<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (May 14, 1998) -- Fools know I've been a long-time advocate of the Dow Approaches. After all, my original Motley Fool screen name was MF DowMan!

For many months, though, I've been writing about the need to see the Dow Approaches, especially those concentrated in only four or five stocks, as first steps in building a larger, more diversified portfolio rather than as ends in themselves. The reasons are simply risk management and greater growth potential.

We have another example of why this is crucial in today's 14% drop in Hewlett-Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %> after the company announced an earnings warning. Now before you say it -- I know. Hewlett-Packard isn't a Dow high yielder, but my real point is that any of these large-cap giants can get sliced up substantially overnight. We saw it not too long ago in Cendant <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CD)") else Response.Write("(NYSE: CD)") end if %> and again today.

Now if Hewlett-Packard had been one of your four Dow stocks and 25% of your savings were on the line, your entire portfolio dropped 3.5% today. That's not fatal, of course, but it's nevertheless a pretty substantial one-day drop caused by a single stock. In the case of Cendant's much more compelling fall of 46% overnight, the damage to one's portfolio would have been 11.5%.

If Hewlett-Packard, however, were only one of twenty stocks, let's say, all relatively equally weighted, today's drop would have pulled only 0.7% out of your overall portfolio value. Even the Cendant meltdown would only have cost you 2.3% under these conditions.

On the flip side, though, don't equate this level of diversification with weakened returns. I'm not talking about the conventional Wisdom where one holds a certain percentage in cash, some in bonds, and the rest in stock funds. By surrounding your four or five Dow stocks, however, with other growth-oriented strategies, you not only spread the risk among twenty stocks, but can also increase your long-term returns. So it's not an either/or decision at all, but very much a both/and proposition.

As your portfolio grows, then, Fools, consider moving beyond the Dow Approach to flesh out a more fully diverse portfolio, with greater risk protection and great potential for returns. And with today's deep-discount brokers, annual trading costs are still reasonable if you're investing at least $1,000 in each stock.

For Fools in the Lexington, Kentucky vicinity, I'll be doing a brief workshop and then a book signing this evening at 7:00 at Joseph-Beth Booksellers in Lexington Green. Hope to see you there! Fool on.

Current Dow Order | 1998 Dow Returns

[Robert Sheard is the author of the The Unemotional Investor (Simon & Schuster, 1998) available now at Amazon.com and your local bookseller.]

TODAY'S NUMBERS
Stock  Change   Last 
 -------------------- 
 UK   -   3/16  53.50 
 IP   +   3/4   55.00 
 MO   -   3/4   36.25 
 EK   -  15/16  70.69 
 
 
  
                    Day   Month    Year 
         FOOL-4   -0.42%   3.01%  12.89% 
         DJIA     -0.43%   1.20%  15.98% 
         S&P 500  -0.13%   0.50%  15.14% 
         NASDAQ   -0.04%  -0.16%  18.79% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  289 Int'l Pape    43.13     55.00    27.54% 
  12/31/97  291 Union Carb    42.94     53.50    24.60% 
  12/31/97  206 Eastman Ko    60.56     70.69    16.72% 
  12/31/97  276 Philip Mor    45.25     36.25   -19.89% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  289 Int'l Pape 12463.13  15895.00  $3431.88 
  12/31/97  291 Union Carb 12494.81  15568.50  $3073.69 
  12/31/97  206 Eastman Ko 12475.88  14561.63  $2085.75 
  12/31/97  276 Philip Mor 12489.00  10005.00 -$2484.00 
  
  
                              CASH    $415.96 
                             TOTAL  $56446.09