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The Foolish Four have fared well in all this turmoil, rising proportionally more than the Dow, which is to be expected (well, at least hoped for). But recently we've introduced the idea of a Foolish Five -- a five-stock growth strategy developed in the Workshop area where it's known as the Keystone 100. With all this turmoil and the rise of the Foolish Four, how have these growth stocks fared?
As of Monday, the five-stock Keystone 100 was up 41% for the year, which is right about where it was at the end of February. Amazing. The "bad" news is that the strategy was up 59% on March 13. Let's look at what that would mean for an individual portfolio. Say you started out with $10,000 in January. By March 13 your $10,000 would have grown to $15,900, and one week later it would have dropped $1,800. That's an 11% drop in one week, which is bad enough, but another way to look at it would be to say that 31% of your gains evaporated in one bad week.
The Keystone stocks have recovered some by now, but that's not the point I want to address. The question is, do you have the stomach for growth investing?
Suppose you had decided to take the plunge into growth stocks the last time I wrote about it. In this kind of market you could easily see such a portfolio jump 10% or 20% in one week only to give it all back the next week. Or drop 20% right after you start and it never fully recovers.
Volatility is part of investing. In theory, being willing to accept risk (defined as volatility) is the reason why stocks pay higher returns (in general) than passbook savings accounts. The market's invisible hand works like an auction, constantly adjusting returns according to the laws of supply and demand.
Imagine an investment that guaranteed a 25% return the same way a bank guarantees its CDs. Everyone would rush to invest, right? But with money pouring into that guaranteed investment, you can bet that the folks that agreed to pay 25% would start thinking. Pretty soon the guaranteed rate would fall to 20%, then lower, until the point where the rate was just high enough to attract exactly the amount of money that was needed.
The returns for nonfixed-rate investments are more slippery and apply only to the market as a whole, not to individual stocks, but the same principle applies. Prices, dividends, and returns constantly adjust to provide investors (as a group) with an aggregate return that compensates them just enough to offset their perception of risk, which also changes constantly.
I remember being very puzzled when I first ran across the formula, Risk = Reward. That seemed to be pretty much accepted by investors and academics alike, but to me it seemed obvious that if high risk = high reward, then everyone would go for high risk since that guaranteed high reward. And if high reward were guaranteed, then how could the investment be risky? (This is the kind of thing that one contemplates in Finance 301 before getting with the program.)
The problem, of course, is that the formula never applies to you. It applies to "everyone," but to no one in particular. A high-risk investment for Jane may lose 70% while John's high-risk stock gives him a 300% return. Their average return for taking on high-risk investments may be 185%, but that doesn't do Jane much good.
So, are you a high-risk investor? The more risky, more volatile growth stocks selected by the Keystone 100 are all high-flyers who could fly even higher this year -- or not. The screening method that selects these stocks has a pretty good track record over the last 13 years, but then we've been in a roaring bull market most of that time.
To me it makes sense, especially since this bull market seems to have amazing strength, to invest in a mix of growth and value stocks, and the Keystone 100 strategy is a good mechanical way to do that. If you are interested, the screen is run every Friday afternoon, and the stocks it selects are published at Current Rankings.
If you think you're ready for it, may I suggest first rereading the IPS Funds disclosure statement that we printed a few weeks ago. If you can get through that and feel comfortable with a high-risk strategy, you are probably ready.
Fool on and prosper!
P.S. Get ready for Sunday night by playing Oscar Wildness! You only have until noon on Friday!