Tuesday, December 09, 1997
The Daily Dow
by Robert Sheard
LEXINGTON, KY. (Dec. 9, 1997) -- As we approach the end of 1997, many readers are concerned about the best approach to adjusting their portfolios, so let me walk through an example of the process today using completely fictional numbers.
Let's suppose Tim Onceayear began 1996 with a Foolish Four portfolio worth $10,000. He bought the following four positions:
A $4,000 B $2,000 C $2,000 D $2,000
At the end of the year, his portfolio had gained 18% and his four positions (plus his cash from dividends) were worth:
A $4,500 B $2,100 C $2,600 D $2,400 Cash $200 Total $11,800
Using that new portfolio value, Tim calculates the average position for next year this way:
$11,800 ------------ = $2,360 5
Since the Foolish Four over-weights the #2 stock from the Beating the Dow rankings, you must treat it as two separate positions. Each of the other three stocks is accorded a single-position weighting. Therefore, you have five positions rather than four, even though you're only purchasing four actual stocks. So for next year, Tim wants $2,360 in each position.
The rankings and the ideal weightings for the next year's four are:
B 40% ($4,720) E 20% ($2,360) F 20% ($2,360) A 20% ($2,360)
The next step is to sell the two stocks from last year that are no longer on his list for the next year (C and D). That raises $5,000. (I'm ignoring commissions for the sake of round numbers.)
The next step is to compare the two stocks Tim is holding for another year and adjust their values to match his new scheme. B is only worth $2,100 right now, so Tim has to buy $2,620 more of B to bring its weighting up to speed (since it's the stock to be weighted as two positions for the next year).
A is worth $4,500 now, but for the second year it's no longer going to be doubled. Tim must sell $2,140 of his position in A to bring it in line for the new year.
So let's see how much cash is left. Tim had $200 in cash at the end of the year and then sold C and D, bringing his cash to $5,200. He bought more of B, lowering his cash to $2,580. Then he sold some of A, raising his cash total to $4,720.
The final step is to buy the two new stocks, E and F, at $2,360 each. And the cash on hand now ($4,720) is exactly enough to do that.
Here's a summary of Tim's transactions, a total of six trades:
Event Cash Balance Cash balance at the end of year one $200 Sold C and D $5,200 Bought more B $2,580 Sold some A $4,720 Bought E and F $0
One important warning to keep in mind is that the adjustments to stocks you're holding over from one year to the next do not absolutely have to be performed if the values involved are small. If the adjustment required is only for a sale or purchase of a few shares, just live with the discrepancy and don't bother incurring another commission or the added tax paperwork for such a small trade.
Another major question we've received numerous times of late is what the effect will be of the new 18-month tax holding period if it's applied to the Dow Dividend Approaches. Unfortunately, we can't yet give you any specific answers based on our own research. Despite my best efforts to keep our researcher chained to his books and computer, he insists that he be allowed to eat and sleep occasionally and won't have any long-term historical results for us until January.
My own feeling, however, is that the holding period isn't likely to have a major effect. About half of the Dow Dividend Approach stocks will remain in a 12-month-cycle portfolio for a second and even a third year. Those positions, of course, will receive the lower tax rate associated with the 18-month holding period. Unless the 18-month holding period produces significantly higher pre-tax returns than the traditional one-year method, I don't suspect the difference will be all that great. But we should reserve final judgment until we've seen the research results.
One final note today. Sears (NYSE: S) slipped into a tie for the tenth and final slot of the high-yield list with DuPont (NYSE: DD). But as Sears has a lower stock price, it joins the group (at least temporarily) and DuPont gets the boot. Fool on!
Stock Change Last -------------------- T + 5/16 58.06 GM - 1/2 63.31 CHV - 3/4 78.63 MMM -1 7/16 94.56
Day Month Year FOOL-4 -0.35% 1.41% 27.86% DJIA -0.75% 2.90% 24.83% S&P 500 -0.67% 2.13% 31.73% NASDAQ -1.88% 1.25% 25.52% Rec'd # Security In At Now Change 1/2/97 479 AT&T 41.75 58.06 39.07% 1/2/97 153 Chevron 65.00 78.63 20.96% 1/2/97 120 3M 83.00 94.56 13.93% 1/2/97 179 Gen. Motor 55.75 63.31 13.57% Rec'd # Security In At Value Change 1/2/97 479 AT&T 19998.25 27811.94 $7813.69 1/2/97 153 Chevron 9945.00 12029.63 $2084.63 1/2/97 120 3M 9960.00 11347.50 $1387.50 1/2/97 179 Gen. Motor 9979.25 11332.94 $1353.69 CASH $1409.35 TOTAL $63931.35