Foolish Four Portfolio
Trial by Fire
Foolish Four investors show their metal

By Ann Coleman (TMF AnnC)

RESTON, VA (Nov. 1, 1999) -- Last week was certainly a trial by fire for Foolish Four investors. The announced switch in the stocks that make up the Dow Jones Industrial Average, which took place officially today, affected many investors who bought their Foolish Four stocks recently. Indeed, at least one of the dropped stocks has been on the Foolish Four list each day for most of this year.

Despite some legitimate fears that being removed from the index would cause those stocks to tank due to strong selling from index funds, trusts, and other institutional investors who follow the Dow, there seems to have been relatively little fallout from the change. Today, when the Dow was down 0.9% overall, the four exiting stocks lost over 2.5% on average. Goodyear Tire (NYSE: GT) was hardest hit. It slid over 4.5%, probably due to a recent downgrade from Standard and Poor's. The new Dow stocks rose a fraction of a percentage point -- 0.2%. Not great, but hardly a blood bath or a bonus for either side.

Concern that these changes had somehow invalidated the Foolish Four strategy, due to the lower or nonexistent dividends paid by three of the four new stocks, put our message board through a rough week, hence the headline. A trial by fire has two connotations: One usually thinks of witches and such, especially around this time of year, but it also implies metallurgy where ores are purified by fire. I have to say that the folks who post regularly on our Dow Investing/Foolish 4 message board have been through this fire and come out 24 karat gold.

(Ha! You thought that headline was a terribly embarrassing misspelling, didn't you, my literate readers? But NOOOOOO, not this time. Close that e-mail window!)

Our message board posters have been showing their sterling mettle by helping to calm fears and engaging in some very intelligent speculation about the effect these changes will have on our strategy going forward.

The question that concerns me most right now is: Just how different is the Dow of today from the Dow that we used for our backtest? I've been staring at a spreadsheet for much of the weekend, and the answer is not yet clear, but it is something we will be looking into very carefully.

One suggestion from the board that I believe has a great deal of merit is to evaluate a combined Foolish Four/Beating the S&P strategy. While we don't have the data to backtest the BSP strategy as extensively as we have tested the Dow, we will be testing such a combination going back at least 13 years. Certainly for anyone who is concerned that the Dow now offers fewer high-yield choices, the Beating the S&P list is a viable alternative.

For right now, though, as those solid gold folks on the message board have been saying, there is really no reason to panic, no reason to sell the stocks that were dropped, and no reason to assume that the strategy will no longer "work."

Not that I can blame those who bought Sears (NYSE: S) and/or Goodyear near their highs for feeling a bit betrayed. They've watched them plummet to new lows only to be kicked off the Dow. It's one thing to calmly think: I'm in this for the long term, and short-term results don't matter. It's another to watch it happen to your very own money. It's probably very cold comfort to see that every stock in the model portfolio is beating the Dow and the S&P. I'm not sure how I would feel if it were me, but I know that being told to wait a couple of years wouldn't exactly make my heart sing.

One of the reasons we don't recommend renewing your portfolio more frequently than once a year is because the database shows that shorter holding periods dramatically increase the volatility of the returns. The average returns aren't all that bad, but the volatility goes through the roof. In English this means that it's quite normal for the Foolish Four stocks to drop soon after they are bought -- and it's also quite normal for them to zoom up and drop back. We've seen all of that this year, and I know that many people are very uncomfortable with it.

Some of you used the Dow switch as an excuse to get out of these stocks that are making you uncomfortable. Well, that's your prerogative -- absolutely. Nobody has to sign an oath in blood that they will hold their Foolish Four stocks for a whole year. But it is an emotional decision. In a few years you might be thinking that it was the best decision you could have made, or not.

What bothers me about such a course of action is that following your "gut" this way, over the long term, is almost a sure recipe for disaster. Some people have great guts for investing -- psychic guts, you might say. But most don't. If you can't stand watching your stocks drop and if you don't have psychic investing guts (and if you do, what are you doing here?), I do have this advice for you: Stick to an index fund or maybe a Rule Maker portfolio. You will be much happier, will sleep better, and will probably make more money than by following your "instincts."

Tomorrow: Barb's out of town, but I will have a list of some of those great posts from our message boards that I have been talking about -- including a bit of advice from the original Motley Fool himself, Shakespeare.

Fool on and prosper!

Today's Stock Lists | 1999 Dow Returns

Read More Foolish Four Reports

Top Dow Stocks
( RP Order )


1. Philip Morris
2. * General Motors
3. * Caterpillar
4. * Eastman Kodak
5. * DuPont
6. International Paper
7. Exxon
8. AT&T
9. JP Morgan
10. SBC Communications

NOTE: Today's Foolish Four stock selections are marked with an asterisk.

Foolish Four Portfolio

11/1/99 Closing Numbers
Ticker Company Dly Pr Chg Price
IPINTL PAPER-1 9/16$51.06
JPMMORGAN (JP)3/8$131.25

  Day Week Month Year
To Date
Foolish Four -1.22% -1.22% -1.22% 24.43% 26.28% 31.29%
S&P 500(DA) -.65% -.65% -.65% 10.74% 10.80% 12.71%
NASDAQ .04% .04% .04% 35.34% 36.60% 43.90%
DJIA (DA) -.76% -.76% -.76% 17.37% 17.54% 20.75%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg

Trade Date # Shares Ticker Cost Value LT $ Val Ch
  Cash: $119.51  
  Total: $5,051.14  

• S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.
• DJIA (DA) = dividend adjusted. Dividends have been added to the total return of the DJIA.

The Foolish Four Portfolio was launched on December 24, 1998, with $4,000. Additional cash is never added, all transactions are discussed and explained publicly before being made, and returns are compared daily to the S&P 500 and the Dow. (Dividends are included in the yearly, historic and annualized returns.) Stocks are chosen once per year using a formula based on dividend yield and price. See The Foolish Four Explained for details.