%
   1/2/97  153 Chevron       65.00     77.00    18.46%
   1/2/97  179 Gen. Motor    55.75     60.63     8.74%
   1/2/97  120 3M            83.00     82.06    -1.13%


    Rec'd   #  Security     In At     Value    Change

   1/2/97  479 AT&T       19998.25  29338.75  $9340.50
   1/2/97  153 Chevron     9945.00  11781.00  $1836.00
   1/2/97  179 Gen. Motor  9979.25  10851.88   $872.63
   1/2/97  120 3M          9960.00   9847.50  -$112.50