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<THE FOOLISH FOUR>
Foolish Four Report
by Robert Sheard
LEXINGTON, KY. (March 25, 1998) -- In yesterday's column, I outlined my "Dozens" strategy for investors who are either starting with smaller portfolios or who are regular savers and want an approach that allows them to add new money every month or two without getting cleaned out in commission costs.
A number of readers asked me to write a follow-up column today about the process one would use a year later when it becomes necessary to start replacing the oldest stocks. So let's look at two possibilities.
If you're investing in a regular taxable account, make sure your account is margin enabled. Even if you never plan to borrow on margin from your broker, it's a good idea to have the option available. What if you buy a stock Monday and find that the price moved higher before your order was filled? After your purchase and your commission, you might have spent $20 or $30 more than you actually have cash for in your account. If you have margin capabilities, your broker advances you the twenty bucks automatically and you pay it back with the first dividend check that comes in or the next time you sell something. The interest rate right now is from 7% on margin loans, so you're not digging yourself into a hole as with credit-card debt. That convenience sure beats sending a check by overnight mail to cover the twenty bucks before the settlement deadline. The tiny amount you'll pay in margin interest in a situation like this is cheaper than the cost of the overnight letter (and it's tax deductible).
But having some room to use your margin account can help you in this rebalancing of your Dozens stocks as well. Let's look at how. At the end of your first year, let's assume your total portfolio is worth $16,000. The stock you're buying for your first replacement stock of the year should be worth 1/12 of that amount, or $1,333.
Now if the stock you're replacing wasn't a very good performer, it might be worth less than $1,333 right now. Let's say it's only worth $1,100. To rebalance this position, then, you'd buy the new stock in an amount worth roughly $1,333, borrowing the extra $233 on your margin account.
Zoom forward to the next month's replacement. Your total portfolio is now worth $16,300, perhaps. To buy the new stock at 1/12 of that amount, you need to invest $1,358. What do you do if the stock you're selling is worth $1,500? When you sell it and buy the new one for $1,358, the remaining $142 pays down your margin balance. Now you only owe your broker $91 of the original $233 on margin. And so on, each month, borrowing a little in months when you're replacing a below-average performer, paying off the margin balance when you replace above-average performers. There may even be a month here and there where you have a few bucks left over in cash because you've had a couple of good performers in a row. So be it.
Using your margin account to help you keep these monthly adjustments equal to 1/12 of your current portfolio is a simple and painless way to rebalance. You're never going to take on much of a margin balance this way, so you're not putting yourself in a seriously risky position. But it affords you the opportunity to make all of your positions roughly equal to 1/12 of your portfolio at the time you buy them, so once a year, each position is in perfect balance to the whole.
If you don't have margin access, however, say, in an IRA where margin is forbidden, the rebalancing dilemma is a little bit more difficult. You'll either have to accept some slight imbalances when positions are over- or under-valued relative to the whole portfolio, or you'll have to keep a small cash slush-fund to add to or draw on when a stock is out of line with its ideal value.
Don't get too wrapped up in getting every position perfectly in line, however. The real goal is to be as fully invested as possible at all times in a dozen top appreciation prospects. If you'll do that as simply as possible and add new money at every opportunity, your long-term success will be the envy of the vast majority of professional money managers. Fool on!
[Robert Sheard is the author of the forthcoming book, The Unemotional Investor, due out from Simon & Schuster on May 12. To pre-order your copy, please visit Amazon.com, where it's available at a discounted price.]
TODAY'S
NUMBERS
Stock Change Last -------------------- UK - 1/8 48.88 IP - 1/16 49.06 MO --- 43.88 EK - 11/16 63.69 |
Day Month Year
FOOL-4 -0.36% 2.80% 8.09%
DJIA -0.36% 3.83% 12.20%
S&P 500 -0.33% 5.02% 13.56%
NASDAQ +0.68% 3.06% 16.19%
Rec'd # Security In At Now Change
12/31/97 291 Union Carb 42.94 48.88 13.83%
12/31/97 289 Int'l Pape 43.13 49.06 13.77%
12/31/97 206 Eastman Ko 60.56 63.69 5.16%
12/31/97 276 Philip Mor 45.25 43.88 -3.04%
Rec'd # Security In At Value Change
12/31/97 291 Union Carb 12494.81 14222.63 $1727.81
12/31/97 289 Int'l Pape 12463.13 14179.06 $1715.94
12/31/97 206 Eastman Ko 12475.88 13119.63 $643.75
12/31/97 276 Philip Mor 12489.00 12109.50 -$379.50
CASH $415.96
TOTAL $54046.77
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