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I'd like to pick a couple of nits with Zeke's table in this evening's Rule Maker column.

http://www.fool.com/portfolios/rulemaker/2000/rulemaker000107.htm
   STRATEGY           RISK     REWARD          TIME/EFFORT
Index Investing Low Mid Low
Mechanical Investing Varies Varies Low
Rule Maker Low/Mid Mid/High Mid
Rule Breaker High High/Very High Mid/High
Foolish 8 High High/Very High High/Very High

*Value Investing Mid Mid/High Very High
---

Nit 1 (minor): I think Time/Effort for Mechanical Investing should be Varies, as I know people who spend lots of time pursuing those strategies.

Nit 2 (major): Under Value Investing the Risk factor should be listed as Low. The whole point of "value" investing is to find companies selling significantly below their actual value.

-Rubic
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Nit 2 (major): Under Value Investing the Risk factor should be listed as Low. The whole point of "value" investing is to find companies selling significantly below their actual value.

Aah... but could there be an unforseen reason why they're selling at such a bargain? Perhaps some know something that others may not... and there lies the risk.
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Nit 2 (major): Under Value Investing the Risk factor should be listed as Low. The whole point of "value" investing is to find companies selling significantly below their actual value.

I think you need to look at Risk in two different ways:

1) The risk that you will lose a significant portion of your investment. Obviously, I think a company that is already trading below what is deemed its "intrinsic" value would have a much lower risk value in this category than a high-flier growth stock like Yahoo or Qualcomm.

2) The risk that your investment will underperform the market. Just because a stock is deemed to be "undervalued" doesn't mean that the market will ever change its attitude towards that stock in the near future. It is quite possible that the stock could be undervalued for a long stretch of time, thus putting you way behind the market average return. Just look at the performance of the value stocks (such as the Foolish Four) over the past few years when compared with the technology-oriented growth stocks (like MSFT, CSCO, etc.) It really isn't a pretty sight.

I think this is a significant risk with value stocks, and for that reason I think the categorization of their inherent risk as MEDIUM is probably justified.

Fool On!

the LanceMan
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LanceMan wrote:
1) The risk that you will lose a significant portion of your investment.

Any portion is significant to me. <0.2 wink>

2) The risk that your investment will underperform the market. Just because a stock is deemed to be "undervalued" doesn't mean that the market will ever change its attitude towards that stock in the near future.

I'm not sure if I should be concerned with how the market values my stock in the near future. After all I'm a part owner of the business, not a fund manager. <0.5 wink>

In fact, if I've found a company that has been (and continues to be) undervalued by the market then the advantage would seem to be mine.

Now, I buy into the Rule Maker idea of investing, and have owned a couple of Rule Maker stocks long before I ever heard of the term.

But I disagree with splitting risk into two different meanings and then penalizing a value strategy for limiting the downside potential of a permanent loss of capital. Zeke already included a REWARD column in his table. I don't think it's necessary mix the semantics. Or should we lower the Rule Breaker REWARD to account for increased RISK?

Best regards and thanks for your reply,

-Rubic
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Hey Rubic,

Thanks for the feedback. I'd be happy to respond to your nits.

Nit 1: For all of the strategies, I ranked the time / effort column as that for the average investor using those strategies. There are a lot of people who spend a tremendous amount of time on mechanical strategies, I know (especially the people who actually
backtest the things in the first place!) Come to think of it, I know people who do nothing but trade the QQQ's all day long! But that's not the norm. I ranked the methods of Foolish investing by how much time and effort is generally required by the average Fool. If I tried to consider the entire gamut of personalities using all of these methods, I'd have to classify them all as varies.

Personally, I began mechanical investing by printing out the strategies and archives from the Fool, spent the weekend reading, and then committed to one. Since then, I just swap the stocks every year when called for. This is probably how most people use the mechanical strategies. The big benefit of mechanical investing, in my opinion, is that once you've made the decision about which strategy to go with, the time investment to maintain the investment is small.



Nit 2: You jumped the gun on me a little here, as I haven't got Part Two out there yet. But here's what I'll say: The reason that I consider the risk of the value investor, taking the Boring Portfolio and Warren Buffett as role models, is that these sample portfolios are concentrated. We're talking about entire portfolios of as few as three stocks here. Despite the fact that value investing involves trying to purchase good companies at a big discount to their intrinsic value, when you're running a five stock portfolio, you're going to be taking on big time risk. Even Warren Buffett had a rough year in '99 due to the concentration of his portfolio. He wouldn't have had a rough year if he was running 100 stocks. But he also wouldn't have a 30 year record of 23% average compounded growth if he was running 100 stocks, either. You simply have a lot less room for error in your portfolio with so few stocks.

I gave Rule Maker a Low / Mid rating primarily depending upon how many stocks there are. If you've got five stocks, you're taking more risk than if you've got ten. Again, I'll be mentioning this in Part Two on Monday.

That's my rationale for my ratings. Thanks for your nits.


Zeke
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Nit 2: You jumped the gun on me a little here, as I haven't got Part Two out there yet. But here's what I'll say: The reason that I consider the risk of the value investor, taking the Boring Portfolio and Warren Buffett as role models, is that these sample portfolios are concentrated.

Good point. If you're talking about a tightly focused value portfolio, then I'd agree the risk could be higher.

Thanks for responding. I'm looking forward to your next article.

-Rubic
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