Rule Breaker Portfolio

[In March 2003, we stopped running a real-money portfolio using the Rule Breaker strategy, because our current stock-picking content competes with it and we were soon to unveil new content plans. The Rule Breaker strategy lives on in our articles and investing. We are editing all Rule Breaker information pages to reflect the change, but it may be a while until that's done. You can check out our reasoning here and our last words on the portfolio's stocks here.]

Rule Breaker Information and Principles
Principle 1

By David Gardner
updated March 20, 2001

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Rule Breaker Principles

For those who are familiar with our 1999 book, Rule Breakers, Rule Makers, please note that the Rule Breaker criteria I lay out there are not to be confused with our portfolio principles. Those criteria define a Rule Breaker; these principles are simply our guide to managing our Rule Breaker portfolio. You can find the six criteria in on our "Strategy in Brief" page.

This page unveils the first of five official principles for this portfolio. Each of these principles serves as an overt statement of our methods and approach as we invest our own real money right here before you. In many ways, of course, we lay out our methods and approach frequently in our column. But heretofore, we had never laid out an explicit description of the Rule Breaker portfolio's mission and its "truths," the truths we may hold to be self-evident but nevertheless need to make explicit! So without further ado, here is the first principle:

We consciously take on lots of risk, believing that for experienced and Foolish investors, high risk will lead to high reward.

The Rule Breaker portfolio does not shy from risk -- quite the opposite, in fact. We consciously take on risk in the belief that smart high risk will lead to smart-looking high returns.

For this reason, copy this portfolio at your own risk. Of all the portfolios at The Motley Fool, this is the most aggressive, the most suitable for those who can afford to lose lots of money -- and many Rule Breaker investments will lose lots of money -- in pursuit of lots of money. Mimic any aspect of this portfolio at your own risk, because we're taking lots of risk with it.

How do we measure risk? We don't really; it's only intuitive. We have little interest in the traditional measures of risk used mostly by the Wise -- things like "beta" that purport to measure risk based on the volatility of a stock or a portfolio. A better measure of risk is the inevitability of a business. The more certain the business future, the lower the risk. We buy up-and-coming businesses whose industries have not become established yet, so that's one evident example of conscious risk. That's OK -- the smaller the acorn, the larger the oak. (We hope!)

We also take risk in our portfolio allocations. At various points in this portfolio's history, one or two stocks have represented huge slices (30%+) of the overall pie. This has been used as a criticism of the portfolio, the idea being that:

  1. we got lucky with one good stock in the first place, explaining our outperformance,
  2. and
  3. we're being irresponsibly risky in allowing such stocks to occupy as much of our holdings as they do.

Answering these, we have never put more than 10% of our portfolio into any single holding. The only way a given stock begins to look overweighted is because it appreciates faster than the rest of the portfolio. Why did that happen in the first place? Ask yourself. Our own answer is that we found a good investment, and we are loath to start selling off portions of it in order to fund what will most likely be lousier investments. That's poor pinochle. Warren Buffett, the self-made multibillionaire who is the richest investor in the world, works in a similar way. Coca-Cola (NYSE: KO) has at various points constituted upwards of 30% of the investment portfolio at Berkshire Hathaway (NYSE: BRK.A), the company of which Buffett is chairman. Crazy, eh? To some, we suppose. Another word we might choose instead is "Foolish."

Finally, if you want to beat the market as a private, little-guy investor, the way to do it IS through your best one or two stocks. Those who buy and hold a single great company for a decade or more will almost always outperform the market in their investing. This remains one of the great secrets -- a secret that will remain hidden by the institutions that simply cannot and will not do this. Note again, if you will, the example of the greatest market outperformer of all: Warren Buffett.

From time to time we have balanced the portfolio by selling off a portion of a big winner, but we generally do that much later than most people expect and only when we believe that the money will be equally or better invested in some new selection.

There you have the first of our five principles: An explicit statement that we are taking on risk consciously in the belief (demonstrated effectively so far) that greater risk will lead to greater reward. This approach is not for everybody -- indeed, it is not for most. That's why we offer other portfolios here at The Motley Fool. For many investors, it may be enough to choose to investigate just one or two stocks out of this portfolio as they look to round out their own portfolios.

Finally, each of our five portfolio principles is not an immutable piece of sculpture. We purposefully offer them here in flexible form in order to gauge and garner your reaction. We would love to hear your thoughts about the principle above (and each one), particularly from those who enjoy engaging in the thinking that underlies what we're doing here. If you have appreciated the explicit statement, let us know. If you see some way to improve on it, please let us know. If it's not clear, let us know about that, too! We're here for ya! In fact, without you, we wouldn't be here. That's at the core of Foolishness.

Next: Rule Breaker Principle 2 »