<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (Jan. 8, 1998) -- After a brief absence from the Hall of Portfolios, we're back!

The editors had decided to remove the Foolish Four model from the Hall of Portfolios for two reasons. First, we're launching a new portfolio, Tom Gardner's Cash-King Portfolio, and there wasn't another slot on the page. And second, all of the portfolios in the Hall are real-money portfolios except for our Foolish Four model.

The production staff, however, was able to rebuild the Hall of Portfolios to squeeze us back in, so you'll again be able to see our model stacked up against the Fool's real-money groups. Incidentally, both the Fool Portfolio and the new Cash-King portfolio use the Foolish Four method for choosing their first four stocks, so the portfolio managers believe in this approach enough to open up their wallets to it.

Switching topics, a number of readers have asked me to reprise my thoughts on using the Foolish Four as a core strategy around which one can layer other stocks to build a fully Foolish diversified portfolio. So today, I'll just develop one example among many possibilities for such an approach.

Emilia Freshstart has no portfolio yet, but she's started a new job, has set up her tax-deferred retirement plan at work to maximize her employer's matching contributions, and has plunked her $2,000 into a Roth IRA. Now she wants to get started building a taxable portfolio in addition to these accounts. She has an additional $500 a month she can invest.

Let's assume she's going with a deep discount broker with either no minimum investment requirement (or at least a very low one) just for the sake of the easy example. If the broker you want to use requires more than you have to start with, save like crazy an extra month or two and then get started.

I generally look at $1,000 as the minimum amount to put in a single stock position. I know you can get by with less and still keep trading costs somewhat reasonable, but I like round numbers and $1,000 is a good starting point. Emilia, then, won't be ready to buy her first stock until she's saved that second month's $500.

When the first $1,000 is in place, she buys her first stock from the current Foolish Four rankings. Easy enough. Two months later, she has another $1,000 in cash ready. Again, she turns to the new Foolish Four rankings and buys the highest ranked stock (or the next one if the first stock is the one she already holds).

After eight months of this pattern, Emilia will own four stocks chosen from the Foolish Four rankings. With each new $1,000 thereafter she will still buy another stock, but she has to start making decisions about which stocks to look at. If she likes the simplicity of the Foolish Four and doesn't want to stray too far from home, she can pick up another Foolish Four stock if one of the currently ranked stocks isn't already among her holdings. Or she can start to branch out into other areas, perhaps Foolish Four-like high yielders from the S&P 500 or growth-oriented strategies she likes.

Eventually, though, Emilia will end up holding fifteen to twenty stocks if she does this routine for a few years. In the meantime, she can replace her original purchases as they become a year old if necessary.

Doesn't this create a lot of extra work? It's true that it requires a little work every other month instead of just once a year, but it's not asking for a lot of time and adding new money every month is a great way to watch your portfolio grow. Her portfolio will grow from nothing to $12,000 in two years, even if no stock increases in price as much as a penny. Add in the hoped-for capital appreciation of her investments and she's off to the races.

Once Emilia has her final number of stocks, whether she determines that should be ten, fifteen, twenty, or some other number (I prefer fifteen to twenty), then she can start to consider playing with her acquisition dates (if she wants to) in order to begin adjusting her entire portfolio all at once every year instead of in pieces every other month. But there's nothing wrong with leaving her schedule set up where she makes one or two adjustments every month or every other month.

One possible advantage Emilia may have if she really wants to condense her work to a single schedule is that since she's just starting out, she is probably still in either the 15% or 28% tax bracket. In those brackets, there's no tax advantage for holding a stock for a full year (although there is if you hold for 18 months). So she's not going to pay any more taxes if she decides to update her portfolio all at once after a couple of years since short-term gains on some of the holdings are going to be taxed at her ordinary income tax rate, just as one-year gains would be.

In other words, when you're just starting to construct a Foolish Portfolio, you have lots of good options. You can put your new money into an index fund, or into S&P 500 Spiders, until your next regular portfolio update. Or try Dividend Reinvestment Plans. Whatever route you take, be patient, save regularly, and use Foolish strategies to choose your stocks. With time and patience, you'll overcome what inevitably feels like a painfully slow beginning.

Keep in mind, if in your Roth IRA over the next thirty years you can return 18% a year (the historical return for the Foolish Four since 1961), and all you ever save is that $2,000 maximum contribution each year, you can still get from zero to nearly $1.9 million. And there are no tax liabilities waiting to grab you on the back end, either. Is that encouraging enough? Fool on!

TODAY'S NUMBERS

Stock Change Last -------------------- UK - 3/4 42.94 IP -1 1/4 44.75 MO - 3/16 46.56 EK -1 1/8 63.63

Day Month Year FOOL-4 -1.65% 2.93% 2.93% DJIA -1.26% -1.34% -1.34% S&P 500 -0.83% -1.48% -1.48% NASDAQ -0.39% -0.94% -0.94% Rec'd # Security In At Now Change 12/31/97 206 Eastman Ko 60.56 63.63 5.06% 12/31/97 289 Int'l Pape 43.13 44.75 3.77% 12/31/97 276 Philip Mor 45.25 46.56 2.90% 12/31/97 291 Union Carb 42.94 42.94 0.00% Rec'd # Security In At Value Change 12/31/97 206 Eastman Ko 12475.88 13106.75 $630.88 12/31/97 289 Int'l Pape 12463.13 12932.75 $469.63 12/31/97 276 Philip Mor 12489.00 12851.25 $362.25 12/31/97 291 Union Carb 12494.81 12494.81 $0.00 CASH $77.19 TOTAL $51462.75