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We've often promoted the Foolish Four as a kind of autopilot strategy. "Crush the market in 15 minutes a year!" It's not working out that way. I don't mean that one needs to do more work than that. I suspect that the folks who are happiest with the strategy are those who buy it and then ignore their portfolio for 12 months. Still, things do change, and, the pace of change is accelerating.
We are in the midst of re-evaluating our strategy in response to changes in the nature of the Dow, and it is becoming apparent to me that Foolish Four investors probably should be keeping an eye, not necessarily on their stocks, but on the discussions that goes on here and on the message boards about how we cope with change and ways to improve Foolish Four investing. If you haven't been doing that, you might want to click on archives over there on the right and at least skim through the last five or six articles.
But our main topic today is renewing your stocks. As we have said throughout the year, it is OK to start the strategy any time, but plan to renew it in late December. Let's look at that advice carefully.
First, when saying you could start "any time," we suggested that investors plan to hold their first batch of stocks through the end of the first year (that's now for a lot of people) and on to the end of 2000. (Wow. There it is again.) The reason for suggesting that people starting midyear hold for more than a year has been clearly demonstrated this year -- short-term returns are very volatile.
As holders of Sears and Goodyear have experienced, in the short term, Foolish Four stocks can go down -- way down. This is exactly how the strategy has always worked -- our monthly database showed that the volatility was higher when the holding period was shorter.
But we didn't advise people starting in midyear to simply hold for a full year -- we said hold until December 2000. When we compare portfolios starting in different months we see a clear pattern. The returns for portfolios starting the first trading day in January are highest, followed by December 1, followed by November 1, then February 1 and March 1 -- the returns fall steadily from the peak in January to a trough in June/July.
Right -- I said that the highest returns were for January portfolios and I am suggesting that late December is the optimum time to trade. I've fudged a bit for three reasons. First, the shape of the average monthly returns curve suggests that the peak is in December, not January. Also, other studies based on portfolios renewing on the last day of each month actually have higher average returns for December. Finally, although I don't know how long this has been going on, we've noticed lately that stocks jump like cheerleaders on speed the first few days of the year.
If you want to see a demonstration of the difference that this can make, take a look at the returns below. Compare the returns for the Year to Date with the return since December 24. That extra 2% would increase your portfolio's total return by 50% over a 25-year investing lifetime.
So the trick is to buy your stocks before the January feeding frenzy begins. Or, wait a week or two until things settle down. For at least the last two years, IRA investors who like to make their annual deposits at the beginning of the year have been able to get prices in mid-January that are about the same as those at the end of December.
IRA investors can pull another advantage. They don't have to worry about holding their stocks for a year and a day to qualify for long-term capital gains rates. They can actually sell their stocks during the feeding frenzy each year and then wait a few days before buying their new ones. Nice trick -- IF the feeding frenzy thing keeps happening, which is anyone's guess.
Those who are not using an IRA for their Foolish Four stocks can use another trick to grab an extra percent or two. Buy your new stocks in late December using your account's margin loan capability instead of the proceeds from the sale of your old stocks. (Talk to your broker first and be sure you understand how margin works.) Then sell the old stocks the first of January and repay the margin loan. It will cost you a few days worth of interest, but at today's rates, that is likely to be much less than the gain.
OK, enough tricks. Given that mid- to late-December is my best guess for the optimal time to renew, and you started after that, it makes sense to attempt to shift your renewal time to December at some point. But how?
One fell swoop is my suggestion. We investigated holding periods longer than 12 months and the results show that the annualized returns were lower than for a two-year hold -- but not by much. The seasonal effect was much stronger. So, at least as far as the past is concerned, the most statistically advantageous thing to do is hold your first portfolio for 12 to 23 months, renewing whenever you hit your second December.
Monday we will talk some more about alternatives to our classic, Dow-based Foolish Four.
Fool on and prosper!