Tuesday, July 13, 1999

Those "Ugly" 12% Returns


There are dozens of stock screens that promise returns of 18%, 24%, 30%, and more per year, and some of them may actually work for some investors. Thus, we are faced with the ever-increasing foolish desire to achieve those returns. Well, if a Fool can safely achieve 24% per year, why not 124%? And how does that make me feel when all I can achieve is a lowly, ugly 12% per year?

Well, let's take two of my favorite Fools, Tom the Tortoise and Harry the Hare. Tom started investing at age 25 with $5,000. Each and every year for the next 30 years Tom invested an additional amount equal to 5% more than the previous year. Thus in year two he invested an additional $5250, $5512 the next year and so forth. Tom, having a hard shell surrounding his cranium, let little in the way of flashy investment ideas get inside his brain. As a result, Tom was always late (remember he is a Tortoise) to the cocktail party and always stood in the corner ashamed of his pitiful 12% investment returns.

Harry, being Tom's buddy, also started his investments at age 25 with $5,000 and similarly bumped up his investment 5% per year. Harry, being a fast kinda guy was very busy with his job and family (making lots of additional hares). As a result, Harry spent virtually no time on his investment portfolio. Instead, for the next 10 years, Harry asked Tom what he should do and followed Tom's advice. After 10 years Tom and Harry where at a barbecue and Harry said: "Tom, I am sick and tired of these measly 12% returns. I can do better. I've been reading all kinds of great stuff on the Internet about achieving 124% a year." Tom felt terrible as if he had misguided Harry.

Harry, being that fast kinda guy put half of his nest egg (approximately $50,000) into Offshore Rabbit Farms (ORF). Needless to say, Harry lost all $50,000 when the expected rise in Hasenpfeffer dining did not materialize. Harry was a little angry and major-league chagrined. He went back to Tom and apologized and said he wouldn't berate Tom's 12% returns ever again.

Ten years passed and Harry's portfolio grew to $320,000. Harry, now age 45 is suffering from short-term and long-term CRS ("can't remember stuff") and has forgotten his experience 10 years ago. Harry, being a fast Internet kinda guy who has forgotten his history proceeds to repeat history. He invests half ($160,000) in Automated Computer Kinetics (ACT). Harry loses it all. Then, feeling really bad, he turns over portfolio management to his wife, Harriet. Harriet, being a little brighter than Harry, follows Tom's lead for the next 15 years and achieves 12% each and every year.

Both Tom and Harry retired from Corporate Animal, Inc. at age 55. Harry retired with a portfolio of $800,000 (equal to an annuity of approximately $68,000 per year). Harry moved to a nice house in the 'burbs and bought a motor home planning to see all the national parks. Tom retired with a portfolio of $2,000,000 (or a $171,000 annual annuity). Tom, being a water kinda guy, bought an island and a condo in Colorado with lifetime skiing lessons.

A few months after retirement, Harry sent a post card to Tom that said "I still hate those lousy, ugly 12% returns but I have to admit that they work." A month later (postal service to the South Pacific is still a little slow), Harry got a return post card from Tom. It said: "I know."

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