<THE FOOLISH FOUR>

Looking at Worse Cases
by Ann Coleman
(TMF AnnC)

Alexandria, VA. (November 2, 1998) -- In the grand spirit of Foolishly challenging accepted wisdom, today I am challenging a bit of accepted Sheard Wisdom. It was often stated in this area that the Foolish Four tended to do better in bad and mediocre markets and that the strategy might offer some protection against a market decline.

I don't buy it.

Below is a chart of all the bad and mediocre years since 1961. ("Bad" is defined as losing money; "mediocre" is defined an average total return of less than 10%.) It's true, sometimes our strategies do do better. Sometimes, though, they lose even more money than the market, and generally, one would be hard-pressed to consider the returns "good."

There is one very conspicuous exception. In the 1973-74 recession (the worst investing period since the '30s), the Foolish Four had a great run -- up over 30% for the two year period while the Dow as a whole dropped 25%. That's a huge discrepancy. The question is, does it illustrate some kind of protective mechanism at work, or is it just a random event?

In other years where the Dow was negative, that pattern is not repeated consistently or even that frequently. In 4 of the 9 money-losing years, both the Foolish Four and the RP variation also lost money -- and in three of those four years, the Foolish Four lost MORE money than the Dow as a whole.

The numbers don't make a strong case for the Protection in Down Markets Theory as far as I am concerned. Once could argue that the absolute returns are better, and they are, with the Foolish Four and RP returning an average of 2 and 3 percent for these years, compared to the Dow's 5% average loss. Hey, anytime you outperform the market by seven percentage points, you are doing great. Still, this is a good example of how an average can be misleading if you don't examine the numbers closely.

A generalized conclusion, that the Foolish Four does well in bad markets because the average returns are higher, may be literally true, but it leads to false expectations. That's really my only problem with it. I don't think that anyone should be complacently thinking that the Foolish Four protects them from bad market conditions.

Hear that, everyone? Don't expect the Foolish Four to do well in bad markets. It might beat the market, but even if it does, it's rather unlikely to beat your savings account, and there is a reasonable possibility that it will do worse than the market. You have to be prepared for that. That's way it works.

Wednesday, we look at the upside. Bad and Mediocre years (Returns < 10%) 13 years, 1961-1997 

 
           Dow 30     DD10      Fool4       RP4 
 1962     -7.25%      0.15%     0.37%     12.89% 
 1966    -15.08%    -17.90%   -17.65%    -22.89% 
 1969     -9.27%    -12.77%    -6.66%     -8.41% 
 1970      5.04%      4.73%    -5.92%    -14.20% 
 1971      9.10%      5.71%    19.74%     19.74% 
 1973    -10.86%      3.89%    25.74%     17.28% 
 1974    -15.64%      1.04%     5.25%     20.00% 
 1977    -12.58%      1.17%     5.32%     -2.96% 
 1978      2.53%      2.44%     9.89%      9.89% 
 1981     -3.30%      4.87%    -4.63%      9.66% 
 1984     -0.12%      7.45%    10.24%     10.30% 
 1990     -9.14%    -10.01%   -17.61%    -17.61% 
 1994      3.73%       2.43     4.72%      7.59% 
  
 Mean     -4.83%     -0.52%      2.22%     3.18% 
 Difference      4.31       7.05       8.01 
 SD        8.19%      7.87%     12.88%    14.70%
For a complete chart (good bad and indifferent years) see Friday's column. Fool on and prosper!

Current Dow Order | 1998 Dow Returns

11/02/98 Close
Stock  Change   Last 
 -------------------- 
 UK   +1  1/2   40.00 
 IP   -1  1/4   45.19 
 MO   +   7/8   52.00 
 EK   +   3/8   77.88 
 
 
                    Day   Month    Year 
         FOOL-4   +0.71%   0.71%  11.70% 
         DJIA     +1.33%   1.33%  10.09% 
         S&P 500  +1.18%   1.18%  14.55% 
         NASDAQ   +1.67%   1.67%  14.68% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  206 Eastman Ko    60.56     77.88    28.59% 
  12/31/97  276 Philip Mor    45.25     52.00    14.92% 
  12/31/97  289 Int'l Pape    43.13     45.19     4.78% 
  12/31/97  291 Union Carb    42.94     40.00    -6.84% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  206 Eastman Ko 12475.88  16042.25  $3566.38 
  12/31/97  276 Philip Mor 12489.00  14352.00  $1863.00 
  12/31/97  289 Int'l Pape 12463.13  13059.19   $596.06 
  12/31/97  291 Union Carb 12494.81  11640.00  -$854.81 
  
  
                              CASH    $754.73 
                             TOTAL  $55848.17