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How to Lose Money with Winning Strategies      

By Moe Chernick ([email protected])

Reseda, CA (June 1, 1999) -- One common mistake of new Workshop investors is that they chase the stock screen that has the best recent results instead of selecting and sticking with a strategy based on the merits of the screen, its long term risk, and how it fits into their overall, long-term investing strategy.

Results for these investors are usually disappointing, as they move in and out of various strategies -- often at the worst possible time.

Let's look at how chasing returns can turn two great mechanical investing strategies into a net loss. Because I am using actual results, I will start this example on November 30th of last year. On November 30th, Investor A (let's call him Alvin) invested $50,000 in a Foolish Four variation. Investor B (Bob) invested the same amount in the RS-IBD Monthly strategy. (In a monthly strategy, the stocks are renewed every month rather than yearly as with the Foolish Four.)

By April 9th, Alvin's $50k was worth $55,200 -- a respectable 10.4% gain. Bob's $50k did much better, however. His portfolio was worth an incredible $111,600, a gain of 123%. (Yep, that RS-IBD was hot!)

Alvin begins to question why he invested in the Foolish Four when he could have been making big bucks in RS-IBD. So he makes the move and switches his money out of the Foolish Four and into RS-IBD.

Fast-forward six weeks. Alvin is having heart palpitations. The RS-IBD Monthly strategy is showing a 14.5% loss since he made the switch. His original $50k investment is now worth only $47,195, a net loss of 5.6%. Alvin is now thinking of putting his money back in the Foolish Four. Why? Because while RS-IBD dropped 14.5%, the Foolish Four went up 11.9% over the same period. If he had stayed in the Foolish Four, his $50k would now be $61,765, a gain of 23.5%.

By changing strategies in midstream, Alvin lost $14,570. Bob, however, is still doing great despite the price drop. At $96,775, his $50,000 is still up an incredible 93.6%.

The above example demonstrates the importance of having a good plan and a long-term perspective. Alvin was focused on short-term results. He took two winning screens and chased his way to losing results. He didn't have a plan, or -- at the least -- he was not carrying out his plan with conviction.

This example also demonstrates why using multiple screens is a good way to get market-beating returns while reducing your volatility. Enter Investor C, Charlene. She also started a $50k portfolio on November 30th. She decided on a mix of 50% value stocks and 50% high-risk growth stocks. To meet that goal, Charlene invested $25k in the Foolish Four and $25k in RS-IBD Monthly.

By April 9th, Charlene's portfolio had climbed to $83,350 -- not as good as Bob's but much better than poor Alvin's. Of course Charlene stuck to her plan, and on May 21st, after RS-IBD's drop, her portfolio was worth $78,550 for a net gain of over 56%. While Charlene's results were not as good as Bob's, she still had tremendous returns and much less volatility. Between April 9th and May 21st, Charlene's portfolio went down by $4,800, compared to Bob's loss of $14,825.

Of course, there's no guarantee that following a plan won't generate losses, too, especially in the short term. But your chances of coming out ahead are far better if you make a plan and stick to it than if you chase the latest, greatest returns.

Fool on!