RULE MAKER PORTFOLIO
Building a Unified Fool Portfolio -- Part 1 of 2

By Zeke Ashton (TMF Centaur)

ALEXANDRIA, VA (January 7, 2000) -- Welcome back to the Rule Maker. For my first column in this new year, I'd like to take a step back from our everyday focus on Rule Maker companies and try to take a big picture view of investing. The topic I'd like to try to tackle is the question of how Rule Maker investing fits in with the many other ideas and philosophical camps that are represented within The Motley Fool.

It's a question that I hear quite often, and I think it's important for Fools to realize that Rule Makers and Rule Breakers (and all the other strategies presented on this site) are ways of thinking about investments. These strategies are not, however, mutually exclusive schools of thought. For clarity in presenting different philosophies of investing, the online Fool Portfolios are very pure to the investing style being discussed.

For example, in the Rule Maker portfolio we generally want to use this space to concentrate on the advantages to the investor that our particular approach has to offer. But this doesn't mean that we recommend that you consider our particular strategy to the exclusion of all others. In my own portfolio I use the Rule Maker philosophy extensively, but I also allocate some portion of my investment funds to Rule Breakers, mechanical strategies, and stocks that I have discovered by using the Foolish 8 spreadsheet.

Each of the tools and philosophies offered here at the Fool have their uses, and they can be combined in ways to create a portfolio perfectly customized to each person's personality, risk profile, interests, and time horizon. This article will be about how a Foolish investor can combine the elements of Foolish investing to create a "Unified Fool Portfolio" of the best ideas Fooldom has to offer, with the Rule Maker philosophy as the foundation.

As a disclaimer, there is no ideal portfolio for everybody, and I will only be presenting my ideas and examples to stimulate your own thinking about how you can combine Rule Making investing with the many other offerings that you can find here at the Fool.

This is a fairly big topic, so I'd like to break it into two parts:

1) An overview of the various investing philosophies offered here at the Fool, and how Rule Maker investing compares to these other ideas in terms of risk, reward, and effort.

2) Some ideas about how to combine Rule Maker investing with the various other Foolish philosophies to create a diversified Foolish portfolio.

Let's start with number one. In the table below, I've listed the various Foolish investing philosophies, with some very general risk, reward, and time/effort characteristics. Please note that the risk and reward characteristics are comparative to other investments in the common stock universe. In other words, ALL stocks are risky over the short and intermediate term (3 years or less), and therefore a Fool should only allocate long-term savings to these strategies. These approaches are not ranked in terms of expected return, but rather in the amount of time, effort, and general financial knowledge required in the pursuit of each strategy.

STRATEGY                 RISK           REWARD      TIME/EFFORT
Index Investing           Low              Mid              Low
Mechanical Investing   Varies           Varies              Low
Rule Maker            Low/Mid         Mid/High              Mid
Rule Breaker             High   High/Very High         Mid/High
Foolish 8                High   High/Very High   High/Very High

*Value Investing          Mid         Mid/High        Very High

* I have included our value investing philosophy (as represented by our Boring Portfolio) as separate to the other items on the list, simply because I'm not quite sure where it fits. I suspect that it requires the most time, effort, and detailed financial knowledge, so I will keep it as the last item. We'll come back to this point when we get into the details below.

Next, let's take these strategies one by one.

Index Investing

Let's start at the bottom of the Foolish evolutionary chain with index investing. This is for all of those Fools out there that are pretty much fed up with paying high fees and capital gains taxes for underperformance from their mutual funds. Additionally, index investing is the ideal solution for Fools who don't have the time or interest to do their own stock research. By dollar cost averaging into index products, investors stand a very good chance of actually outperforming those indexes over time with virtually no effort whatsoever. Discipline is the only ingredient required.

For most people, index investing means using an S&P 500 index fund, such as those offered by Vanguard, T. Rowe Price, and most other large mutual fund families. The fees are rock bottom and capital gains taxes are minimal for these funds. However, you aren't limited to an S&P 500 index mutual fund. If you'd rather, you can set up an online discount brokerage account and put your money in the S&P 500 Depositary Receipts (AMEX: SPY), also known as "Spiders." This is an investment trust that is run just like an index mutual fund, except that you can buy and sell Spiders just like you would a stock. Whether you go with Spiders or an index fund, you will simply be buying small portions of all 500 companies in the S&P 500 index, weighted by market capitalization.

For those of you who'd like to go beyond the blue chips, there's also the Nasdaq 100 Trust (AMEX: QQQ), which is an index composed of the 100 largest tech-savvy growth companies on the Nasdaq exchange. Like the Spider, you can buy and sell shares just like you would a regular stock. The QQQs are likely to be a bit more volatile than the Spiders, but also are likely to offer higher growth over the next decade than the S&P. By combining the Spiders with the QQQs, and adjusting the percentage in each to suit your risk tolerance, you are likely to outperform the vast majority of the mutual funds out there. For example, a moderate risk index portfolio might consist of 75% Spiders and 25% QQQs. More aggressive investors can crank up the weighting of the QQQs to your taste.

In short, index investing offers investors good performance for a very small investment in time and effort, with no actual research in individual stocks involved.

Mechanical Investing

The next move up the chain is mechanical investing. These are strategies that determine which stocks to buy and sell based upon historically backtested returns. Mechanical investing requires that a Fool spend some time reviewing the historical performance and the risk profile of various strategies, and then commit to those strategies through thick and thin. Because mechanical strategies dictate that the portfolios are turned over at various intervals, they are not optimal for the taxed portion of a portfolio due to the capital gains taxes generated. For Fools who manage their own retirement portfolio, mechanical strategies such as the Foolish Four have historically beaten the S&P 500 by a very wide margin.

The Motley Fool offers two different areas for the mechanically inclined. The Foolish Four and its kindred Beating the S&P are strategies that select large companies that are financially sound and pay a high dividend. The idea is that these are companies that typically have been beaten down in price and which are likely to rebound. These high dividend yielding strategies have been particularly impressive in reducing downside risk. If you are new to mechanical investing, you should definitely start with one of these strategies. Head on over to the Foolish Four portfolio if you are interested in this flavor of mechanical investing.

For very aggressive investors who are looking for high octane results accompanied by substantial risk, I recommend checking out the Foolish Workshop. You'll find some strategies there that have produced eye-popping historical returns over a 10 or 12 year period. The historical performance is, of course, no guarantee of future results (sound lawyerly enough for ya?).

Mechanical strategies are great for people who want to reduce their decision-making to an upfront investment of time to choose a strategy, and then to commit to that strategy for a specific period of time. (These strategies do require a rock solid commitment to the strategy.) In that sense, mechanical investing requires more time than index investing, but it doesn't involve any financial or business analysis. It bears repeating that due to the required turnover, mechanical strategies are best for tax-advantaged portfolios.

Mechanical strategies generally involve choosing a very limited number of stocks, most commonly four or five. To further diversify, a Fool can combine index investing with mechanical investing. For example, you might want to allocate 75% of your portfolio to index investing, and 25% to a mechanical investing strategy.

The next step up the Foolish investment ladder is your favorite strategy, the Rule Makers. Unfortunately, I'm out of space today, so I'll continue on Monday with Part 2.

Finally, here's Rob to tell you about a correction to his column from last night:

Oak here... Last night, I got LinuxOne's website address wrong. It's www.linuxone.net, not .com. (Well, I said the site's appearance had changed, but apparently for the better, not the worse. They even cleaned up those meta-tags to something sane.) Good thing the article was about doing your own research and being skeptical about what other people tell you, or this wouldn't have qualified as irony. The story has been corrected in the RM Archives.

Have a Foolish weekend, everyone!

- Zeke Ashton


 




Rule Maker Portfolio

1/7/00 Closing Numbers
Ticker Company Dly Pr Chg Price
AXPAMER EXPRESS3/16$152.44
CSCOCISCO SYSTEMS7/8$105.88
GPSGAP INC1/8$46.56
INTCINTEL CORP1/4$82.00
KOCOCA-COLA CO3/4$60.75
MSFTMICROSOFT CORP7/16$111.44
PFEPFIZER, INC5/16$34.63
SGPSCHERING-PLOUGH1/16$48.00
TROWT.ROWE PRICE ASSOC-1/4$34.75
YHOOYAHOO INC39 1/16$407.25

  Day Week Month Year
To Date
Since
2/2/98
Annualized
Rule Maker 4.53% -1.86% -1.86% -1.86% 70.95% 32.02%
S&P 500 2.71% -1.89% -1.89% -1.89% 47.05% 22.11%
S&P 500(DA) 2.71% -1.89% -1.89% -1.89% 48.82% 22.87%
S&P 500(DCA) n/a n/a n/a n/a 30.50% 14.79%
NASDAQ 4.17% -4.59% -4.59% -4.59% 139.76% 57.31%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg
2/17/9916YHOO126.309$407.25222.42%
6/23/9875CSCO32.865$105.88222.15%
2/3/9859MSFT49.352$111.44125.80%
5/1/9882GPS22.708$46.56105.05%
2/13/9865INTC53.762$82.0052.52%
5/26/9818AXP104.067$152.4446.48%
2/3/9866PFE27.433$34.6326.22%
2/3/9856TROW33.673$34.753.20%
8/21/9844SGP47.993$48.000.01%
2/27/9827KO69.107$60.75-12.09%

Trade Date # Shares Ticker Cost Value LT $ Val Ch
6/23/9875CSCO$2,464.86$7,940.63$5,475.77
2/17/9916YHOO$2,020.95$6,516.00$4,495.05
2/3/9859MSFT$2,911.79$6,574.81$3,663.02
5/1/9882GPS$1,862.06$3,818.13$1,956.07
2/13/9865INTC$3,494.54$5,330.00$1,835.46
5/26/9818AXP$1,873.20$2,743.88$870.68
2/3/9866PFE$1,810.58$2,285.25$474.68
2/3/9856TROW$1,885.70$1,946.00$60.30
8/21/9844SGP$2,111.70$2,112.00$0.30
2/27/9827KO$1,865.89$1,640.25($225.64)
  Cash: $6,103.82  
  Total: $47,010.75  


Notes
The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.