Musings of the Editor

Welcome!

I am extremely pleased to welcome you as a reader of the first issue of “2 for 1”. I sincerely hope that this will be a long and rewarding association for both of us. You may have had a chance to study other promotional literature regarding 2 for 1’s portfolio management and stock picking, but I would like to share a bit of my philosophy regarding investing, the stock market, and this newsletter. Those of us who are fortunate enough to have money to invest for the future generally have fairly simple goals. We want to provide for our retirement. We want to put money aside for our children’s education. We want to preserve our capital but we want growth in our investments within a tolerable range of risk. We certainly want to stay ahead of inflation. For a large group of people, the investment vehicle chosen to reach these goals has been the U.S. stock market. Over the very long term, investing in the stock market has proved to be the best strategy, by far. In this century, stocks have provided an average long term gain of approximately 10% per year, even including the depression years and the significant recessions of more recent times. This news letter is written only for those investors who believe their money, or a significant part of it, should be in the stock market.

We will not be discussing market timing, asset allocation, or cyclical sectors of the economy. We will not be discussing precious metals, real estate, or pork bellies. We do not mean to suggest that investments in these or other vehicles should be avoided. My family has benefited greatly from investments in real estate partnerships and various bond funds. What we are stressing is that this newsletter will be very narrowly focused on a stable stock portfolio designed to “beat the market” with as little risk as possible.

This will be accomplished by following a few simple principles.

·      We will buy stocks soon after they split 2 for 1. This fact alone will give us the slight edge that we need to beat the market.

·      Our portfolio will be well diversified. 30 stocks is a very manageable number but is large enough to insure a good cross-section of the economy and a wide variety of companies

·      We will generally invest in companies that pay dividends. Companies that pay dividends are generally well established, stable enterprises with their shareholders’ interests as first priority. Dividends are also somewhat of a “hedge” against a falling market.

·      We will buy and sell stocks on a very regular schedule. There will be no attempt to time the market. When the market is up we will benefit by getting top dollar for the stocks we sell. When the market is down, we will benefit from bargain prices on the excellent stocks that we buy.

·      We will keep our transaction costs to the bare minimum. Our portfolio is an IRA account invested with E*Trade Securities of Palo Alto, CA. We recommend this broker even if your account is not an IRA.

This newsletter will be a reflection of my own stock market investment strategy, with the 2 for 1 split “signal” being the primary focus. If all of the above makes sense to you, you should feel very comfortable following the advice of “2 for 1”. I invite you to join me in a great new adventure.

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A Little History

My goal as an investor has always been to “beat the market” – not by much, but just enough to know that I was doing somewhat better than average. When I first established an IRA account I was a busy young father just getting started in the construction business and it soon became apparent that I had neither the time nor the expertise to pick and trade stocks with any hope of beating the market. Our retirement money was put in the hands of a very capable money manager and over the next 20 years or so, this account has just about stayed even with the market, which has been a very satisfactory return. Then, just this spring, an article by Mark Hulbert was published in Forbes, concerning a study on the “signal” that a 2 for 1 stock split sends regarding future performance of a company. The hypothesis of Dr. Ikenberry of Rice University and others on his team is that a company’s board of directors won’t split its stock unless it is very confident of the prospects for the next few years. The study showed that performance for this group of companies does indeed “beat the market” by up to 12% for up to three years after the split is announced.

Using this simple criteria as a first “screen” for a group of stocks makes it much easier to then choose the company that holds the most promise based on more other well known standards such as low P/E ratios, consistent dividends, book value, etc. While putting this idea to the test during the spring and summer of this year, a simple but reliable stock picking and portfolio management procedure emerged that indeed does actually beat the market fairly consistently. The portfolio on the back page of the newsletter is real money invested in a real IRA account with E*Trade Securities. We will follow the progress of this account and, although the past can’t guarantee the future, we hope for results somewhat in line with the performance of the “test run” over the last six years.

Since the test portfolio was started using stocks that split in January 1990, it has grown 173% while the S&P 500 grew by 96% over the same period. This growth does include reinvestment of all dividends and capital gains and does reflect transaction costs based on the use of a deep-discount electronic brokerage service. This growth is the result of both our stock picking, which I liken to the “dart board” method using slightly “loaded” darts, and also to the “2 for 1” portfolio management procedure.

Our portfolio will always contain 30 stocks, with the oldest being 2 1/2 years old (30 months). We will buy a new stock every month and sell the oldest position as it gets to the “top of the list”. This easy to manage procedure produces good diversity, is some-what akin to the idea of dollar-cost-averaging, and takes full advantage of the statistical two to three year “bump” that comes after a stock splits.

If all this sounds a little too simple minded, I only ask that you follow the progress of our portfolio. The proof will be in the pudding.

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Is the market too high

The accepted wisdom coming from Wall Street these days is that the market is “expensive” or too high and that a “correction” is in the wings. Contrarians were actually disappointed that the July dip in the market wasn’t deeper or longer lasting. 2 for 1 does not pay too much attention to these discussions. If an investor is in the market for the long term and is following the buy and sell procedures advocated in this newsletter, the fact that the market is high or low should have no impact over time.

Why is this so? The concept of “dollar cost averaging” says that a saver regularly investing a fixed amount of money in a mutual fund, for example, should not be concerned about the fluctuations in the market price of the securities because when the market is down, his fixed amount of money will buy a greater number of shares and when the market is up, his account, as a whole, will be worth more. Our portfolio works the same way, even if we are not putting new money into it every month.

If the market is up we might have to pay a high price for our selection that month, but we will also get top dollar for the stock being sold. The opposite is true when the market is down. We are relying on the overall rise in the value of our companies over time, not in the short term swings of the market.

This does not mean that one should not take advantage of the ups and downs of the market when possible. You may have noticed that we chose to convert our “trial” portfolio to a “real” portfolio at the time of the market dip near the end of July.

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What is “Diversified”

We thought you might be interested in some statistics from an article by Julie Creswell of the Dow Jones News Service, seen in the 9/14/96 edition of the San Francisco Examiner. The common wisdom that 20 stocks provides a well diversified portfolio has been challenged by one academic study and also by Morningstar Inc. Gerald Newbould and Percy Poon of the University of Nevada suggest that most investors should have 100 or more stocks to protect provide protection against volatility.

However, using standard deviation as a measure of volatility, Morningstar finds that mutual funds with more than 100 stocks are more volatile than those with fewer than 30 stocks. The 31-to-50 range is actually the least volatile when comparing standard deviations. Other experts quoted say that anything over 25 stocks is plenty, and still others say that more is better, period.

So, who to believe. We are encouraged to see that 30 seems to be a number that at least some of the experts would be comfortable with. Our reason for choosing 30 as the magic number for our 2 for 1 portfolio derives more from the fact that 30 months is approximately the time period over which all 2 for 1 splits, as a group, historically do better than the market. We also point out that the 30 stocks of the Dow Jones Industrial average have proved to be a reasonably good measure of that segment of the market over a very long period. We find 30 to be a very convenient number to work with and feel that it does provide more than adequate diversification.

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Are we falling behind?

October was not the kind of month we like to brag about for our 2 for 1 portfolio. Our statement on page 4 shows that we lost $577 while the market was up 1.27% for the month. Some of that loss was made up by the $115 dollars earned in dividends and interest. Nevertheless, one always wonders what’s wrong when you are bucking the trend, especially when your trend is heading south. We would be denying the truth if we said that going against the market doesn’t make for some sleepless nights, but to put the issue into a little perspective, we looked back at our test portfolio over the last six years and found some interesting data.

For the 81 months we have been keeping track, our portfolio did better, month by month, than the S & P 500 for 44 of those months. That means that for 37 months during that period we lagged the S & P, twice for five months running. Three times during that period our 12 month running average gain lagged the S & P, once for five months straight during 1995. However, the good news is that our overall performance, when measured from the beginning of the experiment, only lagged the S & P twice, and those were for several months running in 1990 and 1991.

We certainly cannot view October’s performance as any kind of trend or sign that our basic concepts are in need of adjustment. Our procedures for selecting stocks and managing our portfolio will remain unchanged and, in this way, we hope to let the averages work for us in the period ahead, as they have so convincingly in the past.

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Investing on the Net

Your fearless editor has begun to learn to use the Internet for our own fun and enjoyment and also to learn more about the companies we are investing in. We recently switched from using E*trade’s direct connect software to the E*trade Web Page for making our 2 for 1 trades and to monitor our portfolio. There is no added charge by E*trade when you access it through the Internet. We are even looking into having a Web Page for 2 for 1 for those of you who would find it more convenient to download your newsletter onto your computer rather than waiting for “snail mail”. This is all very interesting, but in the end, we don’t believe it will have any impact on how we pick our stocks or how we manage our portfolio.

However, the phenomenon of the chat group and the bulletin board gives me pause. Reading some of the messages posted makes it clear to us that many of the people investing in the stock market are poorly equipped to make good investment decisions and are easily swayed by rumor and half-baked investing theories.

2 for 1 will attempt to remain unfazed by all this added input from the information superhighway. We will remain true to our principles which are: 1) Using the 2 for 1 split signal to find stocks that statistically will beat the market, 2) Picking well managed companies with consistent earnings growth and dividends, and 3) Investing in 30 stocks on a rotating basis to take advantage of the benefits of “laddering”. Using the Internet is fun and useful but does not change the basic fundamentals of long term investing.

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New Years Resolutions

Happy New Year! 2 for 1 begins 1997 with high hopes for our portfolio and the anticipation that your newsletter will become established as one of the success stories in a highly competitive field. We thought it appropriate at this time to share a few of our new year’s resolutions with you.

1.      We will not panic when the correction (down draft, crash, turn south, day of reckoning, etc.) comes. All the popular pundits have an opinion as to when and how drastic the eventual correction in the market will be. We are content to agree that there probably will be one. When it comes, we will recall the history of the market and wait for the inevitable bottom and resurgence, buying and selling stocks each month to pass the time.

2.      We will strive to be accurate in all of our gathering of data and information, calculations, and writing in order to provide our subscribers with the highest quality product possible.

3.      We will attempt to constantly improve our customer service and response time to your suggestions and requests.

4.      We will open our Web Site for those of you who would like to get your copy of 2 for 1 “on line”.

5.      We will only buy for our 2 for 1 portfolio two business days after our monthly issue is mailed or one day after posting on the Net.

6.      We will always provide full disclosure of our real portfolio by publishing our 2 for 1 E*trade account monthly statement.

7.      We will continue to provide an easily followed investment plan for those whose goal is long term capital accumulation.

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Marketing on the Net

Starting at the beginning of January, we have been experimenting with the marketing potential of the Internet. Some of you reading this may have received a sample copy as a result of an e-mail solicitation and 2 for 1 thanks you for your positive response. I bring this up because the advent of “junk e-mail” poses interesting questions for me and many others trying to utilize this new medium to promote our businesses. I found out the hard way that America Online and other Internet Service Providers prohibit the use of their e-mail facilities for sending commercial solicitations. I wouldn’t be surprised if the self-righteous attitude of these companies changes once they figure out a way to charge commercial users for the use of the “mail” servers to send e-mail solicitations.

This will sound self-serving, but instinctively, I feel that the wide dissemination of all types of information is best for our markets and our democracy. It is not hard to figure out why China and other totalitarian regimes clamp such tight controls on fax machines and access to the Internet. This is powerful stuff. Being able to instantly communicate with tens of thousands of people will change the way we do business and how we relate to others. I look forward to the innovations that will inevitably grow out of this new medium. In terms of 2 for 1 and investing in general, our use of E*Trade is an example of how one can benefit from the new Internet technologies to keep costs low and information gathering streamlined. My guess is that we are experiencing only the very beginning of this revolution.

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Greenspan’s Dilemma

Federal Reserve Chairman Alan Greenspan has a very tough job. He doesn’t really want the power over the stock market that he seems to have. On the other hand, he can’t ignore what he perceives to be an important factor impinging on the decisions that his Board must make regarding interest rates. But his biggest problem is the fact that Congress and the media will simply not leave the poor guy alone. Can you imagine what it would be like to have every word you uttered in public examined, analyzed, talked about and interpreted, ad nauseam.

A few weeks ago when his now historic words, “irrational exuberance”, were spoken, the market tumbled over 100 points. More recently, when his arm was being twisted at a congressional hearing, he stated that he thought the stock market was “properly priced”, but only if “profit margins continue to rise”. This caused the market to shoot up on the assumption that this was a “bullish” statement. Our perception is that Mr. Greenspan, in both cases, used words carefully chosen to be the least inflammatory language possible. However, the insistence that a speech or a bit of congressional testimony be either bullish or bearish, positive or negative, black or white, causes writers and commentators to go way overboard on their interpretations, and consequently, investors to overreact in the marketplace.

We find Mr. Greenspan’s comments interesting and we certainly have a lot of respect for his handling of the Federal Reserve and the tough job of setting interest rates. We just wish Wall Street pundits would lighten up on him.

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Back to School

Your editor thought that writing a monthly investment newsletter would be a simple and relatively unregulated enterprise. You know, “Here’s what I did and it worked for me; if you think it’s a good idea and it works for you, you could follow the same strategy. You might even pay me a little once a month to share my thinking.” My attorney thought this a most quaint idea and proceeded to point out a few clauses in the Investment Advisor Act of 1940, among others, and recommended that, ASAP, I apply to become a registered financial advisor with the SEC and the State of California. I got my SEC registration last month with only an application and a fee. However, the California process is a bit more rigorous and, to comply with their application procedure, two weeks ago I took the NASD Series 7 exam. This is the basic test required of stockbrokers for employment with a NASD brokerage firm.

To prepare, I had purchased an excellent home study course published by Dearborn Financial Inc. I studied very hard, flunked a whole series of practice exams, and finally began to master the mysteries of naked calls, long bonds, short puts, markups and takedowns, and all the other words and concepts that, until now, were only vaguely familiar to me. I now know that the Federal Funds rate is not set by the Fed and that a short sale can only take place after a plus-tick or a zero-plus-tick. This is all well and good, but most of this knowledge will probably wither and die in this aging brain which, surprise!, is not as quick as it used to be at absorbing new information.

Most of this new knowledge is going to evaporate because it isn’t relevant to the way I invest or to what this newsletter is about. We do not recommend shorting the market, hedging our portfolio, or leveraging through the use of margin accounts or complicated options strategies. These tactics are for the full time professionals, the active traders, or the brokers who need complicated strategies to justify their high commissions. And, guess what? After studying for and taking this exam, I am more convinced than ever that our very simple, very straightforward approach to investing is the best, bar none. It is better because we are going to beat the market more consistently than the vast majority of investors, professional or otherwise, who use every sophisticated strategy devised by man – those same investors who succeed only in enriching the brokers and advisors who are only too happy to take their money while they try yet another complex investment (gambling) strategy.

2 for 1 succeeds because we buy ownership in an assortment of good companies. We are confident our shares in these companies will grow in value because their directors have split the shares of the companies as a sign of their confidence in the future. We are comfortable with our no-frills portfolio management procedure because it gives us good diversity over many market sectors in both large and small cap companies. We don’t need to buy calls or write puts to hedge our portfolio because we believe, in the long run, it’s going to go up.

Being able to talk the “market lingo” may be useful at a social gathering, but I’m going to stick to the basics when I’m picking stocks for you to buy and sell. By the way, I passed the test with a comfortable margin to spare.

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The Big Picture

My wife and I flew to Ithaca, New York a few weeks ago to spend the weekend with our daughter. I have taken her out to lunch on her birthday almost every year since she was about seven and I saw no reason to break the string this year. As we flew across the country watching the vast plains and deserts pass under us from 37,000 feet, I took pleasure in being a small part of the stream of commerce that drives our great economy. We were on only two of thousands of flights that cross our country every day. The streams of trucks and railroad cars visible from that height represented but a fraction of the billions of dollars in freight moving from factory and farm to the market in a never ending stream. The amount of capital, hard work, and clever innovation needed to keep this engine running is staggering. When I think of the challenges involved in keeping my own small enterprises running smoothly, I find it astonishing and quite wonderful that our economy works as well as it does.

If you’re wondering where I’m going with this, it seems to me that an investor should be more than just comfortable placing his trust in the U.S. stock market when it comes to deciding where to place his/her retirement fund or college savings account. Our economy is healthy and growing. The dollar is still the world’s most trusted currency. My money, and the 2 for 1 portfolio, is invested in a few of the companies that either make things, sell things, or provide capital or services for those that do. I will continue to take part in and grow with this giant enterprise that is the American economy.

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Investing in Education

My son just finished his first year as a UC Berkeley undergrad, my daughter just finished the first year of a five year PHD program at Cornell, and my wife is about to finish getting a Masters in Molecular Biology at San Francisco State. With everyone in my family getting educated except me, I have time to reflect on the costs involved! Numerous articles have been written regarding the high cost of education and, from personal experience, every one of them is true. Even taking inflation into account, the cost of a State school education in California is now higher than Stanford’s was in my day. The question we have to ask ourselves is “Is it worth it?”. I have to answer yes!

Our economy, our local governments, our military services, every sector of our society, now more than ever, is dependant on a highly skilled and motivated work force. And leaders – we cannot afford to waste even one citizen to a poor or shortened education if we expect to find and develop the leaders we will need for the next millennium. So for those of you who have children or grandchildren yet to complete their schooling, let me urge you to develop a financial plan to allow your youngsters to advance their educations as far as possible. Take that first step, start that trust fund or savings account, and do it today. And while we’re on the subject, don’t be stingy the next time your local school district or junior college system needs your vote on a bond issue or special assessment. The money we invest in education, both privately and publicly, brings an excellent return every time.

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One Year Old!

This is the twelfth issue of 2 for 1. For those of you who have been reading these pages from the beginning, let me thank you for your support and encouragement. Although this newsletter has yet to set the world on fire, I am enjoying the challenge of meeting the monthly deadline, making the monthly stock selection, and providing an investment procedure which seems to have an appeal to long-term savers. It has become clear to me over the last year that there are many investors for whom the 2 for 1 methods and procedures are compelling.

However, I also get numerous calls from folks who think they like the idea of the signal that a stock split provides but, after talking for a while, it becomes clear that they are looking for a large, quick profit, not an overall investment philosophy and procedure for long term wealth accumulation. I am quick to tell them that a subscription to 2 for 1 would be a waste of money in their case. This newsletter is not for the trader or the person who likes to “play the market”. They would probably have more fun and might even profit more by spending the subscription fee on lottery tickets.

As we go to print, the portfolio is up almost 29% since the first issue. Remember, this is real money in a real IRA account, not a theoretical gain based on ideal conditions. Even more exciting, the stocks recommended in the past eleven issues are up an average of over 32% each, on an annualized basis. This is gratifying and I hope all of you are enjoying the same kind of success with your portfolios.

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Taxing Matters

It is clear that new federal tax rates and regulations will be agreed upon in the near future. Taxes are a factor to be considered by all investors but some folks get to worry about them more than others. My oversimplified come-back to anyone who complains about taxes is usually the observation that they wouldn’t owe so much if only they hadn’t been so successful or lucky with their investments, their business, their inheritance, etc. Let’s face it folks, we have to educate our kids, maintain our roads, take care of our sick and elderly, and defend our borders, and we all have to pay for these items, sooner or later.

As I hope all of you have discovered by now, the best tax regulations that our government ever passed are those providing for tax-deferred IRA and 401(k) accounts. The new tax laws provide even greater flexibility for IRA accounts, especially regarding how these accounts may be used for education expenses. Other new provisions increase the amount a home seller can keep, tax free, when they make a profit on the sale of their residence. No matter what your particular circumstances, there are probably features of the new tax regulations that can be turned to your advantage with a little forethought and planning.

Whether investments are in an IRA account or a taxable portfolio, all investors should carefully factor the new tax laws into their future plans. I will attempt to cover some of the provisions in detail over the coming months in the Portfolio Management column, but in the meantime, here’s wishing you lots of capital gains.

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A Four Letter Word

Someone asked recently, “What’s a four letter word that is more powerful than love.” The answer is “time”. Now what a powerful idea. Time is obviously the most powerful force in the realms of geology and evolution and, in physics, time is the forth dimension, without which, I’m told, Einstein’s theories make no sense. But even in our less significant personal activities, time is a mighty force. We often feel anger when time is taken from us by traffic jams, boring conversations, or make-work jobs. And time can even overwhelm the power of love, as our high divorce rate might indicate.

So, the trick here is to recognize the power of time and use it to our advantage. Time is the secret ingredient that makes compounding such a powerful tool for the individual investor. I don’t have the space here to show you lots of charts proving the magic of compounding, and it’s probably more instructive for each reader to do the math for him/herself. I would encourage every investor to lay out, for the next 10 or 20 years, the growth curve for your nest-egg, using different percentages to reflect both conservative and more aggressive strategies. In either case, don’t forget that 8% growth over 10 years is not 80%. It’s just shy of 116% if compounding is figured annually. 12% growth over 10 years is 211% figured annually. And that’s only for 10 years!

If time is allowed to work its magic, $10,000 invested in the 2 for 1 portfolio, growing at 2% over the traditional market return of 10%, will return $170,000 at the end of the 25th year. Time will make you wealthy if have the patience.

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You Can Help!

Writing 2 for 1 for the last year and a few months has been exciting and interesting. I believe 2 for 1 provides a stock picking and portfolio management procedure that can be helpful and profitable for many investors. However, no matter how pleased I am with 2 for 1, it is not worth the time and effort to turn out the monthly publication unless other people are also pleased with it and, more importantly, are subscribing on a regular basis.

But selling an investment newsletter is a challenge. I have set up a Web Site, used bulk e-mail, and advertised in the print media. Interest is growing slowly but I am not satisfied with the number of subscribers attracted to 2 for 1 so far. So this is where you can help.

Many members of AAII and/or readers of Forbes magazine recognize Mark Hulbert of Hulbert’s Financial Digest as the “guru” of the investment newsletter business. Folks have asked me where 2 for 1 sits on Mr. Hulbert’s rankings for performance and risk. Hulbert does not follow a newsletter unless asked to do so by a number of readers or other interested parties. If you would enjoy having the 2 for 1 portfolio ranked against other newsletters, please send Mark Hulbert a card or give him a call asking that 2 for 1 be added to the list of newsletters that he follows. This recognition might provide the boost 2 for 1 needs to gain a respectable following. Thanks in advance for your help. His address is: Mark Hulbert

c/o Hulbert Financial Digest, Inc.

3116 Commerce Street

Alexandria, VA 22314

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Peace of Mind

It has been extremely comforting to watch the latest gyrations on Wall Street and know that I don’t have to worry about calling a broker, or try to get through to my E*Trade account on jammed phone lines, or make an emotional decision to buy or sell based on the latest news from Asia. The 2 for 1 portfolio management procedure provides that peace of mind because it has been thought out in advance, it works the same way in flat or very active markets, and the success of the portfolio does not depend on market timing.

Don’t misunderstand, I don’t like to see the portfolio in the red for the month, as it is for October. The point is, for me, the emotion and anxiety have been taken out of the events now making headlines. I can watch the evening news with curiosity and interest, but without fear. I remain confident that the 2 for 1 portfolio will continue to do better than the market, by a few points, over the long term.

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‘Tis the Season

If you are still short on ideas for presents, or you just want to avoid the crowds at the mall, here’s a gift idea worth considering. How about giving your child or grandchild a $million dollars$! Let me explain. If a teenager has earned income, he/she is losing a great opportunity if an IRA account is not started as early as possible. However, most teenagers can’t relate to savings accounts, much less retirement, so they need a little help. By making a gift to your child or grandchild, up to the amount of their earnings, or $2000, whichever is smaller, you can jump-start that fabulous engine of compounding.

If you start your child’s Roth IRA account after the first of the year and contribute $2000 to it each year for just ten years, in forty years it could be worth over $1 million dollars, 100% tax free. This growth would require a 12% return, compounded annually, but that is not out of the question. The historical return of the stock market has been 10% per year. At a 10% return, the nest egg would grow to over $550,000 in forty years. Still not bad. The 12% return might be obtained by investing in a more risky growth mutual fund or by taking advantage of an investment strategy like the 2 for 1 portfolio, with less risk than the market and a good probability of beating the market by several percent per year. So, a $million or ….?

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1997 in Perspective

Investors of almost every stripe were rewarded in 1997. The “gold bugs” may be wondering when they get to join the party, but otherwise, 1997 was a great year. 34% for 2 for 1, 31% for the S&P 500, 29% for the Wilshire 5000, and 23% for the Dow Industrials. But let’s remember this time last year, when the market gurus were saying “The risks of a market-corrective phase … appear to be growing in 1997”. That was Richard McCabe, chief market strategist at Merrill Lynch, quoted in the WSJ, 1/2/97. In the same article, Barton Biggs, chief global strategist at Morgan Stanley, and David Shulman, chief equity strategist at Salomon Brothers, both recommended cutting back on common stock positions and raising cash. It’s amazing to me that investors and money managers pay for and put so much stock in this type of advice. No pun intended. Here’s the herd mentality at work.

The pension fund committee says, “So-and-so is managing money for all these other companies, we might miss out if we don’t follow his advice.” The financial reporter says, “Well so-and-so manages a gazillion dollars and is always available for a good quote so he must know something.” The investor says, “So-and-so is quoted all the time on TV and in the Wall Street Journal so he must know something.” And so-and-so says to himself, “If all these people are willing to pay me a lot of money for my advice, I must be pretty good. I should charge more.” The fact that the returns on the portfolios run by the majority of professional money managers generally underperform the market over time seems to be lost in the hype. Simply stated, the fear of losing ground and the greed for higher gains causes investors to make irrational decisions. People hear what they want to hear, they believe what they want to believe. 2 for 1’s recommendation is to invest unemotionally with a procedure that makes sense to you, stick to your procedure through thick and thin, and filter out all the extraneous noise coming from those that make their living on commissions. Control the fear and greed and you will do better than most of the pros in 1998 and beyond.

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Capitalism 101

During the cold war, at least in the fifties and sixties, teachers used to spend time explaining the differences between the socialist and capitalist economic systems. The discussion often got sidetracked, with politics and religion getting mixed in, but in general, youngsters were given the basics in terms of how our economic system works. I am concerned that this discussion no longer seems to occur in our classrooms. This is troublesome because, in my opinion, in order for our economy to continue to function smoothly and benefit all socioeconomic brackets, it is necessary that the very large majority of our citizens have a stake in it. To achieve maximum participation, the virtues of saving need to be explained and encouraged at a young age. If you have no capital, you can’t be a capitalist. But just as important, parents, teachers, and business leaders need to make clear to our youngsters how our economic system functions to put their savings to work for the good of the community.

It is said that more people are invested in our economy than ever before through pension plans, insurance policies, and 401(k) plans. This may be true on the surface, but most of these folks are completely uninformed and probably uninterested in the investment decisions related to their savings. There are many who really don’t know what a corporation is, how the stock market works, or even what the stock market is for. If I could wave a magic wand, I would bring back the civics courses that I remember from my youth, and make sure they contained a good dose of practical capitalism. In the mean time, it’s up to us to teach our children the basics of capitalism and encourage them to take part in all facets of our economy, not just those found at the mall. Gaining an understanding of how our economic system functions, while learning to save and to become prudent money managers, will reward them and the community at large.

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A Magic Bullet?

It’s discouraging folks, I gotta tell ya. Last weekend an article about stock splits went out on the AP newswire and was picked up all over the country. The article itself was OK – it had the usual quotes like “Stock splits are a zero sum game” and so-forth. The main point of the article was that stock split activity has been heavy and will probably continue to be heavy because of the long run-up in the market as a whole. I have looked back at the records, and the forty to fifty 2 for 1 splits a month we’ve seen lately is well over the average experienced in years past.

The 2 for 1 Web Site was mentioned in this article by Vivian Marino and, as a result, my Web Site experienced about 15 times its normal traffic for a few days. I spent all last weekend answering a flood of emails. This was good and I’m not complaining about the publicity. But what is discouraging is the number of “investors” out there who are looking for the “big bang”, the “hot tip”, the “magic bullet”. I answered a few of the inquiries by phone and most of the time, the callers expressed a superficial interest in the 2 for 1 program but then the discussion would turn to strategies about the exact best time to buy, or worse, exactly how long you should keep a stock split before you “flip” it, usually a few days to a week. At this point I usually said “Nice talking to you, I’ve got to take another call” and excused myself.

Just to review – The reason I stick to stock splits is that, AS A GROUP, they do a LITTLE better than the market as a whole, OVER 2 to 3 YEARS. If it weren’t for this fact. I’d stick the entire 2 for 1 portfolio into SPDRs or the Vanguard 500 Index fund and save myself a lot of trouble. There is nothing magic about the split itself. It’s only a SIGNAL that the company’s board is optimistic about the next few years. By buying into this GROUP of stocks, we take advantage of a slight statistical anomaly and wind up doing a little better than the market itself. And this, my friends, is all there is to it. Doing better than the market by a few points, say 12% instead of 10%, over the long haul, could be worth hundreds of thousands of dollars to your IRA account. It’s a magic glacier, not a magic bullet.

So keep those calls and emails coming. I’ll try not to get discouraged.

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Sex and Money

Money and Sex, Sex and Money – the two things that couples argue about. It’s a cliché that everybody knows. I can only help you with the money part, but the headline got your attention, right? For most couples, one person is the saver, the other is the spender. One partner wants a detailed budget, the other just assumes everything will work itself out given enough time. Money, by itself, is really nothing put paper or numbers on a page. It is the symbolic nature of money that causes all the problems. And because each person can attach his or her own symbolism to their money, it can never mean exactly the same thing to any two people. Each of us has our own way of relating to money and investing and hopefully, if you have a partner, you have learned, or at least have an inkling, how that person feels about money.

2 for 1’s contribution to the discussion of your money might be to simplify some of the concepts that all responsible adults need to get a grip on if they are going to be able to take care of their loved ones as they grow up and be able to take care of themselves as they get old. 1st: Investing is not only for the rich and/or reckless. It is my strong opinion that everyone must invest, from the teenager just entering the work force to the age 60+ senior only a few years from retirement. 2nd: Investing need not be complicated. The idea of investing is that you let someone else use your money to create additional wealth and, after a period of time, you get the money back and share in a portion of the new wealth that has been created. 3rd: You can control the risk of your investments to match your comfort level. Risk is inherent in life itself, but some are more tolerant of risk than others; the lesson is that each person can decide for themselves where they fall on the risk/reward scale.

I have recently published a small booklet entitled “Investing for Scaredy Cats” which elaborates on the points above and goes on to show a person, step by step, how to overcome their fear of investing. It’s directed at those who are not even up to the point where a 2 for 1 type portfolio is practical, but I mention it here because it might be beneficial reading for a partner or teenager that you would like to encourage. To obtain a copy, call or email the numbers on page 3 for more information.

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Our Ranking System

The new 2 for 1 rankings of each month’s list of stocks has been questioned by some readers recently and I want to use this month’s column to explore and, hopefully, clarify the values being used in the ranking list. This topic occurred to me after I got a call from a reader who happened to be very familiar with one of the stocks that I had rated as a #5 in last month’s rankings. He rattled off many numbers reflecting the excellent fundamentals of the company and remarked that he was very disappointed that it had been rated a #5. More on this later.

The first principle here is that the numbering system, 1 through 5 is not linear. There can be only one #1 because we use that for the stock that is selected as our recommendation for the month, and usually there is only one #2, because we reserve that for our backup selection for the readers who don’t like the first pick. (For instance, last month there were some folks who didn’t want to buy General Dynamics because it is a defense contractor.) The #3’s and #4’s on the list land where they do mostly by sorting and sifting within the group itself relating to P/E, book value, etc. But we also do use screens for market cap and trading volume as well, and this is what filters out most of the #5 rankings. As the ranking footnote states, a #5 ranking is given to stocks that are “not suitable for 2 for 1, but may include special situations”. In the case of Greater Bay Bancorp, the company under discussion, this is a terrific small bank holding company in the booming Silicon Valley, and the stock might be a great pick for a few individual investors. But its small market cap and minimal trading volume put GBBK outside the group that I can properly consider for a recommendation. If a newsletter recommends such a stock, the price could be significantly affected and someone, inevitably, would be the last on the list and would pay a much higher price than the early birds. For those who want to do their own research, I recommend looking carefully through the list of #5’s for those great little companies that don’t fit the mold for the 2 for 1 portfolio but may have other qualities that would make them perfect for their own situation. They are still in the group that split 2 for 1 which, statistically speaking, gives them a slightly better than even chance of beating the market for 2 to 3 years.

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Our View of Risk

Are you a risk taker or are you “risk averse”? Everyone has a different tolerance for risk, but before you can decide how much risk you’re willing to take on, it’s important to understand the different types of risk. In a portfolio of common stocks, there is the risk that individual positions will go up and down and there is also the risk that the market will go up and down. The 2 for 1 portfolio is designed to eliminate all risk inherent in the fluctuation of individual stocks. This is accomplished by the diversification of the portfolio among thirty stocks and a small cash position. Statisticians have calculated that twenty-five to thirty stocks is all one needs to completely eliminate the risk that severe damage will be done to a portfolio should one or two stocks go sour. Owning more than thirty stocks does not decrease individual stock risk or market risk, so thirty is a good number. In other words, once you have thirty stocks in your portfolio, the only risk you have is market risk.

So how do we deal with market risk? Because 2 for 1 is fully invested in the market, there is no escaping market risk. Astute market timing is theoretically the way to reduce market risk, but market timing does not fit with the 2 for 1 “laddering” procedure. In addition, because of the underlying theory that stocks that have announced splits will do slightly better than the market for two to three years, we have actually mitigated some (certainly not all) of our market risk. This idea will not be fully tested until we have gone through a full downturn and recovery in the economy and the market, but our numbers, so far, indicate that 2 for 1 will perform, in a downturn, better than the market as a whole. Even if we only stay even with the market, that’s not so bad. The market’s annual return of slightly over 10% for the long term is still the best of any investment vehicle.

So we accept market risk. We know the market cannot continue to return over 30% per year. We know, for some years, it will actually go down. But for the period when we must be accumulating wealth to reach our retirement goals, the risk of the market is worth the reward.

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What’s Going On?

It’s tough to stick to your investment procedures for portfolio management and stock picking in the face of lagging performance. At some point, an investor may have to concede that he or she can’t always meet or beat their target return. The only goal for 2 for 1 has always been to “beat the market”. Usually this means the S&P 500, the index used by most mutual funds to measure performance. The Hulbert Financial Digest uses the Wilshire 5000 as a gauge for its newsletter rankings. In the present environment, with the S&P 500 and all the other indexes regularly setting new record highs, it is hard to look good by comparison. So far in 1998, 2 for 1 has not met its goal of beating the market. For the last twelve months, ending 6/30, our record is only slightly better, putting us almost nose to nose with the Wilshire 5000 and just a little behind the S&P 500.

Should I worry about this? It’s hard not to worry, but to keep things in perspective, I usually find comfort by going back to our past history. One interesting finding is that the S&P 500 has not lost ground for two months in a row since March of 1994. The 2 for 1 portfolio, on the other hand, has declined two months in a row five times over the same time period but has always bounced back stronger. Our most recent two month decline was over May and June just past. This is reflected in the graph on page 3, where we see that the S&P 500 and 2 for 1 are close but not exactly parallel. What keeps me going is that, if you look closely, the gap at each of the six end-of-year lines on the graph has grown wider. As the business commentator on the radio says, “the ‘intraday’ highs and lows don’t count – it’s the ‘close’ that goes into the record books”.

Back to the question of “What’s going on?”, I think it’s safe to say that we’re experiencing one of those dips in the roller coaster ride that goes along with investing in the stock market. For long term investors, measuring performance by the month or the quarter is bound to upset your stomach. Even annual performance measurements may not always be to our liking. But over the long haul, meaning five years or more, I am confident we will continue to achieve our goal of beating the market.

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Into the 3rd Year

This issue marks the start of the third year of publication for 2 for 1. I must say that running the 2 for 1 portfolio, writing the newsletter, talking to subscribers and prospective subscribers, and learning about the newsletter business has been an exciting adventure for me. I am pleased with the progress of the portfolio and gratified that many of you seem to be benefiting from the 2 for 1 procedures.

However, as I have stated in previous issues, this venture is intended to be a profit making enterprise and I need additional subscribers to guarantee that I can continue to publish 2 for 1. Toward this end, I am finalizing plans for a massive marketing effort to be conducted on the Internet over the next few months. Phil Doyle of DirectMart.com, an expert in the new “e-commerce”, will be orchestrating this effort for me. In addition to increasing our presence on the Internet, we will be upgrading our Web Site to allow easier on-line viewing by subscribers, more articles and useful investment information, and a more streamlined subscription process. Newsletter Network, at www.margin.com, where some of you found 2 for 1, is out of business. The good news is that others have taken their place. I recently joined the list of writers regularly contributing to the InvestorsAlley WebSite. My contribution to InvestorsAlley.com will be carried as a bi-weekly column entitled “Getting Started” in the “Opinions” section of that new Web Site. There is also the possibility that I will be joining the newsletter sites of DickDavis.com and InfoBeat.com, two other well established financial information Internet sites. I’d be interested in hearing from any of you who see ads or hear any discussion about 2 for 1 in your email or personal newsgroups.

You hear every day that the Internet will be the primary source of information in the future, but few companies have discovered how to really make it work for them. I will continue to experiment in the hope that I can catch the wave. To be honest, my best marketing so far has been the “word of mouth” support I get from you who have learned the 2 for 1 procedures and are benefiting from our recommendations and investment advice. Thanks!

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A Necessary Pause

It’s been a wild ride since the last issue of 2 for 1 was published in the middle of August. During these five weeks, the Dow Jones went from the high of 8556 on Aug 14th to an intraday low of 7400 on September 1st. There has been much talk in the print media and on television regarding the difference between a correction and a bear market. Market pundits were going over their old columns trying to find a line they could use to say “I told you so!” I don’t mean to sound cynical, but this is just so much wasted ink and squandered air time. Anyone with an ounce of common sense has to know that the 30+% return on investment that we have been reaping for the last 3 1/2 years could not continue forever. To bring the market returns back to the 80 year average of just a little over 10% per year, we should expect to see additional slow periods, if not entire years “in the red”.

Does this mean it’s time to get out of stocks? Does this mean we’ve made a big mistake? No, it’s not time to get out of stocks. It’s time to buy stocks like our selection for this month, a company now looking much more attractive than it did a few months ago. And no, we have not made a big mistake. What we have done is suffered a short term paper loss of the type that comes with the territory when one is fully invested in the stock market. The 2 for 1 portfolio, including the test portfolio going back to July of 1992, has shown a growth of 187.86% through August 31st. This does not look as good as the 246.21% we saw at the end of May, 1998 but hold on folks, it’s still an annually compounded return of close to 19.3% per year. And this is compared to the very respectable 14.5% annually compounded return for the S&P 500 over the same period. In survey after survey, polls show that people are expecting from a 15% to 20% return on their investments every year. This is not realistic and, hopefully, this recent “adjustment” in the market will serve to adjust the expectations of the average investor.

Our goal is to do better than the market, but we have to keep in mind that the market has been on an unsustainable rampage lately and the recent downturn is only a necessary pause to bring prices back closer to the norm.

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It’s Time To Roth

As you know, the 2 for 1 model portfolio is actually my own IRA account, held by E*Trade and utilized as the “proof of the pudding” regarding this newsletter’s recommendations. In the next few weeks I will be submitting the necessary forms to E*Trade to convert this account from a regular IRA to a Roth IRA. For many readers, this is a step that should be considered for your own accounts. To be eligible, your adjusted gross income must be less than 100K for individuals or married couples filing jointly. There are several other factors to consider in order to make the right decision in this matter and, if your situation is complicated or in a “gray area”, you should get help from your accountant or financial advisor. But maybe your situation is fairly straightforward. Here are the basic considerations.

The fundamental difference between the Roth IRA and the regular IRA is that, with the Roth, you pay the taxes going in and, with the regular, you pay the taxes coming out. Assuming the amount going in is less than the amount coming out, the overall tax hit on the IRA will be less if it’s a Roth. However, to gain that advantage, the taxes must be paid on the existing IRA at the time it is converted to a Roth. If the conversion is done in 1998, and only in 1998, the taxes can be spread over four years. Also, because the market is down, the taxes will be based on our present reduced portfolio value. For both of these reasons, it is important that we get this conversion done now. Money to pay the taxes on the conversion can come from the IRA account but, to maximize the benefits of a conversion, paying the taxes with money from outside the IRA will keep the Roth IRA at its “full strength”, preserving the momentum of the annual tax-free compounding.

In the case of the 2 for 1 portfolio, if the account was converted on 9/30/98, the federal taxes on our $71165, at 28%, would be $19926, or $4982 per year for four years. Increasing withholding taxes between now and the end of the year might cover this amount and, if not, filing an additional estimated tax payment may be necessary to avoid a penalty. Inevitably, the IRS always manages to get its share. Taking the hit now will allow a higher, 100% tax-free withdrawal when this money is finally needed for retirement living expenses.

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Change Your Oil

There are some things we do in daily life just because, if we didn’t, we know that later on we would pay dearly for our procrastination. Brushing teeth, cleaning gutters, and changing the oil in the car all come to mind. Even though the owner’s manual says you don’t have to do it so often, we all know that changing the oil in our car every 3000 miles is a really good idea. In my own case, the advent of the quickie oil change places has resulted in a much more regular maintenance schedule for my cars and, isn’t it amazing, the cars seem to run better, with fewer problems, than I ever remember from the times when I used to change my own oil in the driveway. The lesson here is that certain chores get done more efficiently and more regularly if we admit to the need for a little help.

When it comes to investments however, most folks think they need more help than they really do. If you are relying on a full service broker or a mutual fund manager to make all your investment decisions for you, I guarantee you are paying more than you have to for what you are getting. The essence of a good investment program is to settle on a procedure that makes sense and that you are comfortable with, and then carry through with it on a regular schedule through thick and thin. You may need a little help, like your subscription to this newsletter, for instance. But once you get the basics down, paying hundreds of dollars in commission for one stock trade, or up to 3% of your portfolio a year, or more, to let someone else manage your money, does not make sense to me. The decision to manage your own portfolio is a wise one, in my opinion, but it must be accompanied by the realization that there is a little maintenance involved. A portfolio management procedure like 2 for 1 requires a buy and sell routine that must occur on a regular schedule. You need to plan ahead. You need to act before there are problems. You need to keep good records, not only for the tax man, but to gauge your progress against your goals. By doing these chores on a regular schedule, like changing your oil, your portfolio will be more likely to perform better over time, and with a minimum of anxiety and hassle.

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Clichés for all Occasions

Talking about the stock market is like talking about the weather. There are only so many ways to say “It’s hot”, “It’s cold”, It’s wet”, or “It’s dry”. Likewise, for the many commentators and writers who make their living expounding on the stock market, it can be a challenge to come up with something new and interesting to say about a subject that can be maddeningly routine. Just for fun, I called and emailed some of my favorite market commentators and asked them to send me their best clichés and/or catch phrases used to explain the market. Paul Kangas, of the Nightly Business Report said, “What! You’re accusing me of using clichés.” I quickly explained that I was looking for the phrases that he was tired of hearing from OTHERS. Here are some of the responses.

Thom Calandra of CBS.MarketWatch.com offered “The trend is your friend” and “Don’t fight the tape”. Use these when you can’t think of any other reason to jump into the market as it soars to new heights. Don’t forget, this is the wisdom of the ages. From no particular source, I’ve heard “Buy the rumor, sell the news.” This will probably work for you just about 50% of the time. These “nuggets” are just too clever to be useful to the serious investor. The fact that they are used to fill air time or space on the printed page does not make them true or useful. Words can be used to entertain and to explain ideas, but usually not at the same time.

Eric Tyson, author of “Investing for Dummies”, claims authorship of “Ignore soothsayers and prognosticators”, which is a phrase that is undoubtedly pretty good advice. As with most of the catch phrases, Eric was probably attempting to say or emphasize a basic principle in a new way. Paul Kangas questions the need for new terms like “going forward” when “future” would work just as well. But he also points out that it’s a struggle for financial journalists to keep their scripts fresh and interesting. I hope my readers will let me know when they start to see catch phrases and clichés popping up on a regular basis in these pages. Until then, Happy Holidays, Have a nice day, and be sure to Buy low, sell high.

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1998 In Review

The year just concluded was an exciting one for stock market investors. Too exciting, in fact, and the 2 for 1 portfolio has suffered as a result. Our return for all of 1998 was a gain of 11.95%. The 2 for 1 portfolio went from $72871 to $81581, including all transaction costs and dividends. This is an IRA account, so capital gains taxes are not a factor.

Given that 2 for 1’s primary goal is to beat the market, this result is very disappointing to me. This is the first year that 2 for 1 has fallen behind the S&P 500 on an annual basis and, obviously, I have to take responsibility for the results. In general, the overall market benefited from the amazing performance of just a handful of hi-tech and Internet stocks, many seen on our monthly split lists. For example, Microsoft split in January and Dell Computer was on the February list. Regarding the Internet, we had an opportunity to add Amazon.com to the portfolio in May, Yahoo in August, and American Online in both March and November. All of these stocks turned in fabulous results for 1998 and would have greatly enhanced our bottom line had we selected them rather than our more mundane banks, utilities, and manufacturing enterprises.

In retrospect, I suppose I have been too conservative, and I’ll say it now, I do intend to inject a bit of the high tech sector into the portfolio when the opportunity presents itself. Given the 2 for 1 splits already announced in January, this may happen sooner rather than later. Stand by.

Looking on the bright side of our results for 1998, we did outperform many mutual fund yardsticks. Of the 36 categories of funds tracked by Lipper Inc., 2 for 1 beat all but eleven. Six of Lipper’s categories were in negative territory for the year. In years past, a 12% gain would have been cause for cheers, and if I could be guaranteed a 12% gain every year, I’d take it in a heart beat.

Starting with our pick of Ameritech last January, half of 1998’s recommendations have been double digit gainers so far, on an annualized basis, with AIT up 50%, SVU +47%, GD +41%, etc. Compared to 2 for 1’s 1997 picks, it appears that 1998’s stocks are doing quite a bit better, and that bodes well for the 2 for 1 portfolio overall for the coming one to two years.

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A Personal Note

Mixing your personal life into your business or professional life is usually not a very good idea. This conventional wisdom notwithstanding, I’m going to use this month’s column to tell you about a wonderful man that passed away late in January after a long and productive life. My Dad was 86 when he died due to complications from Parkinson’s disease. Neil Macneale Jr. worked for Procter & Gamble for 38 years as a mechanical engineer, with several patents to his name. He was a world class birdwatcher with over 700 species on his life list. He made, by hand, dozens of the finest jigsaw puzzles you could ever imagine. He was a great Dad and his community and large extended family is going to miss him. The story about my Dad that particularly relates to stock market investing has to do with baseball.

All through the 1950’s Dad would take my brother and sisters and me to see the Cincinnati Reds play ball at Crosley Field. The Reds had some powerful hitters at that time, including first baseman Ted Kluszewski. I would always be rooting for him to smash the ball over the right field fence, something that he did with awesome regularity. But my Dad would be telling us, all the while, that the team would win more games if the hitters would simply knock a bunch of bloopers over the infielders’ heads instead of swinging for the home run every time they got to the plate. Of course none of the young fans, or many of the fans in general, were interested in that approach and Dad’s advice went unheeded.

It must have stuck with me at some level, however, because I use that wisdom regularly when I have occasion to re-evaluate the 2 for 1 investment strategy. Taking small but manageable steps toward a realistic goal, in my mind, seems to be a tactic much more likely to lead to successful long term investing than forever swinging wildly for the “home run” stock or mutual fund.

Neil Macneale Jr. was not famous or wealthy, but he was extremely successful in most of the carefully chosen endeavors he undertook. I am indebted to him for many “life lessons” like this story of the base-hit approach to winning at baseball. I am going to miss my Dad and I thank you, my readers, for allowing me this bit of public sentiment.

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The Fast Lane

My home on the San Francisco Peninsula is near Highway 101 and I have driven that route to work for more years than I care to think about. The commute traffic is horrendous and getting worse, but it does offer a lesson that is relevant at this time of Internet stock mania. Normal traffic finds the freeway behaving as you would expect, with the fast lane traveling faster than the middle or slow lane. But during the morning commute, when the average speed is maybe 20 miles per hour, a fascinating counter-intuitive phenomenon occurs.

I usually stay in the slow lane because I only travel three exits and it’s not worth going through the hassle of changing lanes. Some years back I began to notice that cars in front of me or just behind me would scoot to the fast lane as soon as they entered the freeway from the on-ramp. However, by the time I reached my exit, the cars that entered the traffic flow at the same time I did were often behind me, even though they were in the fast lane. I could see that they would pull ahead on the stretches between exits but then the slow lane would catch up and blow by the other lanes as traffic sorted itself out around the interchanges. To confirm this, I have been picking out an easily identifiable vehicle ahead of me in the fast lane just as I enter the traffic flow. On most days, by the time I exit the freeway, I will be ahead of that vehicle, even though it has been in the fast lane the whole time. This all starts to make sense when you notice that the fast lane speeds up and then has to hit the brakes with much more “volatility” than the slow lane. Maybe it has something to do with the type of people that “have to” always be in the fast lane. I would venture a guess that the folks in the fast lane on the freeway are also the investors that jump in and out of mutual funds or stock positions and wonder why they can’t seem to beat or even keep up with the index funds or a long-term strategy like the 2 for 1 portfolio.

The patterns observed in freeway traffic seem to validate certain laws of physics and psychology. We have here the modern manifestation of the hare and the tortoise fable we all learned as children. If you want to reach your goal faster and with less stress, keep your car and your investments in the slow lane. It works!

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Forget Day Trading

The calls and emails to my office asking about split predictions, buy and sell timing, and other issues important to the day traders are getting more frequent. The day trading phenomenon is worrisome, in my opinion, especially when you consider some folks are actually quitting their real jobs to get involved in this madness.

I am reminded of a vivid memory I have from one of my drives across the country on my way to college. A friend and I had been driving all night and, as we passed through Reno, Nevada at the first light of dawn, we passed a middle aged man trying to thumb a ride out of town. Our car was stuffed with all our possessions and we had no room for a hitchhiker. There was no opportunity to hear the story first hand, but the quick glimpse of dejection on his face, the rumpled suit, and the time and place were enough to paint a clear picture. I know, I’m sure, this guy had come to Reno a day or two before with very high hopes. He put his hard earned stake to work on the tables or in the slot machines, sure that this was his lucky day. In his mind, he had already spent his winnings on a new car, a wonderful gift for his wife, whatever. But, come the light of dawn, his bubble had been popped. There was going to be no new car or beautiful gift; he didn’t even have the bus fare to get home. I felt so bad for this poor schnook that I still feel a twinge, 35 years later, as I write this article.

Just as the mathematics of the gaming tables should tell us all we need to know about Las Vegas or the lottery, the math of the stock market says that day trading is a “zero sum game”. For a person to make money in the short time frames of the day trader’s world, someone else has to lose money. The winners today will be the losers tomorrow and, when transaction costs are added in, even the rock bottom costs of the on-line brokers, you can be sure that over time, a trader’s capital will simply erode away, all other factors being equal.

The lure of the fast buck is powerful and there is no denying that some will get lucky. But please, faithful readers, don’t use your IRA or your kid’s college money to play the day trading lottery. In a year or two, when I’m listening to tales of woe about failed day trading gambits, I will feel the same for those callers as I felt for that sad-sack hitchhiker in Reno.

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John Bogle, My Hero

Every so often a person comes along with such a fresh approach to a subject that you just have to pay attention to what they say. John Bogle, founder of the Vanguard Mutual Fund group is such a person. Seeing him on Wall $treet Week With Louis Rukeyser a few weeks ago was such a pleasure, I decided, with permission, to repeat some of his very astute remarks here. Mr. Bogle is best know for his belief in index funds and here are a few reasons why.

Rukeyser: Index funds have never been more popular than they are right now. Is it possible that some of their present eminence will fade in the next few years and active managers will start to do relatively better?

Bogle: I think the chances are small if we follow the right index, and … the right index is the total stock market index based on the Wilshire 5,000… The theory of indexing says if you own the market at a very low cost, you must, and you will, beat the other participants in the market who operate at a high cost.

Rukeyser: Would you advise people not to try to pick individual stocks ever?

Bogle: I think there’s room for individual stock pickers. I think an individual wants to pick a diversified list of … stocks for the long term….

Rukeyser: And it’s cheaper to buy them (stocks) yourself than even to buy them from Vanguard.

Bogle: It would be, a little, tiny bit.

Rukeyser: What do you think when you see a TV commercial in which Peter Lynch talks with Don Rickles?

Bogle: Well, my first thought is, “Who’s paying for this?” And it’s, of course, the shareholders of those funds…

Rukeyser: Do you think investors are conscious of costs?

Bogle: Not nearly conscious enough… They’re hipped on performance, yesterday’s performance, without realizing that yesterday is never tomorrow in this business.

Now readers, relate this to our portfolio.
1) Great diversification – 30 stocks in big and small, growth and value stocks is all you need.
2) Dynamic tracking of the market, like an index fund – laddering keeps your portfolio refreshed.
3) Very low cost – trade on-line with a deep discount broker with your only extra being the cost of your newsletter. If you want to manage your own portfolio, 2 for 1 is a great way to do it. If not, then buy an index fund.

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