Author: A.T.

A number of you were not pleased with my recent comment on the Motley Fool’s “Dogs of the Dow” strategy.

Under the subject heading, “Bad Calculations!!!” Mohammad Samiullah wrote, “It seems that you are doing inconsistent calculations. See response to your answer by Robert Seard. You should disclose your real motives rather than do haphazard calculations to misguide people.”

While I can’t imagine what secret motive Mohammed thinks I might have, I certainly read the article by Robert Sheard (it’s Sheard, not Seard) with interest. (If you haven’t visited the Motley Fool site, you should —http://www.fool.com)

Rather than make you click to find it and go back and forth between Robert’s comments and mine, I hope the Fools won’t object to my cutting and pasting his remarks here [with my responses in brackets, like this]:

FOOL GLOBAL WIRE by Robert Sheard (MF DowMan)

LEXINGTON, Kentucky (January 23) — A reader asked me to comment on today’s Andrew Tobias column (available at www.ceres.com), which was itself a response to a question about the Motley Fool’s beloved Foolish Four approach. And as I have no desire for this to be seen as the start of a flame war, let me point out that I agree with many things in his column.

[Ah, if the Democrats and Republicans could only be so civil. Needless to say, I much appreciate Robert’s approach, not to mention the plug.]

First, we all know that past performance is no guarantee of future performance, but since it’s the only thing we can measure, it’s what we talk about. That said, though, when you’re talking about decades of performance, most investors feel a little bit of security that the approach is sound, as Tobias mentions.

He also asserts a long-held Fool belief that most managed mutual funds just can’t beat the index funds, so as a first step, if you have to be in funds, at least check out index funds.

But his comparison between the Foolish Four approach and an index fund after taxes is where we part company. His claim is that if one rotates every year with the Foolish Four, and thus incurs capital gains taxes each year, then the buy-and-hold approach with an index fund, which defers taxes, is more attractive. Not so unless you cook the numbers as he has in his example.

[Just before we get to the cooking, or lack of same, I should point out to new readers what the Dogs of Dow strategy is: namely, that at the start of each year, you buy the second through fifth highest-dividend-paying of the 30 stocks that make up the Dow Jones Industrial Average. It’s a strategy that has some underlying logic but also some potential flaws, as I wrote last week, and to which Robert is responding.]

First of all, he reduces the Foolish Four return to 20% because he doesn’t believe the rate it has posted since 1971 (23%) is sustainable. Fair enough. But then he declares a tax rate of 40%, including federal and state taxes and a mixture of long- and short-term capital gains. Un uh! This approach only generates long-term capital gains if you update a year and day after your last update. No short-term penalties here, which means the federal rate can’t go higher than 28%.

[Fair enough. I should have used something more like 32% instead of 40% in my example. My motives were pure, but my thinking was sloppy.]

Then he declares a 15% annual return for the index funds. But that overstates the actual return of the Vanguard Index 500 fund since its inception in 1976 (14.2% according to the Vanguard representative I called). Now if you’re going to declare that the Foolish Four can’t possibly sustain its historical 25-year growth rate, isn’t it a little bit unfair to overstate the actual historical growth rate you calculate for the index fund?

[Well, here’s where we begin to disagree. In my comment, I said I thought both rates I was using in my example — 15% for the index fund and 20% for the Dow strategy — seemed wildly optimistic. So the real question is simply, by how much, if at all, the Dow Dog strategy will outperform an index fund. I still think I was being generous by saying 20% versus 15%. I’m not sure it will continue to outperform the index at all.]

But a more glaring disparity is that Tobias uses only a 35% combined federal and state tax rate for the index fund. That won’t do either. Both approaches are taxed each year on dividends and both are taxed upon any sale at the long-term tax rate. So those rates have to be the same or the comparison is meaningless. Choose 35% or 40% or whatever rate applies to you, it doesn’t matter, but the rate must be the same for both investment approaches.

[Again, fair enough. Let’s use 35% for both.]

Let’s compare apples to apples using actual historical return rates and the same tax rate (say a combined federal and state rate of 35%). After you take 35% out of the annual growth rate for the Foolish Four of 23%, you’re left with an after-tax rate of 14.95%. And that assumes the entire portfolio turns over every year, which of course doesn’t happen. Compound that for 25 years and a $10,000 portfolio grows to $325,630, after taxes.

Put the same $10,000 into an index fund at Vanguard’s long-term return of 14.2% and let it grow tax-deferred for the 25 years. That comes out to $276,473. Now take out the deferred taxes you owe on the gains from the original $10,000 at 35%, and the total value after taxes is only $183,207. That’s only 56% of the value of the Foolish Four portfolio after 25 years.

[Yes. As long as you assume the Dow strategy will blaze along at 9% a year ahead of the market — 23% a year instead of 14%, in this example — then you should certainly follow it, regardless of taxes. No question. But can it really be that the second-through-fifth highest-paying slots on the Dow are so magic that they will outperform the broader market at all in the future, let alone by 9% a year? Maybe, but I think that’s a very aggressive assumption. Robert is well within his rights to use a 35% tax rate. And he is of course right that with hindsight, you would have done great using this strategy. But can you really use historical returns to predict the future this way? I can say with some certainty that the index fund will perform just slightly worse than the index (because of the management fee). Can the Motley Fool predict with any reasonable certainty how the dogs of the Dow will do? Might the market of the next 25 years act somewhat differently in this regard from that of the last 25 — especially now that so much attention is being focused on this strategy? The attention itself could be self-fulfilling and make it work even better for a while . . . but in the long-run it could make it work worse.]

So while I agree with Tobias that taxes are important and that index funds beat out the vast majority of managed funds, I don’t at all agree that taxes render the Dow approach a weaker alternative than buying-and-holding an index fund. The numbers, when you compare actual rates of return and equitable tax rates, simply don’t support that conclusion.

*

Listen. You could certainly do worse than to try this. It’s not a crazy speculation, because the stocks in the Dow are not crazy speculations. And the historical pattern could continue unabated, and unaffected by the fact that a million extra eyes are focused on it now. But backtested systems rarely are the winners going forward that they were when “discovered” by looking back. And selling most of one’s holdings once a year, exposing the gain to tax, really is a weighty handicap. Consider: Warren Buffett has managed to compound his money at something like 26% a year for four decades. At that rate, $1 grows to $10,000. But chop taxes out of that 26% annual return (using a 28% tax rate, which cuts the return to a “mere” 18.7%), and that same $1 grows to just $950. Big difference: $10,000 versus $950. Not that any of us can do as well as Buffett. But I do think it makes the point. Because the Dogs of the Dow strategy entails considerable annual turnover, it must appreciably outperform the index funds (unless you’re investing through tax-deferred accounts) just to keep up.

Two columns generated a lot of good feedback recently — the one on the Motley Fool “Dogs of the Dow” strategy, which I’ll revisit tomorrow, and the one about why the rich don’t give more. As I often find your comments a lot more interesting than mine, I wanted to share some of what you had to say:

“I think your correspondent is right on the mark. I especially agree with his first point, that rich people do not see themselves as rich.

“This is an issue I constantly struggle with. My husband and I are not rich (just like the people your gentleman talks about). We are typical DINKs; he earns about $80,000 per year and I earn about $55,000. We make another $15,000 on investments and have a net worth of something like $500,000. I feel we are well able to help others, both with our money and with our time. My husband, however, was not taught as a child the obligation to help others less fortunate; getting him to agree to contribute time or money is always an uphill battle. We have adopted a ‘what he doesn’t know won’t hurt him’ policy and, since I control the checkbook, I just do what I feel is right. Whenever I volunteer my time at my chosen non-profits I have to endure his disparaging comments.

“Your correspondent hits the nail on the head. The best way to engender support for a cause is to somehow make the cause personal to your targeted donor. Please do not use my name if you quote the financial information included here.” — Anonymous

*

“Your friend says he’s not racist, but confesses he makes powerful and negative emotional distinctions based on race. If that isn’t a form of racism, what is? Agreed, perhaps it’s human nature to be afraid of the ‘stranger’ and to be ethnocentric about one’s own group, but it’s human nature to do and think a lot of rotten things. And the more matter of fact someone is about them, the more it [allows them to continue]. As good and kind and generous as your friend obviously is, he ought to be — at least a little — ashamed about his coldness about suffering when it happens in Burundi as opposed to when it happens in Cracow.” — James Glickman

*

“I agree with your anonymous friend about the size of Asians’ donations being less compared with their relative success. I have often made the same point myself — see for example: www.nssl.uoknor.edu/~lakshman/Sane/newyr.html.

“However, in our defense, I should mention a couple of things. Since Asians are, by and large, recent arrivals in America, ties to the homeland remain strong. Giving among Asians (Indians at least) is mainly personal — when you know so many poor people like I do, it is hard to give to an anonymous organization like the Red Cross. I would rather help to pay the college tuition of a kid in my village. Such donations do not show up in your friend’s radar screen since a) They are not claimed as deductions on a tax return. b) They do not go to any named charitable organization.

“That said, we can do more though.” — Lakshman

*

“My company (Sabre Group Inc. (TSG) formerly a division of American Airlines) makes it easy for me to donate by making payroll deductions in every paycheck to give to United Way. I don’t feel the pinch so much because it is deducted before money is deposited to my bank account and it is spread over the entire year. Regarding your friend’s comments on Asians tending to give less: I don’t think it has anything to do with the absence of the Judeo-Christian heritage as he suggested (charity is extolled in all cultures). It is partly because of the earlier reason he gave viz. identification. They can identify more easily with poor people in their home countries than they can with the needy here. Also, many Asians (including me) regularly send contributions (not tax deductible in the U.S.) to charities and development projects in our home countries. This more or less satisfies our urge to give. That may explain, at least partly, why Asians seem to give less here in the U.S.” — Jambardi Maheshkumar

*

“Your friend’s statements are absolutely correct. ‘Rich’ is very relative word. You might not think you are rich, but others who have less may think so. Asians (mostly) believe in direct giving (where they can feel the pleasure of someone saying thank you). If you ever go to India, see how many people give to beggars. Often News Media reports beggars having millions of rupees (Rs 36 = $1) in their bank account. It has become a profession in major cities and beggars fight for key spots, even bribe the police for it.

“Personally, I’d not give to United Way no matter how much I have, nor my alumni association or college, because I do not want to support their overheads, even though I think they do a good job. Sorry, but I’d rather hear and feel the thanks of a homeless and hungry.” — Vijay Sinha

*

“I am just curious (as a poor person who is tired of the male-bashing and the rich-bashing) what are those ‘after-tax percentages terms’ referred to in the beginning of the article and who is ‘everyone’ else? Of all of my fellow everyone else’s, most are just living paycheck to paycheck. We have discussed charitable contributions in the office and very few admitted to doing it at all. This article seems to imply that working class is out there contributing 20-30% of their income while those rotten rich are only giving 10% (on top of the added 50% in taxes mentioned in the article which comes to a remaining 40% to live on for those rotten rich.) How much do we poor working class actually give? I don’t know anyone who lives on 40% of their gross earnings, that’s for sure!” — Rene

I think the reason low-income people tend to give more percentage-wise than rich people — especially after factoring in the tax advantages to the rich — may be the collection box at church. Someone who earns $20,000 a year and manages somehow to stick in $10 a week is giving a lot more, relatively speaking, than someone earning $300,000 who writes a check for $1,000 or $2,500. And as a percentage of “discretionary income” (the amount available after paying taxes, rent, and other basics like food and utilities), that $10 a week at church may represent a HUGE chunk. Very few rich people give a huge chunk of their discretionary income, quite possibly because (as my friend suggested in point #3 of his message, and you do, too) they feel they already “give” a huge chunk to the tax man.

According to the IRS, the average itemized charitable deduction in 1994 was between $1200 and $1800 for itemizers who reported adjusted gross income between $15,000 and $75,000. That’s pretty good, considering how tough it is to take care of your own family’s needs these days on an AGI of $15,000 to $75,000. Of course, most low-income taxpayers don’t itemize their deductions, so it’s hard to say how much they really give as a whole. But especially when you take into account that collection plate, I think the overall giving level of low-to-moderate income folks could average 3%.

Now go up to the $100,000-$200,000 adjusted gross income range. Yuppies, lawyers, doctors. Their average charitable deduction in 1994 was $3,420 — less than 3% on average.

Now go up to the $200,000-$500,000 range. Surgeons, law partners, big-time corporate VPs. They averaged $8,372 — still barely 3%.

Those in the $500,000-$1,000,000 range averaged $21,582. Still about 3%.

*

“The recent back and forth debate on giving by the wealthy may be forgetting one key factor. The number one reason people give is because the right person asked them for their support. That doesn’t mean everyone who is asked gives, but is a much clearer indication of success. If you don’t ask someone to give, how will they know the money is needed? And I don’t mean stuffing their mailbox with begging letters and grant proposals.

[Why not? Between reading the headlines and getting those appeals, how could anyone not know their money is needed? — A.T.]

“Each point your friend made along the way was based on his individual experience. However, readers of your daily epistles can not take his observations and infer any reality or trend to how the wealthy contribute. Take his point about the ‘rich’ preferring to give to United Way rather than the pediatric ICU. I am not challenging his experience. But in reality, it is not true.

“The wealthy — people whom fund-raisers call ‘individuals of high net worth’ — provided such great support to museums, hospitals, the arts and education, that United Way was feeling left out. They used to complain, ‘Why don’t the rich give to us?’ It was only ten years ago that United Way began appealing directly to wealthy donors. Before that, rich didn’t give much to United Way but NO ONE ASKED THEM TO GIVE TO UNITED WAY.

“Thanks to the leadership of a few key people in Nashville, Tennessee — most notably Dr. Tommy Frist — an entire national program sprang up. Called the Alexis De Tocqueville Society, it has helped local United Ways target appeals to and successfully raise funds (minimum gift of $10,000) from people who have the means to contribute at this level. It then spurred a million dollar roundtable that has attracted million-dollar-plus gifts from people like Walter Annenberg, Jenny Craig, Bill Gates and others. And then it developed other programs which gradually step people up to the $10,000 level by first getting individuals of means to give $1,000 or $5,000. It radically altered the landscape for United Way and got it out of the mindset of asking for just one hour’s pay per month from people who actually have the ability to give far above and beyond that level. Giving by wealthy individuals is now the fastest growing segment of gifts to United Way growing at 15 percent or more most years.

“Rather than lamenting why the rich give so little…people should examine those successful programs charities have put in place that are working to expand giving by this important segment of our society.”

[My question: has it expanded giving, or shifted the money from one good cause to another? The IRS statistics show that high-income people claim a pretty steady 3% or so of their adjusted gross income as a charitable deduction, which is about the same as not-high-income people. — A.T.]

“By marketing the individual and society benefits of a charity — any charity from the local United Way to the pediatric ICU — to this target group, charities can successfully help increase giving from a group of people most likely to have the means to give. It won’t happen overnight. But charity has to be more than a field of dreams. Just because the Boy Scouts, the Urban League or the Red Cross are there, it doesn’t mean people will just give. THE RIGHT PERSON STILL HAS TO ASK THEM TO GIVE. (BTW — I used to be the national public relations director for United Way.)” — Tony

Hats off, for sure, to the people who ask. It takes time and courage. It’s never fun asking for money — whether a friend or an imposing wealthy stranger. I always try to remember to thank the people who ask, even when I say no . . . but it’s easy to forget, because next to asking people for money, one of the next least pleasant things is being asked. (Well, I take that back. It’s a pleasure to be asked when the cause is compelling, the planned use of your money sounds efficient, and the amount sought is easy to part with, whether for you that means $5, $500 or $5,000. But one or more of those conditions is often not met, and then being asked is not so much fun.)

*

“Your generous friend provides great insight into the penny pinching of the wealthy. It reminded me of this anecdote from For God, Country and Coca-Cola:

Notorious for his petty frugality, [Ernest] Woodruff saved hotel soap and strapped bulky bonds under his clothes to avoid paying freight charges on them. Once, while a porter awaited a tip, Woodruff fished unproductively through his pockets. ‘I have a quarter here somewhere,’ he muttered. “Mr. Woodruff,” the porter said, “if you ever had one, you still got it.”

“I think that touches on a seventh reason the wealthy do not give. They associate money not only with purchasing power, but with the power to build up, to influence, and to destroy. Power of that voltage is never relinquished easily, if at all. My guess is that that’s why most of the great charitable foundations have been established after these titans are in their dotage; in their prime, they are too attached to their thunderbolts.” — Dave Davis

“Please tell me how to look for stocks (their trend and what to look for). I would appreciate a reply. Thanks. Mr. Nayeem Aziz”

Nayeem, this is a question that only took you 21 words to ask but would take a book to answer. Suggestions: WHAT WORKS ON WALL STREET, by James O’Shaughnessy; Peter Lynch’s ONE UP ON WALL STREET or his more recent BEATING THE STREET; a subscription to INVESTORS BUSINESS DAILY, with the free William O’Neil book and tape that often come with it; or even MY book, which will discourage you from looking for stocks at all and steer you toward low-expense no-load mutual funds.

Do Ties Cut Off Blood Flow To The Brain? “Want to destroy a good programmer?” one of you wrote me last month. “Put him in a tie. Maybe it cuts off the blood flow to the brain?”

This touched a chord with Robert Brown, who responded as follows: “Several years ago I read of a study, I believe out of Cornell, which addressed this question. Using what is apparently a standard test for general mental attention, they had subjects indicate at what point they could no longer detect flicker in a rapidly flickering light. (Possibly analogous to clock speed on microprocessors.) Turns out subjects wearing ties lost track of the flicker significantly sooner than those with unencumbered jugulars. The proposed conclusion was indeed that neckties were restricting blood flow to the brain. Since I don’t have details on the study this probably needs to be considered an urban legend (or worse). But I must say I agree that my mental state is affected by my attire. (My favorite attire anecdote, which I think came from an old Dale Carnegie book, is about a woman with a terminal illness who had been in a ‘sanitarium’ for many years. As her condition was deemed hopeless she was sent home to die. Her only clothing for many years had been a drab hospital gown, so they bought her a brighter civilian outfit. The story goes that just putting on that new outfit so changed her whole outlook that she welled up with optimism, came back to life and returned to health.)”

So wear a cheerful tie. Thank you, Robert.

Charity and Taxes. This correction from Alan Levit: “I was interested to see that you described $90,000 as 10% after-tax to a family with a $500,000 income. I don’t see it quite that way. Let’s assume that the combined marginal state and federal tax rate is 50% (close enough for those of us in NY or CA). The family’s after-tax income is $250,000 if they contribute nothing, and $205,000 if they make the $90,000 contribution. The reduction is 45,000/250,000, or 18%. Let’s give those 90K contributors all the credit they deserve!”

He’s absolutely right, of course. At any tax rate, it works out to 18%. My tie was obviously too tight as I wrote that.

Piggy’s Kid Brother, Peeper. Previously, we learned a little about Paul Felix Warburg, known to all in the family as Piggy. He’s the one who got in trouble with his dad for investing in some cockamamie scheme that became known as “television.” Thanks to Dave Davis — and to his reading of Ron Chernow’s excellent family history, The Warburgs — we now learn that the youngest of Felix Warburg’s sons, Edward (nicknamed Peeper), had an early appreciation for modern art. In the summer of 1929, he took a trip to Germany and made an interesting acquisition. Chernow’s account:

“Having turned twenty-one in June, Eddie had inherited money from Grandpa Schiff [famed Wall Streeter Jacob Schiff]. A friend who worked in a Berlin gallery showed him Picasso’s BLUE BOY. This downcast, pensive figure enchanted the young Harvard undergraduate who plunked down seven thousand dollars for it. On the trip home, he worried about Felix’s reaction and decided to reduce the amount he had paid by half. When Eddie told the customs officer that he had paid thirty-five hundred dollars for the painting, the man gasped. ‘You bought a $3,500 picture? You mean you actually paid that for this? Sonny, I’m going down the dock, and when I come back, you change that figure to $1,000.’ Piggy was there to add comedy to the scene. ‘Thanks,’ he told the customs officer. ‘You see, we find it cheaper to let him do this than to keep him at Bloomingdale’s.'” Bloomingdale’s was a posh loony bin of the time.

In truth, if BLUE BOY would be worth $20 million or $40 million today, then it has appreciated at 12.5% or 13.5% from its 1929 purchase price. Nothing like the annual rate of gain most Americans expect from the stock market these days, but extremely brisk nonetheless.

Thought of another way, if a buyer in 1929 would have been satisfied with 6% annual appreciation, he could have paid $380,000 instead of $7,000 and still seen his investment grow to $20 million by 1997. And really, 6% is not so awful. But can you imagine the look on the customs guy’s face if he had declared a $380,000 purchase price?

Last month, one of the updates concerned this question of why those best able to afford to give money actually give less, in after-tax percentage terms, than everybody else.

A friend who makes several million dollars a year — and who has donated some of it to build a pediatric intensive care unit at a major university hospital — has pondered the question at my request and provides this considerable insight:

I have often wondered why (some) “rich” people don’t give to charity. Here are my conclusions. Most of these were learned when I solicited funds for the pediatric intensive care unit that I largely underwrote. Even with my underwriting, and offering to match two-to-one, this is what I found out:

1. Most people who are rich don’t think they are. They do not adjust to their new circumstances. If they started out poor, as did many, they are still into saving pennies, and cannot easily change their habits.

2. Many cannot connect the dots between the giving and results. They are too busy to do anything but work, and thus give to United Way or some other umbrella organization, and don’t feel the connection. Those who have the time, start the kinds of project I did. Mine came from a tragedy [the loss of his infant daughter], a catalyst I don’t wish on anyone.

3. Taxes. I am sure you will disagree here, but when taxes approach 50%, as they do in NYC, people feel they have “given at the office.” When only 50 cents of every additional dollar earned is retained, the thought of giving becomes less attractive. [Actually, I believe studies show that the higher the tax rates, and thus the tax “benefit” from a charitable deduction, the more people are inclined to give, “since it just would have gone to the government anyway.”]

4. Failure to identify. When I was in Eastern Russia, I could not get the money out of my pockets fast enough to give to the blue-eyed, blond children there. When I watch the local nightly news “perp walk,” or the Rwandan tragedy, I do not feel the same “pull” on my heartstrings that I do when I see kids who look like my kids. Notwithstanding our pediatric ICU serves mostly minority kids, it took me some time (6 months, day to day) to identify with them (their parents never came to see them). While this may sound racist, I feel there is a lot to it. People often give because “…there but for the grace of god…,” and they don’t identify with gang members, drug addicts or welfare mothers (even though the situations could easily be reversed — the thought is a tough one).

5. The Balkanization and Asianization of America. When people come from societies without a Judeo-Christian heritage, where “no work, no eat” is the norm, they are less likely to be “givers.” There is a surprisingly small amount of donations from Asians and Asian-Americans, relative to their success. The same for Hasidic and Lubovicher Jews in NYC (Balkanization). And for actors and actresses. (They will make appearances, but rarely donate cash, no matter how successful they are – see #1 above). I know my metaphor is a bit mixed here, but I hope you get the point.

6. The rapid pace of change, both technological and societal, makes people anxious, and enhances their perceived need for economic security. Storing chestnuts away for a long winter — a winter artificially lengthened by biotechnology for the Baby Boomers — may account for the growth in IRA’s and Mutual Funds. They are worried about a life after employment (sooner, rather than later) with no Government support, or at least none that they would like to think about.

Good reasons — but, my friend suggests, not good enough.

From John Dorgan: “As I’m sure you know, your advice regarding mutual funds is in stark contrast with the folks at the Motley Fool who say that mutual funds rarely keep up with index funds. They suggest buying numbers 2 through 5 of the top five dividend paying Dow Jones Industrials has yielded an annual growth of 22.23% over the past 25 years. Your comments would be appreciated.”

As long as you have some way of going back 25 years to start investing that way, you will definitely earn 22.3% compounded on your money. Whether this will work going forward is less clear.

Certainly, the idea of buying the highest dividend-paying Dow stocks each year has some appeal. The notion is that these companies, having made it into the Dow, are not, by and large, the type to go broke. So if you buy those with the highest dividends, you will (a) get the highest dividends, which can’t hurt, and (b) generally be selecting stocks that are out of favor (their prices have fallen to the point that the dividend, as a percentage thereof, has become relatively high). Things that go out of fashion have a way of coming back into fashion.

So there’s some logic to it, but I think there are lots of holes one could poke in it going forward. One is simply a tax problem (if you’re doing this in a taxable account). Index funds generate little by way of taxable gains. Rebalancing a “dogs of the Dow” portfolio each year, on the other hand, exposes much of the gain to tax. Say you could earn 20% a year taxably with this strategy going forward (which I doubt), but you’re in the 40% bracket, between federal and local taxes, given some blend of long- and short-term gains. That means you’re not getting 20% a year but more like 12%. After 25 years, the $1,000 you started with (say) would be worth $17,000. But earning “just” 15% in an index fund, and assuming for simplicity sake that none of it would have been taxed along the way (although the dividend portion, at least, would have been), your $1,000 would have grown to $33,000 — subject to capital gains tax if you sold the fund. How does a potentially-taxable $33,000 compare with $17,000 on which taxes have been fully paid? Well, at today’s 28% rate, plus say another 7% for state and local tax, you’d get to keep north of $21,000. So 20% with the “Dow dogs” might be less good, in a taxable account, than 15% with an index fund.

Of course, numbers like these — 20% and 15% — are extremely aggressive and optimistic. It’s much more likely both the Index funds and the Dow dogs will revert to much more modest returns. But however well they do, taxes are one item to consider.

Aside from taxes, what else might go wrong with the Dow dogs? Perhaps nothing. Or perhaps relationships will just change going forward. For the next few years, perhaps the Dow dog with the highest dividend, which the Motley Fools would exclude — it’s Philip Morris for 1997 — will really rock and roll, while the second through fifth, which the Fool suggests you favor, will do worse than the sixth through tenth — or worse than Berkshire Hathaway, say, which has also outperformed most mutual funds for the last 25 years (and without your having to pay taxes along the way).

As for your/their comment that most mutual funds rarely keep up with index funds — this is absolutely true, and a point I frequently make myself. That’s why I think super-low-expense index funds are a good choice for most people who want to put some of their money in the market.

But I’d also agree with those who think the big “index stocks” may have been pumped up even more than the rest of the market because so much money has been going into these index funds. I’m not sure we’re anywhere near the end of that, but would suggest looking at index funds that invest more broadly — or that invest abroad.

From a woman of good spirits and not inconsiderable means: “I wrote to you in April ’96 asking what I should do as I had an $11,000 gain on a $22,000 investment. You said sell, but I decided to be the pig and held on … all the way back to break-even. That’s one for the DUM, DA, DUMB, DUM file. But this year I’m going to try again. I subscribed to Investor’s Business Daily, read his book, listened to his tape and am still looking for the cup and handle on stock charts. He must have better eyes than I do. So, I have decided to begin with $20,000, which of course I fully intend to turn into $40,000 by year’s end. Just as an experiment. No more getting caught up in the Iomega crazes, etc., etc. So, wish me luck. I’ll let you know if it works.”

What’s your guess? Is she likely to turn $20,000 into $40,000 this year? Even with the benefit of William O’Neil’s book and tape?

The two things she has going for her — possibly three — that she wouldn’t have had 20 years ago:

Low Commissions. It used to be, brokers nicked you for 1% or 2%, coming and going, when you went to do a trade. In a world where stocks might be expected to average 9% a year in dividends and growth, going in and out a couple of times ate up your entire expected return. Today, you can trade for practically nothing. But note that the taxes involved in trading in and out are still there, as are “spreads” between bid and asked prices that are the less obvious transaction costs you have to pay to play.

A Bull Market. When the trend is up, everyone’s a genius. Twenty years ago, the market had been largely lousy for nearly ten years and would get lousier still before bottoming out five years later. That’s a long, long time for a lousy market. When the next bear market arrives, it will be quite a shock — of the long, drawn out, demoralizing kind — for a lot of people. When it will come no one knows. But the more years the market rises at way beyond a sustainable rate (like its recent annual 20% or 30% gains), the closer and deeper the bear market is likely to be.

Better Information. From your laptop, you can get S.E.C. filings and other such info all but instantly, just like the pros. But so can your competition. So unless you are the kind of investor who really does her homework, crunches the numbers, talks to the customers, and so forth, you are competing against an ever better informed investor. If you take the easy way, doing “research” by tapping into two-sentence tips from fellow speculators on any number of investment forums, you’ll have more fun but are just playing the horses. Or musical chairs.

From J.J.H.: “Do you have any advice for someone who followed your suggestion awhile ago (from The Only Investment Guide You’ll Ever Need, Revised and Updated) and purchased some shares in the Mutual Series Fund family (now that Heine Securities Corporation has been joined to Franklin Resources)? Although the individuals involved in the management of these funds have promised to remain with them for several years, can I expect to see any radical changes now that ultimate oversight is provided by Franklin Templeton? Is there an historical precedent I should be aware of when this type of takeover happens? Are there cautions you’d suggest?”

Well, I haven’t sold mine.

When The Only Investment Guide You’ll Ever Need was first published in 1978, it recommended only a handful of funds, including Mutual Shares (which in the years to come was joined by some Mutual brothers and sisters). It was only recently dropped from the “revised and updated” 1996 version in a printing subsequent to the one you apparently bought, because for new customers (only), the Mutual Series funds, recently acquired by the Franklin family of funds, as you noted, will charge a sales commission (or “load”) — and I only recommend no-load funds.

But for those of us lucky enough already to have shares in any of the Mutual Series funds, any future purchases will be grandfathered as no-load, so that’s not an issue for you or me.

I actually bought my first shares in Mutual Shares in 1976 or 1977 when my employer, New York Magazine, was acquired, and I needed a place to rollover my gargantuan retirement account. (It was around $5,500, if memory serves.) I put it into an IRA with Mutual Shares, and today, bless its little greedy heart, it’s grown to $125,000 or so. Yes, it was helped along by five or ten voluntary, non-deductible $2,000 contributions along the way (non-deductible because I was also contributing to a self-directed Keogh Plan). But I’m still more than pleased with the performance.

Interestingly, the genius behind Mutual Shares, Max Heine, died many years ago. But the young fellow he trained, Michael Price, did every bit as well as the master. Now Price is easing his way out (having just picked up $550 million in his sale to Franklin, with the chance for a couple hundred million more if things go well), but he has a cadre of key people he’s trained.

Will Mutual Shares do as well in the future, relative to other funds, as it has done in the past? Without Michael, maybe not. But I’d be in no great rush to sell on the basis of the merger, if I were you. And if I did sell, I’d retain a token position in the fund because, as I understand it, that will allow you to reinvest in any of these funds in the future without having to pay a load.

PS — For more, you might want to read Fortune’s excellent take on Michael Price and his lieutenants.

If you were born in 1947, like me, you’ve probably spent most of your life hoping for things that seemed impossible. Nuclear disarmament, freedom in Eastern Europe, an end to apartheid, democracy and free trade throughout much of the world, cheap air fares, fat-free cheese. Also: low interest rates, low inflation, a bull market, declining crime rates, low unemployment, declining deficits. Not to mention a country at least a little closer to judging its citizens based on the content of their character rather than the color of their skin. (Happy Birthday, Dr. King.)

Needless to say, there’s a long list of problems, too. But those are for the next 1,460 days. Today is a day to enjoy a little — even if you preferred the other guy.

With the departure of Malcolm Forbes some years ago, a man who virtually defined “joi de vivre” for many of us, even those of us a little unsure how to spell it (I took Russian), one might have expected interest in ballooning to fade from the scene. But now come three — count ’em, three! — sets of madmen (the maddest of whom is a set of just one guy, solo, with no pressurized cabin) who propose to circumnavigate the globe by balloon.

I am no stranger to hot air. And I have even inhaled a lungful of helium or two. It makes you talk like this. But to risk one’s life just to end up approximately where you started? When Magellan tried it by boat, he was killed by natives, but at least he proved the earth was round and got a hell of a mutual fund named after him. But now we know the earth is round — smoother than a bowling ball, they say, despite Everest and the Empire State Building — so why is Virgin Atlantic’s Richard Branson leading one such expedition, with two other lesser knowns in hot pursuit? Why risk getting shot down by the North Koreans?

OK, OK, it’s thrilling. To read more about it all, click here.

But why am I telling you this? It is because I hold in my hand a letter written in 1878 by the famous French balloonist Louis Godard to the Mayor of Avignon. Or at least I hope he was famous. When I bought it, I just sort of assumed he was the Godard for whom the Goddard Space Center was named, but now suspect that it was named for the American rocket scientist Robert Goddard, with two D’s. And I just sort of assumed he was famous because, well, I knew the name Godard (Jean Luc Godard, perhaps, the famous French film director?).

But he must have been famous, because look at his letterhead. It’s festooned with engravings of Godard balloons, “with joyous and excited clients as well as professional entertainers and daredevils suspended in some fashion from these wondrous contraptions” (as the catalog copy had it).

I should point out that not quite 120 years after he wrote this letter you could, for the price of a sandwich, pull a phone (the prototype having been invented by Alexander Graham Bell in 1876, just two years earlier) from the seatback in front of you, slide your credit card through, and make a call from 37,000 feet as you make the 4.5 hour trip from JFK to LAX.

But in 1878 — as today — people were enthralled by balloons, and Godard was haggling with the Mayor of Avignon over prices. “Mr. Mayor,” he wrote, “The price quoted you by Montbrison for 800 francs is correct, but that was for an ascent in a Montgolfier in which a descent is made 5 minutes outside of town — which is of interest to no one — and in which an ascent is made to a height of 200 meters.” [Ninety-one years later, man would walk on the moon, but I digress.] “If I have not asked for more, it is because I was pressed not to charge more, but ordinarily these are not my prices.”

Whereupon he lists:

“A simple ascension in a 280 cubic meter balloon capable of carrying the aeronaut — 100F. The cost of gas and travel costs to be borne by the city.” [The first automobile was about a decade away, so gas would presumably have been for the balloon.] “Ascent with a trapeze exercise suspended by one hand — 1,000F. Ascent with a parachute descent — 2,000F and the balloon containing 900 cubic meters of gas carrying 4 persons.” [You might wonder what parachutes were for given the stark absence of airplanes in 1878. Yet they were, apparently, for balloons — the first successful jump from “a great height” — 920 meters — having been made in 1797 by another Frenchman, Jacques Garnerin. I’m going to get my money’s worth from the multimedia encyclopedia that came with my new computer if it kills us.]

“I would suggest to you also to take for 100F some balloons of 5 meters’ height which will descend some 15 or 20 leagues from the city, bearing the names of the cities which commissioned the flight, the letters 50 centimeters in height and each balloon carrying 5 parachutes dropping toys and hard candies — which are a very nice accompaniment to an ascent. I would make a dozen for you if you accept.

“So, Mr. Mayor, there are my prices. If by the end of the week I have not received your answer, I shall consider the matter closed. Please accept, sir, the expression of my deepest respect. Godard, Aeronaut for the Government.”

A hundred years from now, when Bill Gates’ ideas are going to be considered quaint, and today’s Pentium-powered notebooks objects of amusement, will some wiseass autograph collector be quoting his handwritten letters? I think not. Unless I miss my mark, Bill Gates is an e-mail kind of guy.

(Where do you find letters like this? There’s a list of them printed every day. No, wait. That’s NASDAQ. You find these letters via dealers and auctions).

Next Week: What of Mutual Series Now? and Playing the Fool