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Friday, March 01, 1996

Foolish Physics and the Laws of Inertia--Part TWO

by Joseph Hecht

In part one of this Fribble, I reflected on some of the "residue" of my past financial decisions. Using my Foolish inquisitiveness and a spreadsheet, I recently assessed these investments against the S&P 500's performance, an exercise called: "Foolish Physics."

EXAMPLE 2:

There was a second bit of "residue" in my IRA account, and I put that to the spreadsheet test as well. Several years ago, in my un-Foolish days, my broker convinced me to invest in his company's family of mutual funds. In 1993 and 94 he put my retirement money in an Income Fund, because he felt that stocks "were not the safe place to be." Here comes my spreadsheet again. The Income Fund gained a meager 3% in 1993 and a paltry 0.2% in 1994. I guess the definition of 'safe' is a fund that does not lose money. In 1995, he recommended that I switch to their "Growth" Fund. Yes, "the market was looking up," he said! Given the previous sluggish results, I was glad to try a growth fund. At least it sounded sexier than that crummy Income Fund. And in 1995, such a fund should have done pretty well, no? After all the market had it's best year in a long time, didn't it?

I just received the "Growth Fund's" 12/31/95 annual report. I won't say which major brokerage it's from, although I'm not doing this to protect the innocent. I don't consider them innocent. The report from the fund's President starts out (in bold face type no less):

**1995 was great**

It goes into detail about the economy, the fact that the markets didn't have high expectations going into the year, and a potpourri of other WISE retrospective observations. Did Mr. Fund President predict this a year ago? No way. Not a shred of clairvoyance. That did not stop him from gazing into his crystal ball once again, though.

Mr. Fund President now feels that corporate earnings will not be as good in 1996, and he expects less than 10% growth for the year. He feels that the lowering of interest rates will reflect economic weakness, as well as disappointing corporate earnings. So why is this non-clairvoyant fellow still prognosticating? Is it to distract his investors from the important stuff that gets written about four long paragraphs into his report?

**Finally, the important stuff**

"Although absolute returns for the Growth Fund were excellent, and it is difficult to be too disappointed with near 30% return (actual 29.1%), WE DID UNDERPERFORM the S&P 500." Yup, if Mr. Fund President had just mimicked the S&P 500 he would have brought home a full 5% more than his Growth Fund. (Maybe with all his management, we should chalk it up to management fees, hmm?)

So why didn't things work out in such a good market? SAFETY?

Their braintrust did explain: "We deliberately did not shift into the kind of technology stocks that were the top performers, fearing that they will have a hard landing in the not-too-distant future (which actually may already be upon us)." So they stayed with their bottom performers? Out of fear?

FEAR: a perfect prescription for UNDERPERFORMANCE.

So why am I paying this fund's management team to underperform the Index? From 1/86 to 12/95, $10,000 invested in this fund would have grown to $40,000. The same investment in the S&P Index would now be worth $39,700. What does this mean? I guess it must take a whole lot of management fees to mimic the Indices. What is this "Growth" fund equivalent to? Can you say expensive Index Fund? I knew you could! I know I will be saying "Beating the Dow"...from now on. Sorry Mr Growth Fund. I may now be a Fool, but I'm no longer a dummy!

**REFLECTIONS ON THE FOOLISH PHYSICS COURSE

AND THE LAWS OF INERTIA**

Now that I have a perspective on this topic (a year ago I was just a blank slate), I urge you to read The Motley Fool Investment Guide. It may be a shameless plug, but the reason I wrote this Fribble is to give real testimony as to what the investing industry is full of (. . . mostly full of themselves!). What the Gardners have said, whether in the online articles or their hardcover treatise, has been so on target that you, too, can get to the heart of the matter.

So breakout those spreadsheets and overcome some inertia. . . today!

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