We're almost six months into 2001 in the Rule Maker Portfolio. From a numbers point of view, it's been another difficult year. As of last week the Rule Maker is down 18.5% for the year, compared to about a 2.4% decline for the S&P 500.
Since its inception on January 6, 1998 the Rule Maker is down 14.74% compared to a gain of 16.69% for the S&P 500. We've been soundly beaten over the last three years by a basic market index fund.
In this article I'd like to address a few of the lessons I've taken away from my experience as a Rule Maker investor up to this point. Much of this is basic, but the lessons, in my opinion, aren't all as black and white as they might seem.
The power of indexing
In a world where people are driven to exceed the average to succeed, the simple index fund shined a bright light on par performance. Successful investing doesn't have to involve crushing the S&P 500 over a five-year period. Rather, it involves investing early enough to pace it over the next 20, 30, or 40 years. Isn't it amazing that less than 20 years ago, many investors regarded index funds as a kind of nod to mediocrity, an easy bronze medal for anyone unwilling to reach for the gold? Nonsense.
Anyone expecting the kind of double-digit returns the market index fund delivered over the last decade to continue is probably in for a disappointing stretch. The market isn't a magic carpet ride. It's a reflection of corporate profits, interest rates, and inflation. It will ebb and flow, but over time it's likely to march upward. Many smart investors will participate in this upward climb while minimizing the frictional costs of trading and taxes by investing in a simple index fund.
As I've learned more about investing, it's become clear to me how difficult it is to assemble a portfolio of stocks capable of beating the S&P 500, particularly if the portfolio is risk-adjusted. I'm not a big fan of beta, which measures risk in terms of a stock's price volatility rather than long-term business success, but in the real world few investors are comfortable seeing their portfolio down 25%, 30%, or more in a year -- nor should they be. The average investor shouldn't be invested in stocks with this kind of downside, in my opinion.
Indeed, the lack of downside protection based on the prices we paid for a few of the stocks in our portfolio has been one of the chief liabilities of the Rule Maker approach, one I think we've moved to remedy this year. This is a long way of saying there's no shame to index investing. On the contrary, provided you keep expectations in check with the forces of financial gravity, indexing in a total market portfolio remains perhaps the soundest long-term investing vehicle available.
There's nothing wrong with getting help
Changing the oil in your car isn't hard, but not everyone has the time to do it. Some don't know how. Others could learn, but don't want to risk spilling oil in the driveway. The same is true with investing. Stock picking is tough. It requires time, stamina, insight, specialized skills, and patience. The same is true for retirement planning, or picking the right insurance policy.
There's nothing wrong with getting help from a financial advisor, or even using a full-service broker if it makes you more comfortable. Hopefully the revolution in personal investing that occurred over the last five years has given folks better information and access to a kit of tools they can use to make better decisions.
You don't have to use these tools as a club to beat the investment professional in your life. Rather, if you choose to use a finance professional, you can use what you've learned to pick the best one, or make sure they're on the right track. For example, do they have an approach that focuses on a long-term strategy, one that's based on solid financial analysis? Are fees reasonable relative to performance? Does the manager have a consistent approach or change horses every time he exhausts the one he's riding? If you're investing in a mutual fund, how do the results stack up against a benchmark portfolio like the S&P 500, and are the results presented in a way that sheds light on the portfolio's real performance? Does the manager seek to minimize churn and therefore capital gains taxes, or clean out the woodshed at your expense every October?
These skills -- being able to ask the basic questions -- are just as important to the average investor, perhaps much more so, than an understanding of competitive advantage or valuation. You don't have to be a doctor to get quality health care, and you don't have to be Warren Buffett to be a smart investor.
Time is on our side
With this said, I'm very comfortable with the most of the stocks in our portfolio and I believe we're positioned to do well over the coming years. We have a solid group of companies, some of which have built focused franchises, well-protected by competitive advantages we expect to last. I'd put Johnson & Johnson (NYSE: JNJ), Pfizer (NYSE: PFE), Schering-Plough (NYSE: SGP), American Express (NYSE: AXP), T. Rowe Price (Nasdaq: TROW), Intel (Nasdaq: INTC), and Microsoft (Nasdaq: MSFT) in this category. With the exception of Schering-Plough, these companies were purchased at reasonable prices, and I expect the strength of the franchise each has created to grow, even though companies such as Intel and Microsoft won't shine as brightly as they once did.
The heart of this strategy is to find companies that have already planted a stake in the ground, and to pay a reasonable price to participate in their long-term growth. In 20 years, I expect American Express will still have the premier brand name in the charge and credit card industry, and that it will be using this brand name to grow its number of cards in force well above the 55 million mark, and to grow its financial services business into a titan. American Express doesn't have to crush the S&P 500 to pay off as a Rule Maker investment. We're looking for a couple points better than average from these stalwarts. It won't be easy, but these companies have a shot at beating par.
Richard McCaffery, who's still listening to the same Bruce Springsteen records his sister loaned him in high school, doesn't own any stocks mentioned in this story. The Fool is investors writing for investors.