The Foolish Four is a homegrown version of the Beating the Dow strategy proposed in 1990 by Michael O'Higgins and is a close relative of the "Dogs of the Dow" strategy. The Foolish Four strategy is a mechanical stock-picking system that selects four stocks from the 30 companies that comprise the Dow Jones Industrial Average. The stocks are selected based on low price and high dividend yield.
The Foolish Four portfolio launched as a real-money portfolio on December 23, 1998. Prior to that we had followed a paper portfolio for several years. In 1999, a number of questions about the statistical validity of the strategy were raised by academic researchers and by our own community. The debate that ensued spurred us to perform the most extensive historical test of the Dow-dividend strategies ever undertaken, as far as we know.
The results were not encouraging. The original test, on which Beating the Dow and our first version of the Foolish Four was based, covered a time period that turned out to be a very, very good one for low-priced, high-yielding Dow stocks. Returns for these stocks in the '70s, '80s, and early '90s were phenomenal, almost unbelievable. Pervious and subsequent periods did not show the same kind of outperformance. We concluded that, at best, the Foolish Four might be useful as a large cap value strategy in a diversified portfolio. Therefore, in January 2001, the Foolish Four strategy became one of six strategies in the Workshop Portfolio.
What went wrong
In retrospect, we did some things right and some things wrong. Right: We continued to expand our backtesting, which eventually overturned our original premise, and we announced our findings as soon as we were sure we had the right answers. Wrong: We could have done what we did right more quickly, and we could have listened earlier and more carefully to the critics.
Where to start? We learned a whole lot more than we ever thought we would need to know about statistics. We learned that open debate is the best way to get to the truth, even if the process is long and difficult. We learned, once again, that "if it seems too good to be true, it probably is."
We haven't given up on the idea of mechanical investing. The lessons learned with the Foolish Four are still being put to use by the Foolish Workshop community.
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