RULE MAKER PORTFOLIO
Step 1: The Rule Maker Philosophy

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11 Rule Maker Steps

By Tom Gardner

Small cheer and great welcome make a merry feast.
-- The Comedy of Errors, Shakespeare

Welcome and good morning, afternoon, and evening to you, Fool. You've stumble-clicked into an 11-step explanation of the Rule Maker approach to investing in the stock market. The curtains are now opening, the overhead lights are dimming, a shaft of red light darts across the stage, and here enters The Fool. Listen in.

Pleasure to be here. I have a short tale to share.

In July of 1995, after suffering through another brief, handsome television advertisement from a big financial firm - one of the many which suggest that you, the individual, don't have the time, expertise, or discipline to manage your own money - I decided to string together a portfolio of ten stocks online which I believed could be held as a group for ten years and expected to generate excellent returns.

This idea directly conflicted with the colorful advertisement. The voice-over from the nice man on TV was saying "You can't do this. Don't try." But then this ten-stock, ten-year portfolio suggests that you can. Further, this proposal implies that if you know where to look, your stocks might provide you a 9 ¾-year break from doing anything more than reviewing the performance of your companies each quarter. Gone are the worries about your savings money every day, week, or hour.

Can it be that simple?

The Simpleton Portfolio was presented to The Motley Fool Online in July, 1995. Again, it was designed to hold ten stocks for ten years and, thus, to dramatically curtail the commission, tax, and opportunity costs of investing. With deep-discount brokers offering trades for $10 (some even go as low as $7, and they may be headed lower), a Fool could buy the ten stocks for a total fee of $100. An investor in this sort of approach could start with between $5,000 and $10,000, and meet the Foolish aim of holding commissions below 2% ($100/$5000 = 2%). In fact, commissions per year would run far less than that since an investor would pay them today and then not again for another ten years. Not bad.

There's another cost to investing, too, which you don't hear much about - capital-gains taxes. Here, too, buying and holding provides a steep reward relative to other options. In traditional money management at a brokerage firm or through mutual funds, active trading hits individuals with taxes on profits every year. In direct contradiction, buying and holding companies for ten years deflects tax charges for the entire decade, allowing one's savings to grow without yearly hurdles to o'erleap. And, heck, some of the stocks might be worth holding for 25, 50, or 150 years.

Finally, pursuing long-term ownership of businesses, rather than short-term trading of stock paper, cuts the opportunity costs of investing. A Fool can spend weekdays at work aggregating more funds for her account while weekends might bring trout-fishing in Wyoming, or riding hot-air balloons across North America, or watching television -- whatever her fancy.

So, with these in mind - and a faint memory of Manhattan's message to America ("You're not as smart as we are. You can't do this.") - The Simpleton Portfolio was published in Fooldom's haunt on America Online in July, 1995. What follows is the performance of this portfolio during the first 3 years of its 10-year run. These returns do NOT include cash dividends.

1. The Simpleton Portfolio

                7/7/95   6/9/00
Purchase Present Total Company Price Price Gain
Dell Computer $1.00 $45.06 +4389% America Online $1.66 $54.75 +3198% Sun Micro. $3.17 $89.94 +2735% Cisco Systems $3.07 $64.38 +1997% Texas Inst. $8.58 $83.75 +876% Intel $17.02 $127.06 +647% Gap Inc. $5.00 $33.06 +561% Microsoft $11.95 $68.81 +476% Hewlett-Pack. $29.89 $128.00 +328% SGI $43.25 $8.69 -80% TOTAL N/A N/A +1513% S&P 500 556 1457 +162%


As you peruse the numbers, Fool, consider the following:

  1. Without a single trade in 59 months, the Simpleton Portfolio is 1,351% ahead of the S&P 500. During that time, between 80-90% of all managed mutual funds have lost to the market.

  2. $10,000 invested in this portfolio would be worth $161,300 today. This compares to $26,200 for index fund investors (which disregards the taxable distributions that index funds deal out each year).

  3. Hooowww-ooooooo! The portfolio has one dog: Silicon Graphics, down 80%.

  4. Even though technology cannot be classified as a single industry, this portfolio is too much weighted in growth-technology businesses. Gap Inc. is the only company not considered a tech company.

How Were the Stocks Selected?

How were these stocks selected, and how might a Fool find ones like them today? It is that question which our 11 Steps to Investing in Rule Maker Stocks will address. And the mission of our new Rule Maker portfolio (launched January, 1998) will be to teach you how to build a diversified portfolio of strong businesses for the long haul. You can expect to read a good deal about consumer companies that you're already familiar with, about those with huge cash savings that haven't borrowed much money, about businesses that have superior operational management, and about those which have been in the public markets for at least a decade.

Before charging forward into Step 2, though, you should know that we don't recommend that you blindly follow any investment approach -- ours, or anyone's but your own. There are certainly controversial points made in this collection, and you'll have to pick and choose what of our Foolishness makes sense to you and what doesn't. In other words, your critical faculties and that Thinking Cap are as crucial here as anywhere.

And, lookie here, there's some important evidence to support that advice right here at the end of Step 1. In May of 1997, responding to calls for another list of ten great companies and in an effort to spotlight Rule Maker companies in a variety of industries, I pulled together a second portfolio... again promising not to trade out of the positions for ten years. Coming up with a name for it was tough, but I labeled it The Money-Heavy Portfolio (it sounded like a villain in a James Bond movie, so I stuck with it). Like Bond, the portfolio is winning, and winning with style. Three years after the launch it's more than doubling the S&P's return.

2. The Money-Heavy Portfolio

               5/29/97   6/9/00
Purchase Present Total
Company Price Price Gain

Cisco Systems $7.42 $64.38 +768% Dell Computer $6.90 $45.06 +553% Gap Inc. $10.03 $33.06 +230% Intel $40.83 $127.06 +211% Microsoft $31.47 $68.81 +119% Johnson & John. $56.61 $86.13 +52% Pioneer HB* $22.73 $27.58 +21% Coca-Cola $65.56 $52.31 -20% Gilette $42.37 $33.38 -21% Oxford Health $65.13 $21.56 -67%
TOTAL N/A N/A +185%
S&P 500 556 1457 +73%
*Pioneer Hi-Bred was acquired by DuPont
on 10/7/99 for 0.5643 DD shares per
each share of PHB

    As you peruse the numbers, consider the following:

  1. The Money-Heavy is leading the major market index by 112%. $10,000 invested in the Money-Heavy would be worth $28,500 today while the same money in the S&P 500 index fund would be worth $17,300 (which disregards the taxable distributions that index funds deal out each year).

  2. Howwww-ooooo! This portfolio also has one real dog, Oxford Health (read: "Stealth") Plans, the HMO which missed estimates and showed (gasp) unexpected accounting irregularities.

  3. The portfolio is much more balanced than its predecessor. It features companies in the industries of technology, health, consumer non-durables (Coke, Gillette, Gap), and even biotechnology. That said, the price of diversification has been lower returns thus far, compared to the tech-dominated Simpleton.

The MoneyHeavy Portfolio has outperformed during a strong market performance, and I'm quite confident in the principles that gird the portfolio and have good feelings about its performance relative to the market through to May, 2007. But you are forearmed, having been forewarned that we don't think you should blindly follow anyone's investment counsel -- be they broker, uncle, media celebrity, or Fool.

Now, let's work through the specifics of what a Rule Maker Portfolio is, how to build one, and what to expect from such a portfolio. Would that we had gotten much of this simple information in high school or college... ah, but, better late than never.

Step 2: Mastering Your Personal Finances »