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For a Workshop newcomer, choosing a screen (or screens) to invest in is probably the most difficult thing to do. In some ways, this is more difficult to do when you have limited funds, as you have to select only one or two screens out of the many choices. Unlike Moe's highly informative Real Money Port, this portfolio only has $10,000 available to invest. This article is a walk-through of my thought process in determining which screens to choose for Y2K.
First, here's a thumbnail sketch of my general goals. I'm in my early thirties, so this money can't be touched (without heavy penalties) for over 20 years. Volatility is not a concern (this is not my only investment, and it has a lot of time to make up any losses). I would like to keep trading costs under 2.5%, preferably much lower. My preference is for screens with a long backtested history and good returns across various start months to ensure that the screen is not just a statistical fluke. Also, the screens that are chosen are ones that I plan to stick with for an extended period of time (at least 10 years, preferably longer). This is to help me avoid creating rationalizations for running off and following the latest "hot" screen.
For now, I'm sticking to the "basic" workshop screens, such as PEG, Spark, and the like. Many of our contributors have developed screens that are derivations of the basic screens, which choose such things as bullets, cherries, movers, freshmen, and overlaps. Although many of these screens might be superb performers over the long haul, there is also a chance that some of them are "overfitting" our available data. Until we get more comprehensive "out-of-sample" data, I'm sticking to the basic screens. Also, the results from the Sum of the Parts article have persuaded me to purchase the top five stocks from any given screen.
Given the ground rules listed above, what are my general constraints with this portfolio? This is an IRA account, so taxes are not a concern. However, I only have $10,000 to work with, which effectively limits me to annual (or possibly semiannual) screens. Otherwise, transaction costs would be much higher than 2.5%.
Currently, my IRA is in the RP4+ strategy (same as the Foolish Four with a double investment in the two highest-ranked stocks). I chose a Dow-based strategy because we had very limited historical information on the available annual trading workshop screens. My goal was to shift over half of my IRA to an annual growth screen this year, assuming that it backtested as a superior screen. As difficult as this may be to believe, the PEG and Spark screens were introduced less than 18 months ago! Backtested history was mainly limited to January start dates. By contrast, Dow-based strategies have a 30-plus-year backtested history, covering quarterly starts. Thanks to the wonderful contributions of the Workshop community, this has all changed. If anything, we now have information overload.
So, which growth screen to use? Looking at the historical returns presented last week, the five-stock annuals are remarkably close. To review: PEG, 28.67%; Spark, 25.32%; Keystone, 28.02%; RS-26, 29.92%. None of the differences among these screens are statistically significant.
My first choice was PEG, which is a growth screen with a value component. I have a small concern about the PEG's inconsistent returns for different start months, but otherwise it seems very solid. However, in the last few weeks, some data from 1969 thru 1985 has been released on the boards courtesy of a huge collaborative effort by many Workshop contributors. This data only covers the Keystone and Relative Strength screens. RS screens did very well in that time period, while Keystone did OK but did not dramatically outperform the S&P 500.
The superior returns of RS over a 30-year period, combined with its simplicity, have persuaded me to make it my first choice for a growth stock screen. So, about $6,000 will go into a five-stock RS-26 screen.
Now, what about the rest? Originally, I wanted to stick with a Dow-based strategy. However, my current Dow-based strategy, the RP4+, has underperformed this year. (With a total return of about 8% since November '98, compared to about 26.5% for the S&P 500, "underperformed" may be charitable.) Also, given the changes in the Dow, are Dow-based strategies still valid?
Many people are dropping Dow strategies, and they might be correct. However, for now I am sticking with it. Given the tremendous bull market we've been having, one would expect a value screen to underperform the indices. Unfortunately, there's no way to know when this run might end. Dividends may not be "in vogue" currently, but over the last 50 years, dividends and inflation have been highly correlated (when inflation is low, so are dividends). If inflation picks up, dividends might grow as well.
However, the main point keeping me in a Dow strategy for now is that, as recently as April, my RP4+ had returns of about 29%, compared to only 14% for the S&P over the same period. Dropping the Dow now would seem like a rationalization for moving to the latest "hot" screen, which is not a good approach. If more data comes in that shows other growth screens with superb 30-plus-year returns, then I might drop my Dow strategy. But for now, 4K will stay in it.
A last note. I also have a Roth IRA. This is currently in an index fund. As it gets more contributions, I will start a growth screen (possibly PEG) in that account. However, I will always leave some money in an index fund to allow for easy comparisons of returns.
So, today I'll be purchasing the top five stocks in RS-26, and four stocks in a Dow-based strategy (yes, I'm still waffling on which one). This is just one person's Y2K port. Yours will likely be much different, depending on your risk tolerance, time frame, goals, tax concerns, etc. But I hope that this walk-through has been helpful to those deciding on their portfolios for next year. I would also recommend reading (or re-reading) Moe's comments on his Real Money Port, and please stop by the Foolish Workshop board if you'd like feedback from our many contributors.
Until next time, Fool on!
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