Reweighting the Fool Four
What should we do with our next $2,000?
by Al Levit
Glendale, CA (July 16, 1998) -- Now that the Cash-King Portfolio is finally fully invested and comfortably ensconced in a four percentage-point lead over the S&P 500 (and by extension, more than 95% of managed equity funds in America), I thought it'd be nice to spend two columns exploring how we'll go about managing our portfolio from here.
Now, I'm well aware that, lately, it looks like we'll have our hands full trying to match the Fool Portfolio's one-year performance in our first decade. Of course, the Fool Portfolio's results will be a tad more volatile than ours, and it should be compensated for that. That said, the motivation for this portfolio -- the Simpleton Portfolio -- outlined by Tom Gardner in July 1995, is really beating the whole world right now. Look at the numbers:
1. The Simpleton Portfolio
7/95 7/98 Purchase Present Total Company Price Price Gain Dell Computer $4.02 $111.00 +2661% America Online $13.28 $117.00 +781% Gap $11.59 $63.50 +448% Cisco Systems $18.42 $95.75 +420% Microsoft $23.91 $117.50 +391% Sun Microsystems $12.69 $49.88 +293% Intel $34.13 $83.38 +144% Texas Instruments $35.47 $62.38 +76% Hewlett-Packard $39.94 $59.75 +50% Silicon Graphics $43.25 $14.00 -68%
Simpleton n/a n/a +519.7% S&P 500 556 1175 +111.3%I'm not sure there is any more compelling defense of buying great businesses, tracking the pure value of earnings through tools like the Flow Ratio rather than the P/E ratio, ignoring short-term stock price volatility, and smiling at the bluster and the hullabaloo on Wall Street. How Foolish.
Now, regardless of any competition between The King and The Fool ("As long as the Fool Port keeps amusing us, we promise not to lop their heads off") in terms of portfolio performance, there's one element about our portfolio that I really do love: Our decision to add $2,000 of new savings every six months. We started with a lump sum of $20,000 in February of this year, and now we've committed to adding $2,000 of new savings to the portfolio every six months. Twenty years from now when we're all tapping into The Fool from space stations around the galaxy, we'll have invested a total of $100,000 into this portfolio.
We hope this sets an example for you and your families and friends, no matter how much or how little money you have. The idea of investing once and then never saving again just doesn't fly with us, yet it's the working model used to scare folks about bear markets. They say: "If you'd bought an index fund at the peak in 1966, you wouldn't have started making money until 1982." Well, it's our hope that no Fool would ever blunder so badly. Methodically adding new savings allows you to participate in the market's gradual ascent (and intermittent descents) at many points along the way. We think it's a very important discipline -- both in personal finance terms and when investing.
But let's look more closely at how we'll manage the Cash-King Portfolio going forward. Yesterday I outlined how we would be accounting for these additional deposits using the share-valuation method. Today, I start with a personal plan for the actual investment process.
As most of you know, the Cash-King Portfolio is made up of two pieces:
1. Between 8 and 12 Cash-King stocks, designed to be held for at least 10 years. We may well add to the positions with new money, be we don't intend to sell them except under extraordinarily adverse circumstances (false accounting, executive fraud, a dramatic turn in the industry. We'll be publishing the 12th Step to C-K Investing, When to Sell a C-K, at some point this summer.)
2. A Foolish Four component, initially representing 25% of the portfolio, which we've put in to help smooth out the portfolio's overall performance.
Originally, we felt that the Foolish Four part of the Portfolio would take almost no time to manage. We would simply buy the four stocks selected by the RP variation, hold them for 18 months and a day, rotate, and start over.
However, we've now hit two turns in the road.
First, as time goes on, we do want to keep the Foolish Four to at least between 20% and 25% of the total portfolio. Currently, the Foolish Four represents 22.75% of the total value of the portfolio, down from 25% at the beginning of the year. If Gap, Pfizer, and Microsoft continue to soar, then the Foolish Four could easily make up less than 20% of the Cash-King portfolio by New Year's Day.
That would hardly create anxiety in the C-K corner of Fool Global HQ, but we would be faced with a puzzle. Were that to happen, would we want to make our February investment of $2,000 into the Fool Four? Should we do that in anticipation now in our August investment? These questions keep us from getting in the last four minutes of a three-hour Sunday nap. You see, they're HAUNTING us.
Here's my opinion.
Whenever the Foolish Four share falls to less than 20% of our entire portfolio, we should commit the next $2,000 toward this high-yield approach. Even as it's in vogue to criticize the Dow model today, remember that it's primarily a defensive approach. It proved a magical hedge against that flat market (1966-1982) mentioned in the bear's scenario above.
So that's that. End of C-K report for the day.
But, no! I said we'd hit TWO turns in the road. What's the second? Well, in the last few months, hundreds of contributors to our Dow Dividend message folders have researched and published a lot about this model and about seasonality. The work is still ongoing, but a general consensus is has formed championing the idea that Foolish Four investments be made in either December or January and then held for two years, to take advantage of long-term capital-gains tax rates. [Ed. Note: Legislation that has been passed by Congress and is now waiting for President Clinton's signature will change the holding term for favorable long-term capital gains treatment from 18 months to 12 months.]
But that's tough for us. Our next $2,000 cash infusion will come on August 3rd. The following one will be on February 3, 1999. So, what should we do if the Foolish Four dips below 20% between now and February 1999? The way I see it, there are two possibilities, each with merit:
1. Don't make any new purchase in August, leaving the $2,000 for a Fool Four investment in December of this year.
2. Don't sweat the Fool Four seasonality too much, and just put the February $2,000 into that group if it's fallen to less than 20% of our overall portfolio. Don't get me started on how to rotate our Fool 4 portfolio from there, though.
I would welcome the input of my fellow Fools -- that's Rob, Phil, Tom, and YOU -- in the Cash-King Strategy Folder (Web). How should we manage the Fool Four component of our portfolio?
Tomorrow, I'll spend some time talking about how we might pick Cash-Kings that aren't in our portfolio today and also about when I think it's proper to buy more shares of the Cash-Kings we already own. Until then....
Stock Change Bid ---------------- AXP + 11/16 115.25 CHV + 3/16 83.13 CSCO + 1/4 95.75 KO - 5/8 87.19 GPS + 3/4 65.75 EK +4 1/2 87.00 XON - 3/16 71.44 GM + 5/16 70.13 INTC - 1/8 84.19 MSFT - 1/8 117.25 PFE +2 118.00 TROW - 11/16 41.56
Day Month Year History C-K +0.51% 6.78% 21.78% 21.78% S&P: +0.78% 4.42% 18.25% 18.25% NASDAQ: +0.30% 5.58% 21.03% 21.03% Cash-King Stocks Rec'd # Security In At Now Change 2/3/98 24 Microsoft 78.27 117.25 49.80% 2/3/98 22 Pfizer 82.30 118.00 43.38% 5/1/98 37 Gap Inc. 51.09 65.75 28.69% 2/27/98 27 Coca-Cola 69.11 87.19 26.16% 2/6/98 56 T. Rowe Pr 33.67 41.56 23.43% 6/23/98 23 Cisco Syst 86.35 95.75 10.89% 5/26/98 18 American E 104.07 115.25 10.75% 2/13/98 22 Intel 84.67 84.19 -0.57% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 63.15 87.00 37.77% 3/12/98 20 Exxon 64.34 71.44 11.04% 3/12/98 15 Chevron 83.34 83.13 -0.26% 3/12/98 17 General Mo 72.41 70.13 -3.15% Cash-King Stocks Rec'd # Security In At Value Change 5/26/98 18 American E 1873.20 2074.50 $201.30 2/3/98 24 Microsoft 1878.45 2814.00 $935.55 2/3/98 22 Pfizer 1810.58 2596.00 $785.42 5/1/98 37 Gap Inc. 1890.33 2432.75 $542.42 2/27/98 27 Coca-Cola 1865.89 2354.06 $488.17 2/6/98 56 T. Rowe Pr 1885.70 2327.50 $441.80 6/23/98 23 Cisco Syst 1985.95 2202.25 $216.30 2/13/98 22 Intel 1862.83 1852.13 -$10.70 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 15 Chevron 1250.14 1246.88 -$3.27 3/12/98 20 Eastman Ko 1262.95 1740.00 $477.05 3/12/98 20 Exxon 1286.70 1428.75 $142.05 3/12/98 17 General Mo 1230.89 1192.13 -$38.77 CASH $94.76 TOTAL $24355.70 *The year for the S&P and Nasdaq will be as of 02/03/98
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