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Thursday, February 29, 1996

Foolish Physics and the Laws of Inertia--Part ONE

by Joseph Hecht

Practice what you preach. Easy to say and hard to do.

I like to think of life's experiences as a collage. The previous years leave layer upon layer of the residue of past decisions. Financial decisions are often made under very different contexts that change as one's future unfolds. My retirement account has several investments that are great examples of this. They were funded based on my job situation, and have been left to compound in the same vehicles in which they were set up. The inertia to change an account (especially when your advisor says, "that's long term money, let's keep it safe") is hard to overcome.

But since I've acquired a Foolish demeanor, I've taken the time to analyze these financial matters on a spreadsheet. Actually, it was simple enough to do. . . and kind of fun. Much of the money in these IRA accounts have been accumulating for 5 to 10 years, so there's plenty of data to review. I just plugged in the annual figures from 12/31/XX, and the spreadsheet showed me what was really going on!

With a Fool's perspective, I recently assessed these investments against the S&P 500's performance. With your indulgence, the term for this ritual will now be coined: "Foolish Physics." These lessons are not pretty, but the experience is worth learning from.

EXAMPLE 1:

One bit of "residue" was IRA money that had been rolled into a U. S. Government Bond fund. This fund gained 7.7% annualized from 1989 thru 1994. As we know, the no-brainer S&P Index Funds average about 10% annualized, and Beating the Dow has flown high at about 20% average gain per year. By those standards, my fund was an underachiever. The trick is to know what standards to compare it to. Thank you, Motley Fool, for this insight. I'm looking at this with new eyes now, and now I can say: I WANT TO DO BETTER THAN THIS!

So in becoming a Fool I began to change things. Last June, I called my broker---who was perfectly happy that I was earning a 'safe' 7% annual gain (not so subtle insult intended)---and told him to sell the fund. I took half of the money and bought stocks, planning to put the remainder in the market within 6 months, or whenever opportunity knocked. As it turned out those remaining funds were used in January 1996 at a time when the Nasdaq market was getting creamed. I purchased a beaten up software company that goes by the name "Microsoft" (surprise. . . even my broker had heard of them). The "wise" may have been selling, but I was bargain shopping for a stock I could live with for a long time. The results have been shocking. In 6 months, my stocks have already gained 50% of what the lazy bond fund returned in over 5 years. The stocks as a group are up about 30%. . . but those gains are not exactly the point.

The point is that a portfolio of stocks built upon the foundation of a diversified group of large companies with great management, growing earnings, increasing margins and cash-rich balance sheets---basic Foolish principles---will outperform in the long run what conventional wisdom calls their "safe" investments.

So why was I using a "professional" from a large well-known brokerage to give me such terrific advice? The truth is I didn't know any better. The equivalent shares of Microsoft, if bought in 1990, would have created a pretty fine jump-start for that nest egg. But better late than never. I won't cry over spilt milk, I'll just be glad my glass will now be getting filled.

My innocence may be fading, but this once naive storyteller has yet another example up his sleeve.

To be continued. . .

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