<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (Mar. 5, 1998) -- On a day like today, when much of the overall market's movement is the result of an earnings warning from a single company (albeit one of the largest public companies in America), my mind doesn't immediately turn to market timing and trying to call the top, as seems to be the case for so many of Wall Street's Wisemen.

Rather, it turns to an aspect of long-term investing that I've preached about repeatedly in recent months: diversification and risk management.

Now when most of us hear the conventional wisdom about diversification and risk protection, we're hearing advice to buy some stocks, some bonds, keep some in cash, and never expose ourselves to much risk at all. Unfortunately, that approach also limits our opportunities dramatically and we don't think it's Foolish at all.

When I talk about diversification, I mean within an equity portfolio only. And while buying a diverse portfolio reduces individual stock risk, it doesn't necessarily go hand in hand with reduced opportunity for returns. By matching a basic approach like the High Yield Dow strategies with some well-chosen growth stocks, you can actually improve on the already impressive returns we've seen historically for the Dow Approach and reduce the risk of an individual stock hurting your portfolio significantly.

For example, let's say you're holding four stocks in your portfolio. If one of them loses 13% like Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> did today, your entire portfolio suffers a loss of 3.25% just from Intel's drop -- not to mention the effect it has on other stocks. Now 3.25% isn't fatal obviously, but what if the stock dropped 33% instead of 13%? It happens, even with large caps. Then your whole portfolio suddenly drops 8.25%, and the pain increases.

But if that troublesome stock is just one of 15 or 20 stocks in a more diversified portfolio, the risk associated with the bad news is watered down. That 3.25% loss in a four-stock portfolio is only 0.65% in a 20-stock portfolio. The 8.25% loss is reduced to 1.65%.

I think the temple of diversification is worshiped before all else in some circles, to the detriment of long-term returns, but there's something to be said for spreading the risk inherent in surprises across a reasonably large field of stocks. Watching Intel today (and I own Intel as one of my current 19 holdings), the loss just doesn't hurt all that much because it's not dominating my overall portfolio. And I'm not emotionally pushed into making a rash decision because of what a 13% drop in one day will do to my net worth. When a single stock starts getting to be 20%, 30%, even more of your portfolio, it's virtually impossible for that kind of emotion to be kept in check.

So grab your favorite Dow stocks as a core, and then layer those growth stocks around to flesh out a true portfolio. Don't gamble on a few positions. Bets are funny that way; they have a nasty habit of turning against you at the most inopportune times.

Fool on!

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

TODAY'S NUMBERS
Stock  Change   Last 
 -------------------- 
 FOOL-4  -1.71%  4.71% 
 DJIA    -1.10%  6.79% 
 S&P 500 -1.17%  6.66% 
 NASDAQ  -2.72%  9.01% 
 
            
                    Day   Month    Year 
         FOOL-4   -1.71%  -0.42%   4.71% 
         DJIA     -1.10%  -1.18%   6.79% 
         S&P 500  -1.17%  -1.36%   6.66% 
         NASDAQ   -2.72%  -3.31%   9.01% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  289 Int'l Pape    43.13     47.88    11.01% 
  12/31/97  291 Union Carb    42.94     45.94     6.99% 
  12/31/97  206 Eastman Ko    60.56     64.69     6.81% 
  12/31/97  276 Philip Mor    45.25     42.56    -5.94% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  289 Int'l Pape 12463.13  13835.88  $1372.75 
  12/31/97  291 Union Carb 12494.81  13367.81   $873.00 
  12/31/97  206 Eastman Ko 12475.88  13325.63   $849.75 
  12/31/97  276 Philip Mor 12489.00  11747.25  -$741.75 
  
  
                              CASH     $77.19 
                             TOTAL  $52353.75