<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (Jan. 14, 1998) -- After a full day with my 5-year-old son, I often feel as if I'm ancient. His sustained energy alone makes me feel twice my age. But in reality, I understand that my 37 years puts me in a dicey position from which to comment on investing as a retiree. Nevertheless, I'm going to.

I've received a number of letters from investors who have either retired recently or are approaching retirement soon. The questions they have in common are all borne out of what we hear as conventional Wisdom. They typically ask: Shouldn't I, as a retiree, reduce my stock holdings and rely on bonds for the income I need?

My answer to that is no. And hear me out before you dismiss me as a pup who has never been through a bear market.

Let's say you retire at age 55 or 60. What's to say you won't have another four decades ahead of you? If you no longer have earned income, your portfolio must continue growing at a pace faster than inflation in order for you to maintain your standard of living. If you get locked into fixed-income investments, especially with the yield on the 30-year bond now below 6%, any appreciable rise in inflation in years to come will seriously hamper, if not downright eliminate, any chance for growth in your portfolio.

The answer, even for the retired investor, is still a stock portfolio, even if it is an ultra-conservative one. We know that the Foolish Four approach has returned better than 18% annually for the last 37 years. But concentrating on only 4 stocks obviously isn't the answer. So perhaps use the Foolish Four as a starting point for a larger and more diverse portfolio and you should still be able to generate the kind of long-term returns the Foolish Four has returned since 1961.

But let's get even more basic and look at a simple S&P 500 Index fund to give us a baseline. Even this simple approach has generated 11.9% a year since 1961. That eclipses by far the returns you could have made over such a long period with bonds or real estate or gold.

Assuming the retiree is properly insured (health insurance, home insurance, liability, auto, but probably no need for life insurance) and has a suitable emergency fund of several thousand dollars to handle anything in a hurry that insurance won't cover, I would suggest that the actual long-term investment portfolio should be in stocks for long-term growth.

A good rule of thumb if you're living off of your investments is to try to limit your annual spending (withdrawals from your portfolio) to somewhere between 5% and 7% of your total portfolio value. This would be your "salary" for the year and should pay for everything you need, including taxes. If you can limit yourself to withdrawals in that range, your portfolio should continue to grow ahead of inflation and you will have a decent cushion against bad stretches in the market.

For example, if you need a "salary" of $50,000 a year today, your portfolio needs to be roughly twenty times that, or $1 million. In an average year, then, your portfolio would grow by 11.9% (the long-term S&P 500 return). Your $1 million portfolio would earn $119,000. You would withdraw roughly five percent of that $1,119,000 for your next year's "salary," or $56,000, leaving a new total of $1,063,000 to invest for the coming year.

The next year, the $1,063,000 would grow to $1,189,497. Your withdrawal for the following year would be 5% of that total, or roughly $59,500, leaving $1,129,997 to invest for the next year. And so on. You're staying well ahead of inflation while both your annual spending limit and total portfolio value grow over time.

A pattern like this, of course, can be sustained indefinitely. When the market goes down and your portfolio loses ground, you can increase the amount you pull out that year to 7% if you need the extra money for your annual expenses. By limiting yourself to such a range, you won't feel compelled to sell out all of your stocks during a bear market. You'll have a suitable cushion.

In my mind, then, the stock market isn't just a young investor's playground. I think a conservative stock portfolio is still the best "income" investment around for retired investors. You simply need to look at capital appreciation as a way of generating income instead of only considering the traditional sources like dividends and interest. Fool on, even in your golden years.

[Want to be first on your block to order Robert Sheard's forthcoming book? Click here to pre-order The Unemotional Investor.]

TODAY'S NUMBERS
Stock  Change   Last 
 -------------------- 
 UK   +   5/16  41.56 
 IP   +   5/16  42.94 
 MO   -   7/8   47.00 
 EK   -1  9/16  59.75 
 
            
                    Day   Month    Year 
         FOOL-4   -0.76%  -0.28%  -0.28% 
         DJIA     +0.68%  -1.56%  -1.56% 
         S&P 500  +0.61%  -1.29%  -1.29% 
         NASDAQ   +0.48%  -1.38%  -1.38% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  276 Philip Mor    45.25     47.00     3.87% 
  12/31/97  289 Int'l Pape    43.13     42.94    -0.43% 
  12/31/97  206 Eastman Ko    60.56     59.75    -1.34% 
  12/31/97  291 Union Carb    42.94     41.56    -3.20% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  276 Philip Mor 12489.00  12972.00   $483.00 
  12/31/97  289 Int'l Pape 12463.13  12408.94   -$54.19 
  12/31/97  206 Eastman Ko 12475.88  12308.50  -$167.38 
  12/31/97  291 Union Carb 12494.81  12094.69  -$400.13 
  
  
                              CASH     $77.19 
                             TOTAL  $49861.32