Foolish Four Portfolio
By
Do You Believe in the Foolish Four?
Clap, if you do
RESTON, VA (Sept. 23, 1999) -- I received an inquiring e-mail today from a reader who found the Cumulative Returns chart that we introduced on Tuesday to be just too good to be true. He didn't believe me! I wasn't insulted in the least.
One of my favorite quotes regarding investments is that old saw that says "If it seems too good to be true, it probably is." You should question returns that promise you millions with very little work. We aren't promising you millions next year -- or ever, for that matter -- but the chart that shows a $10,000 investment in the Foolish Four stocks turning into $5.5 million in 35 years is very true. However, some explanations may be in order.
First, no one knew about the Foolish Four 35 years ago, so it would not have been possible to follow the strategy from that point. Also, commissions were higher then, and very few if any options existed for tax-free investing, so no one could have started 35 years ago and duplicated those returns. But that wasn't the point of the exercise.
We do have the data that lets us calculate what the Foolish Four stocks would have been on the first trading day of each year back to 1961. And we know how those stocks performed subsequently. So that's what our Cumulative Returns chart shows. If you had somehow selected those stocks each year, and if investing conditions 35 years ago had been similar to the conditions now regarding commissions and tax-free accounts, you would have duplicated those returns.
But that wasn't even what the reader was questioning. He just couldn't believe how fast the returns snowballed. That, my friend, is the magic of compounding. You make money and the money you make makes money. As long as you aren't taking money out of the account, your returns compound at what appears to be an ever-increasing rate.
What threw this particular reader was that the total for the Foolish Four went from $27,000 ($10,000 invested from 1994 to 1998) to $76,000 ($10,000 invested from 1989-1998) by investing for 10 years instead of five. But it went from $3 million to $5.5 million when you went from 30 years to 35 years. The idea of the account increasing by $2.5 million in just five years seemed, flat out, too good to be true.
Actually, though, going from $27,000 to $76,000 is a 181% increase over five years, but going from $3 million to $5.5 million is only an 83% increase over the same time span. No doubt about it, millions are more impressive than thousands. Even though the amount of money is far greater, the percentage increase is actually smaller.
Questioning everything is very Foolish. I love it when readers really dig into the numbers. So here's how we got those impressive cumulative returns, and how you can duplicate the process at home with nothing fancier than a four-function calculator.
Start with the annual return numbers (from the Performance History page). Take the first year's return for the Foolish Four and convert it from a percentage to a decimal and add 1. Then multiply that times $10,000 (e.g., if the return was 20.50%, you multiply by 1.2050. If the return was
-8.41%, you multiply by 0.9159). That will give you the result of an investment that grew 20.5% ($10,000 turned into $12,050) or lost 8.41% ($10,000 dropped to $9,159) in one year. That's not hard to follow.
Then multiply THAT amount by the next year's return (converted to a decimal, plus 1) and then the next and so on. Each year you are taking the results of the previous year's investment and increasing it by the amount that those stocks went up (or down). You can watch it grow year by year right before your eyes.
If you want to verify the actual yearly increases, check out the Foolish Four History page. For each year, it lists each Foolish Four stock and its annual return. Those returns can be independently verified in any number of ways.
My correspondent asked why, if those numbers were true, would anyone invest anywhere else. (Let's hope they do -- this wouldn't work if everyone followed it!) Fortunately, lots of people think that they can do better with hot Internet stocks, or they don't have the patience to just follow a boring recipe year after year, or they just don't believe it so they invest in an index fund, or they have a bad year and drop out.
There are reasons to question whether the returns in the future will be as good as they were in the past. There are no guarantees. Since first publicized, the Foolish Four has continued to work more or less as expected, but if it becomes too popular or we suffer a global economic meltdown or whatever.... The past doesn't guarantee the future.
I just think it's a more reliable guide than most other things.
Note for regular readers: We were all hoping Barbara Bayer would be back here today. You may have missed her this week in her usual Tuesday slot. We traded places, but unfortunately, even though power was restored to her neighborhood yesterday, the phone lines are still out and things are far from normal.
No, she doesn't telecommute from North Carolina, where conditions are far worse. (As bad as things are, I suspect she would take downed trees over rivers full of rotting farm animals any day. My heart, and wallet, go out to all those folks.) Still, Barb is battling the aftermath of Hurricane Floyd, who sideswiped Woodstock, New York, with a batch of tornadoes last week. She'll be back next Tuesday hissing and scratching. Watch out, Mother Nature -- Barb isn't happy.
Fool on and prosper!