[This Rule Maker article, written by former portfolio manager Matt Richey, originally ran in November 2000. Matt's idea of an index plus a few is a message we want to share over and over with our readers. Enjoy.]

I'm currently reading an interesting book, Simplicity Marketing, by Steven M. Cristol and Peter Sealey. The basic premise is that our lives are overly busy, cluttered, and just plain stressful; thus, tomorrow's successful companies must position themselves as the customer's partner in stress relief. This idea that our lives are in desperate need of simplification strikes a deep chord with me. Some of us may even benefit from a simpler way to invest in Rule Makers.

In describing the condition of today's consumer, the authors of Simplicity Marketing quoted Dr. David Kundtz's book, Stopping:

"Most of us in this hurry-up, e-mail world of instant response are feeling the same sense of overload.... Indeed, the primary challenge of successful human life in the postmodern millennial world is the challenge of too much: too much to do; too much to cope with; too much distraction; too much noise; too much demanding our attention; or, for many of us, too many opportunities and too many choices. Too much of everything for the time and energy available."

Add "too many stocks" to that list, as well. Some of us need to examine whether we really have the time to carefully select a full portfolio of individual stocks, as well as re-examine their business positions on a quarterly basis. Part of the advantage of Rule Maker investing is its basic simplicity, but to really stay on top of six or more companies in your portfolio demands that investing be at least a minor hobby for you.

I figure -- at two hours per quarter, for each company, for six companies -- that's 12 hours minimum, or at least an hour a week. What if you have eight, 12, or more companies in your portfolio? Neglecting to follow your companies will likely cost you at some point.

However, who says you have to invest your entire portfolio in six to 20 stocks? Why not just invest in one or two stocks that you follow very closely and that you're very confident in, and then allocate the remainder of your portfolio to an index fund? This was the thinking behind an article I wrote back in April (and which I'll draw on for some of the remainder of this piece), in which I proposed an alternative way to try to beat the market, a way distinguished by simplicity and logic, a way I call the "Index Plus a Few" strategy, hereafter simply IPF.

As the name implies, IPF is a hybrid strategy mixing the best aspects of index funds and individual stocks. On the 13 Steps to Investing Foolishly, it'd probably land around Step 9, somewhere between straight-out index investing and a diversified portfolio of Rule Makers.

IPF is a simple two-pronged portfolio strategy. The first prong stems from our fundamental goal as investors of at least matching the average return of the S&P 500. The easiest way of achieving this goal is to allocate a significant portion of the portfolio -- say, 60-80% -- to Standard & Poor's Depositary Receipts (AMEX: SPY). "Spiders," as they're called, trade just like an individual stock and match the return of the S&P 500.

The second prong, which is aimed at extending our returns beyond the market's average, is to allocate 20-40% of the portfolio to a few -- as in, one or two -- individual companies. The key here is identifying truly great companies, just one or two that you know inside and out, and that have the potential to be market-beating long-term winners.

When you identify a potential winner, you'll want to concentrate your investment study and dig deep to learn as much as possible about the underlying business. You'll want to read the annual report, read the quarterly earnings releases, crunch the quarterly numbers, assess the valuation, listen to the quarterly conference calls, use the company's product/service, read articles and books related to your company, read the quarterly 10-Q and annual 10-K SEC filings (including the footnotes), scour the company website, and read the company's Fool discussion board. Whew! That's a lot, yes, but if business fascinates you, and you love to learn, then this stuff actually should be a lot of fun.

Doing these things will provide you with a thorough understanding of a company's industry attractiveness, its position in the industry, and its business quality. These specific insights on just one or two companies will give your IPF portfolio its market-beating ability. Let me emphasize that you should know these one or two companies so well that you don't have any fear allocating 20-40% of your portfolio assets to these holdings.

An IPF portfolio is actually a low-risk strategy, too. You can't beat the diversification of an index, and your concentrated bets on a few companies are bolstered by deep knowledge. My favorite definition of risk is that risk is not knowing what you're doing. As long as you have a genuinely rock-solid understanding of why your one or two companies are poised for long-term success, then your portfolio isn't any riskier than the market as a whole.

Fool, this strategy is totally contrary to conventional Wall Street Wisdom, but I think allocating a major portion of your portfolio to a few companies that you know exceedingly well is the easiest way to beat the market.

Further, this strategy has many other attractive benefits. First among these is cost efficiency. By owning only two or three holdings -- including the Spiders -- your transaction costs will be minimized. Additionally, the expense ratio on the Spiders is only 0.18%, which translates to a cost of only $18 per year on a $10,000 investment.

Second, the simplicity of this strategy minimizes your time opportunity costs. By focusing your efforts on a few outstanding companies, you'll have more time to get out from behind the derned computer and actually live a little!

Third, the tax advantage of only keeping track of a few holdings is a great burden off your shoulders. Also, unlike a mutual fund, which distributes annual capital gains taxes, Spiders (as well as other index shares) are taxed just like a regular stock, so you control when taxable gains or losses are recognized. Many investors would have no need for an accountant come tax time if they employed a simple portfolio strategy such as this.

Fourth, the IPF strategy is ideal for "capital challenged" investors, such as 20-somethings like myself. Even if you don't have much money, you don't have to worry about transaction costs eating away at your principal with this strategy. At $10 a trade, you could start with as little as $2,000 and keep your transaction costs to around 1%, based on two buys: the Spider shares and one well-researched individual company.

The final advantage of the IPF strategy is that having the S&P 500 as part of your portfolio helps keep you accountable to your benchmark. If, by chance, your individual companies don't outperform the Spiders over a period of three or so years, you might want to give thought to allocating 100% of your funds to the index. Heck, if you can't beat 'em, join 'em. Chances are, though, if you really do your homework and uncover one or two outstanding companies with great management, prospects for global leadership, and a secure business model, they'll be long-term outperformers.

So, if your portfolio more closely resembles a stock collection than a deliberately designed portfolio, and if you're attracted to a simple, efficient, and rigorously logical way to beat the market, then you might want to consider restructuring your portfolio with the IPF in mind.

You also might consider checking out The Motley Fool's online seminar on choosing stocks -- to evaluate those few companies to add to your portfolio in addition to your index fund.

Fool on!