<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (March 27, 1998) -- It's no secret that mutual funds take it on the chin in a lot of the writings here in the Motley Fool, and we believe with good reason. But let me talk about accountability going both directions today.

Am I completely dead-set against all mutual funds? Of course not. Even though more than 80% of actively managed stock funds lost to the Standard & Poor's 500 over the last decade, and more than 90% lost to the index over the last five years, that still leaves a number of fine funds that managed to beat the index even after expenses.

As much as I come down hard on funds, I still believe the concept of a mutual fund is a great idea. A bunch of investors who don't wish to, or don't believe they can, choose their own stocks pool their investments and pay a professional manager a fee to make all the decisions for them. Believe it or not, I don't even object to the management fees of most funds.

I object to front-end loads and 12b-1 fees, but a straight fee to the manager to cover reporting costs, trading costs, custodial fees, and the manager's salary is reasonable. It's no different in my mind to pay a mutual fund 1.5% than it is to pay your broker 1.5% a year in trading costs. (With flat-fee commissions, though, that percentage at your brokerage firm gets smaller as one's stock portfolio gets larger.)

So if you can find a top-flight diversified fund that beats the S&P 500 consistently, even after the management fee is accounted for, hang on to it; it's a rarity. But before you think I've gone soft on mutual funds, realize that there's another higher standard out there to beat besides the simple index fund.

Even buying the very conservative High Yield 10 Dow Approach would have generated annualized returns of 15% for nearly the last four decades. And even after taking 1.5% a year off the top for commissions, that comes out to 13.5% a year. The S&P 500 index over the same stretch returned between 11% and 12% over that period. (You know, that benchmark that funds keep losing to.)

In other words, when measuring a fund, don't just measure it against the S&P 500, but take into account the easiest of all stock portfolios you can duplicate for a very low cost -- the Dow Approach. If your fund can still stack up over the long haul, by all means stay with it as long as the manager remains in place and the fund doesn't get so large that the management style shifts. But it's a pretty high bar for any fund to jump over. The ones that do so regularly are maybe a couple in each hundred.

So despite what it seems, I don't hate funds. I think they should be wonderful investment tools. The fact remains, though, that far too many of them -- nay, the vast majority of them -- nowhere near live up to their marketing hype. Just as with any stock, you should scrutinize the details of any fund and compare it to the historical returns of the Dow Approach as well as the S&P 500.

Go Kentucky!

Current Dow Order | 1998 Dow Returns

[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 --- 48.88 IP - 1/4 48.56 MO - 1/8 42.50 EK + 1/2 63.81

Day Month Year FOOL-4 -0.01% 1.86% 7.10% DJIA -0.57% 2.93% 11.23% S&P 500 -0.49% 4.39% 12.88% NASDAQ -0.27% 3.00% 16.13% 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 48.56 12.61% 12/31/97 206 Eastman Ko 60.56 63.81 5.37% 12/31/97 276 Philip Mor 45.25 42.50 -6.08% 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 14034.56 $1571.44 12/31/97 206 Eastman Ko 12475.88 13145.38 $669.50 12/31/97 276 Philip Mor 12489.00 11730.00 -$759.00 CASH $415.96 TOTAL $53548.52