So What Did You Expect?
Go ahead, pick a number.

By Elan Caspi

[Editor's Note: Ann Coleman is on vacation through August 26.]

EL CERRITO, CA (August 16, 1999) -- Pick a number from 1 to 10. Now write it down. C'mon, write it down. I want you to be committed to your number as we go through a little exercise, so that you're not tempted to cheat. So you wrote it down? Good.

Americans are inundated with statistics all the time. We watch the stock market, we keep track of batting averages and home run records, we have Nielsen ratings for TV and Gallup polls to rate our president's performance. We live off a constant diet of numbers, and we are conditioned to accept them as gospel much more than we should.

The problem is that statistics are used not only to tell us what has been, but to predict the future. That fine distinction between statistics as a snapshot and statistics as a crystal ball misleads many of us.

Some of the most frequent questions we get on the Dow Investing message board are about expectations: "I bought the Foolish Four last month and it's down 5%, what's wrong?" Last year it was: "The Foolish Four hasn't beaten the Dow index for two years in a row. Why isn't it working?" Now we hear: "I bought the Foolish Four last year and got a 15% return. Didn't you say I would make 22%?"

I hope this exercise will help you adjust your expectations in the face of all those statistics you've seen. Take a look at the following table. Look down the left column to the number you picked. Then look at the Dow and Foolish Four returns next to that number.

      Dow 30  Foolish Four  
1     14.64%     22.08%
2     44.24%     68.71%
3    -15.68%     20.00%
4     19.59%     56.88%
5    -15.10%    -22.91%
6      4.82%    -14.64%
7      3.73%      7.60%
8     11.34%     17.36%
9     22.32%     19.49%
10    -8.91%     -7.90%
Madame Rue -- you know, that gypsy with the gold-capped tooth -- has looked into her crystal ball and whispered that, based on your choice, the Dow and the Foolish Four will end the year with That Exact Number.

Well, of course, that isn't true. But all the numbers in that table were taken from real past annual returns of the Dow and Foolish Four. Whichever row you picked is just as likely to be the return for this year or next year as any other row in the table. So forget statistics, average returns and CAGRs for a moment, and keep your mind open to the right expectations. The Foolish Four will not return 22% every year.

Now let's deal with another kind of mis-expectation regarding the Foolish Four. This time I won't ask you to pick a number. Instead, there's a quiz.

Question: If we look at the monthly returns in a year when the total return of the Foolish Four was, let's say, 24%, will the monthly returns:

a) Be close to 2% every month

b) Be down or flat early in the year and then zoom ahead later in the year

c) Be strong in the first half of the year and then settle into a rut

d) Any of the above or something else entirely

The correct answer, my friends, is D. We just can't predict what the Foolish Four will do from one month to the next. In fact, the closer you look at the returns of any stock, index, or portfolio -- look every month, look every week, every day like I do, or every five minutes like day traders do -- the closer you look, the more the price changes will seem like a random walk.

In fact, they look so random that some very smart people in academia have developed the Efficient Market Theory and concluded that no one can beat the market averages consistently. But that's a story for another day. In the mean time, here are the monthly Foolish Four returns for the last two years. See how widely they fluctuate from one month to the next, and learn to expect it.
Month            1997     1998  
January        -0.48%     1.85%
February        1.72%     3.23%
March          -5.51%     1.58%
April          -0.20%     2.62%
May             5.14%    -2.81%
June            1.73%     1.94%
July            3.72%     4.97%
August          1.13%   -11.12%
September       9.68%     9.41%
October         2.90%     0.06%
November        5.48%     2.91%
December        1.57%    -1.36%

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08/16/99 Close
Stock  Change   Last
CAT  +   1/16  62.31
JPM  +   5/16  134.06
MMM  +   5/16  98.00
IP   -   3/4   53.25

                  Day    Month   Year   History
      FOOL-4   -0.15%   6.71%  31.15%  33.10%
        DJIA     +0.67%   3.68%  21.10%  20.62%
        S&P 500  +0.23%   0.15%   8.84%   9.10%
        NASDAQ   +0.28%   0.26%  20.64%  22.30%

    Rec'd   #  Security     In At       Now    Change

 12/24/98   24 Caterpillar   43.08     62.31    44.64%
 12/24/98   14 3M            73.57     98.00    33.21%
 12/24/98    9 JP Morgan    105.51    134.06    27.06%
 12/24/98   22 Int'l Paper   43.55     53.25    22.27%

    Rec'd   #  Security     In At     Value    Change

 12/24/98   24 Caterpillar 1034.00   1495.50   $461.50
 12/24/98   14 3M          1030.00   1372.00   $342.00
 12/24/98    9 JP Morgan    949.62   1206.56   $256.94
 12/24/98   22 Int'l Paper  958.12   1171.50   $213.38

              Dividends Received      $49.99
                             Cash     $28.26
                            TOTAL   $5323.81