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Author: TMFPixy Big gold star, 5000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 76082  
Subject: Re: Racy and Reasonable?? Date: 12/16/1999 11:35 AM
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Kenoops writes:

<<I'm retired, but not dead, and yes, we would like to retire "in style". Thus, I could not believe the contents of these two "retirement" portfolios.

After first starting off very cautiously by (1) reading Bogle on Mutual Funds, (2) investing in my own O'Shaughnessy Value Port and then (3) following the MI board this past year, the "Racy" and "Reasonable" retirement ports make about as much sense to me as investing 100% in bonds, as they did in the old days.

And limiting each port to four stocks or so and not blending in some growth ports with it (to at least balance out growth and value) just adds insult to injury.

I know that RP4 is a proven port, and beats the S&P by a small margin, as does BSP, but taken just by itself it is much more volatile than the S&P and has larger losses, in its losing years, than many of the supposedly riskier growth ports discussed on the MI board--and decidedly larger losses than the MI blends of several ports (of four or five stocks each).

These are new areas of TMF to me, and I have not done much reading in them, but my initial reaction is one of shock. >>


I gather you believe this approach is too risky. If so, I would welcome a similar analysis over the same time period of 1961 through 1998 for a mechanical approach you prefer using the same constraints as I did. If it shows the same kind of results for less risk, then I'm certain many would appreciate seeing that outcome, to include me.

While I appreciate your concern over the use of just four stocks, you should be aware of how I arrived at their use. Critics of the FF strategy decry its lack of diversity, and accuse it of being a prime example of data mining, the process of examining factors and patterns to establish a correlation by discarding those that don't fit a hypothesis while retaining those that do. Further, they say that the exceptional returns of the FF disappear when adjusted for risk and the costs of income taxes and transactions. Other skeptics caution that increasing use of Dow investment strategies will curtail future exceptional returns. These criticisms have been fully explored and largely refuted in various articles in the Fool Four forum on The Motley Fool website. Details may be found by exploring the May 1999 Fool archives available at http://www.fool.com/DDow/1999/DDow1999.htm.

Suffice it to say I believe these criticisms miss their mark by a wide margin. The FF has been tested and retested with monthly data spanning a 37-year period. Its superlative returns over time simply cannot be denied. The FF average annual total return for the 38 years ending in 1998 is 19.6% versus 12.3% for the S&P 500, hardly the "small margin" you allege. Volatility as measured by standard deviation is 19.3% versus 15.9% for the S&P 500. In that sense, then, the FF is "risky." But on a risk-adjusted basis as measured by their respective Sharpe ratios for the period 1961 through 1998, the FF is definitely superior at 0.79 versus 0.46 for the S&P 500. In that same period, the S&P 500 showed a loss eight times, the worst being -26.5% in one year. The FF suffered five setbacks, with the worst return coming in at -22.9% for the year.

It seems, then, that the FF suffers an upward as opposed to a downward volatility. Is that not a risk worth taking? I certainly think so. The proof is in the pudding, and as far as I'm concerned the proof is there. Thus, unlike some critics, I have a tough time believing the FF is nothing but an anomaly of favorable statistics that's destined to fail.


Regards..Pixy
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