<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (Mar. 9, 1998) -- I need to address a couple of items today that have been of interest here in recent weeks. First, Bob Price ([email protected]) announced today in the AOL message boards that a change is called for in his RP Variation.

If you're unclear what the RP Variation is, please see my columns in this area from February 13 and 17. Originally, Bob skipped the highest-ranking RP stock and included the next four in the rankings. But there's some data to suggest that such an idea was based on what may have been an anomaly in the data surrounding January 1's numbers. It doesn't appear to be a good idea the rest of the year. So to make life simpler, Bob is now recommending using the RP approach and simply including the top five stocks, period. No skipping, no over-weighting, no howling at the moon.

Bob continues to work on his update of the Dow database. The problem is that like Tristram Shandy, it's taking him longer to test each period than the actual time covered in the test, so each month takes him 32 or 33 days to record. We promise to cut his food rations until the project is finished. Those extra eight seconds we allow him to spend eating lunch are just too comfortable!

On another issue, I recently wrote an article explaining how to calculate the Internal Rate of Return using Excel's XIRR function and then followed that column with one explaining the Unit Value method used by mutual funds and investment clubs when new money comes into the portfolio. In that follow-up article, I suggested that such a method could be used in lieu of the XIRR function to calculate the portfolio's return, and then even supplied an example to demonstrate this assertion.

Boy, was I wrong! By dumb luck, I chose a model that included evenly spaced contributions and an even rate of growth throughout the year, so my final return came out the same as the XIRR return for the same scenario. Unfortunately, if the deposits aren't evenly spaced and the growth rate is not constant throughout the year, the return can vary quite a bit from the one I calculated in the example. In other words, you can have several different returns using this method, even though in each scenario the cash flow and the final value is identical.

The long and the short of it is that the Unit Value can only really measure the growth of a single unit over time, but it doesn't measure the time-value return for an entire portfolio that includes an irregular cash flow.

I've sent notes to a couple of fund companies and Morningstar to see how they handle this problem of calculating mutual fund returns each day (since they have daily irregular cash flows), but I haven't yet received a satisfactory answer.

Until I hear more or can find a good resource to answer this toughie, I'm sticking to my original method of calculation using the XIRR function. Commercial software packages like Quicken also include a return calculator like the XIRR function if you don't have Microsoft Excel.

[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 -------------------- UK + 3/8 46.50 IP +1 3/16 50.06 MO - 3/8 44.31 EK - 13/16 63.75

Day Month Year FOOL-4 +0.34% 1.65% 6.88% DJIA -0.03% 0.25% 8.33% S&P 500 -0.32% 0.28% 8.44% NASDAQ -1.62% -2.56% 9.86% Rec'd # Security In At Now Change 12/31/97 289 Int'l Pape 43.13 50.06 16.09% 12/31/97 291 Union Carb 42.94 46.50 8.30% 12/31/97 206 Eastman Ko 60.56 63.75 5.26% 12/31/97 276 Philip Mor 45.25 44.31 -2.07% Rec'd # Security In At Value Change 12/31/97 289 Int'l Pape 12463.13 14468.06 $2004.94 12/31/97 291 Union Carb 12494.81 13531.50 $1036.69 12/31/97 206 Eastman Ko 12475.88 13132.50 $656.63 12/31/97 276 Philip Mor 12489.00 12230.25 -$258.75 CASH $77.19 TOTAL $53439.50