Rule Breaker Portfolio

Rule Breaker Portfolio
The Long Term
Adjust your returns for taxes, Fools

By David Gardner

ALEXANDRIA, VA (Oct. 6, 1999) -- Well, "interest rate concerns" have been cast aside, if you read the official market news today, and (according to Bloomberg), investors "turned upbeat about third-quarter earnings."

Investors.

That's you.

So tell me... did you feel that, today? Was there any particular moment in your day -- perhaps a sudden breeze, or a certain look from someone, or a pause over lunch -- in which you suddenly sat up and thought:

"Hey! I'm suddenly upbeat about third-quarter earnings!"

No? If not, you're like most of us. Most of us are not very accurately described in these market recaps. Those who write them feel some need (perhaps it's a human need, a love of reason, call it what you will) to explain the daily moves of the market. Thank God I don't have to do this. I couldn't. Not with a straight face, anyway.

The Rule Breaker portfolio rung up another 4%+ gain today, which isn't a bad day. In fact, it's almost half of what one might get in a typical year, when you look at the market's historic annualized returns.

Of course, the way this market is going, we could just as easily give up 5 percentage points tomorrow.

We don't celebrate short-term gains in Fooldom.

So what gains do one celebrate? Easy. Long-term ones. Ah, but what's the long term? Well, in human stock-market investing terms, we traditionally use five-year returns as the Foolish minimum to assess your long-term performance. So if you've been investing for two years and you think you're great or you think you're not great -- don't think either of these things. Don't think about your performance for at least three more years. Over any short-term period, great investors can look bad, and poor investors can look superb.

Consequently, we remain unimpressed by some hot fund's great 1998, just as you don't see us taking out a national advertising campaign trumpeting:

The Rule Breaker Portfolio was up 199% in 1998!!!


...which we were. But that was one year. 1998. If we built an advertising campaign around that, I'd encourage you to boycott our ads and our site as well. That's just not Foolish.

These things said, we are proud of our five-year returns, which as of market close today look like this:

Rule Breaker portfolio:   +1322.45%
Standard & Poor's 500:     +203.39%
92% of all mutual funds: less than the S&P 500
                          (many markedly worse).
Earlier, I asked what gains does one celebrate? And the answer is long-term ones. But there's one other thing we each need to do. We need to adjust for taxes -- adjusting for capital gains. Because in the end it's only what you have left over after ALL expenses in all forms, that counts.

We don't regularly report our tax-adjusted returns here, mainly because there's no good standard that we can apply that works for everyone. AND, we started this portfolio to compete directly with mutual funds' reported returns, since the conventional wisdom continues to say to most people, "Mutual funds, mutual funds, mutual funds."

We have talked the talk and walked the walk from the outset that the Foolish investor can and should invest in stocks directly, and beat the market, instead of invest in mutual funds. So to provide total comparability, we have reported our numbers on a daily, annual, and historical basis -- just as funds do. And we compare our returns to the S&P 500, just as funds do, without tax adjustment, just as funds do. This is the lingua franca of the financial world, and not to be speaking it would mean that we couldn't show our numbers versus the big boys.

Now, we fully encourage you to tax-adjust the big boys, tax-adjust our portfolio, and especially, adjust your own portfolio for taxes. We all should be doing this! (Reason #336 not to be a daytrader. What a nightmare.) For this portfolio, we have never managed it firmly with taxes in mind; had we done so, we would probably have traded even less. (As it is, we trade very infrequently.) In fact, if we had made a point of this, I think we would probably have added money to it each year. You see, the way we run the portfolio, if we have a new stock pick we force ourselves (in the present format) to sell out of something we already hold. In reality, most of us have a salary income stream that would not force the Rule Breaker investor to trade out of existing positions in order to adopt new ones.

But the way we've set things up, it hasn't worked this way heretofore, so even our tax-adjusted numbers (as good as they are) undershoot what we probably would have shown. We are buy-and-holders to the core. We generally only sell our losers.

The point is, if you took out taxes our returns wouldn't be 1300+ percent, but would still be way ahead of the market. In fact, remember that the average mutual fund fully turns over 70% of its assets each year, whereas our BreakerPort turnover is a fraction of that (and compounds out at a tiny fraction). The overall point is that Foolish investing works.

But the second point to underline is that you should take time out to fully adjust your own personal returns for taxes each year, including trying to keep up with what after-tax returns your mutual funds are tossing you. That's not easy, but it is worthwhile. The higher the turnover, in my experience, the lower the chance that you'll truly beat the index fund.

Obviously, for those who have their investments in tax shelters like retirement plans, they have the lovely situation of not having to tax-adjust. In this regard, you can think of the Rule Breaker portfolio as a self-directed IRA account... which is effectively what we're simulating here. This is the reality for many, especially those who have Foolishly taken advantage of Roth IRAs... but if this isn't you, watch out for how often you trade, what you're paying in commissions and (most importantly) what you're paying each year to Uncle Sam. It's what you have left over that really matters.

America Online, Amazon.com, and Excite@Home led the portfolio higher today, with Excite@Home rising on a brokerage initiation ("Buy," said Warburg Dillon & Read). These three stocks have been behind lots of gains for our portfolio, as we continue to position ourselves as investors in the most compelling growth industries, buying the top companies managed by the best people.

It ain't that difficult, is it?

Fool on.

-- David Gardner, October 6, 1999

As always, share any thoughts about tonight's recap in our Rule Breaker Strategies board. And if you are looking into, or for, any new Rule Breaker prospects, the conversation always continues on our Rule Breaker Companies message board.






Rule Breaker Portfolio

10/6/99 Closing Numbers
Ticker Company Dly Pr Chg Price
AMGNAMGEN INC3/16$88.19
AMZNAMAZON.COM4$82.44
AOLAMERICA ONLINE1/2$120.00
ATHMAT HOME CORP CL A1/2$46.56
CATCATERPILLAR INC2$56.56
CHVCHEVRON CORP1/16$87.63
DDDU PONT (EI) DE NEMOURS1/4$65.06
EBAYEBAY INC10 1/2$151.69
GTGOODYEAR TIRE & RUBBER CO1/4$50.56
IOMIOMEGA CORP-3/8$3.44
SBUXSTARBUCKS CORP7/16$24.00
TDFX3DFX INTERACTIVE7/32$8.44

  Day Week Month Year
To Date
Since
8/5/94
Annualized
Rule Breaker 5.25% 7.36% 8.46% 41.67% 1,324.65% 67.14%
S&P 500 1.85% 3.32% 3.33% 7.82% 189.14% 22.79%
S&P 500(DA) 1.85% 3.32% 3.33% 8.40% 203.39% 23.94%
NASDAQ 2.06% 4.40% 4.04% 30.31% 296.74% 30.53%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
8/5/942200AOL0.917$120.0012,984.72%
9/9/972640AMZN3.188$82.442,486.26%
5/17/951960IOM1.280$3.44168.47%
12/16/98580AMGN42.889$88.19105.62%
12/4/98900ATHM28.040$46.5666.06%
2/26/99300EBAY100.527$151.6950.89%
2/23/99300CAT46.964$56.5620.44%
2/23/99180CHV79.169$87.6310.68%
2/20/98260DD58.844$65.0610.57%
2/23/99290GT48.715$50.563.79%
7/2/98470SBUX27.955$24.00-14.15%
1/8/98425TDFX25.667$8.44-67.13%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
8/5/942200AOL$2,017.62$264,000.00$261,982.40
9/9/972640AMZN$8,415.03$217,635.00$209,220.00
12/16/98580AMGN$24,875.50$51,148.75$26,273.25
12/4/98900ATHM$25,236.13$41,906.25$16,670.13
2/26/99300EBAY$30,158.00$45,506.25$15,348.25
5/17/951960IOM$2,509.63$6,737.50$4,227.87
2/23/99300CAT$14,089.25$16,968.75$2,879.50
2/20/98260DD$15,299.44$16,916.25$1,616.81
2/23/99180CHV$14,250.50$15,772.50$1,522.00
2/23/99290GT$14,127.38$14,663.13$535.75
7/2/98470SBUX$13,138.63$11,280.00($1,858.63)
1/8/98425TDFX$10,908.63$3,585.94($7,322.69)
  Cash: $5,954.23  
  Total: $712,074.60  



Note
The Fool Portfolio was launched on August 5, 1994, with $50,000. It was renamed the Rule Breaker Portfolio in October 1998. The investing strategy began with the first investments of the Fool Port and has evolved with time and experience. In July 2001, the portfolio began adding $12,500 each quarter (We missed Jan. 2002, so we added $25,000 in April 2002). We skip a quarter if we have enough uninvested cash or cash available in stocks we would prefer to sell to make new investments. All transactions are shared and explained publicly before being made, and returns are compared in each week's column to the S&P 500 (including dividends where noted) and the Nasdaq composite. For a history of all transactions, please click here.