This Thanksgiving holiday, Cora and I will pretend to purchase sixteen live turkeys at $25 each (which is about the going rate for a frozen one in urban markets). We want to see how these birds respond to four different environments over the next decade. This experiment will illustrate how these different holdings provide varying results, both for turkeys and for our investments.

These turkeys should, if all goes well, still be alive at the end of this experiment. Their value should increase, also. They will be grouped into four groups of four birds, so we'll invest $100 in each group for a total of $400. We'll check on them several times a week, so we can avoid major catastrophes if possible (although the first group might be hard to track):

1. The first four turkeys will reside in high-risk environments. The enclosure is vulnerable. Better yet, these might be free-range birds.
   
   
2. The second group will reside in a more secure holding; therefore, we will presume these turkeys will also experience less risk to their survival than the first group.
   
   
3. The third group will reside in a much safer environment than the first two groups. This holding is much more rigid.
   
   
4. These final four turkeys are pampered, because they will languish within a huge structure that is very, very safe. In fact, the last two groups are exceptionally secure, because they've been insured, and we usually can't touch them without being penalized. If something happens to one of the original four turkeys in #3 and #4, they will be "magically" replaced.

We'll base our turkey survival rate on percentage rate increases derived from four different financial tools from 1926-1999.1 Although there's absolutely no guarantee these figures will repeat themselves, these estimates are all we have to work with at the moment. In addition, the time frame is compressed for this experiment, and we cannot predict what will happen in the future, so the following figures could alter drastically. The percentage rates may be much higher or lower because of changes in the market for turkeys and other investments.

That said, the first group of turkeys will increase in value by 12.6% (0.126) per year. The second group will increase by 11.3% (0.113) per year. The third group will increase by 5.6% (0.058) per year, and the fourth group will increase by 3.8% (0.038) per year. The percentage per year is called the Annual Percentage Rate, or APR.

The formula we use to determine our outcome is: P x (1 + APR)^Y or our initial Principle of $100 per group times (the year following the ten-year experiment + Annual Percentage Rate) squared by the number of Years we hold the turkeys. We hope to see the first group increase by 12.6% (0.126) that first year; therefore, that 12.6% is applied to a figure of $112.60 for the second year total ($100 x 0.126 = $12.60; $100 + $12.60 = $112.60).

However, we can't just multiply $112.60 by 10, because we're dealing with compound interest. The third year would be $112.60 x 0.126 = $14.19; $112.60 + $14.19 = $126.79, and the following year would be $126.79 x 0.126 = $15.97; $126.79 + $15.97 = $142.76. We can do several different calculations like this and come up with the same results shown below, but it's much easier to square the equation by ten on our calculators. According to the above APRs, when we gather our turkeys in the eleventh year we expect them to be worth the following:

When we add these four totals and subtract the $400 principle, our profit equals $536.98. "Wait a minute," you might exclaim, "those calculations don't look right! Why would safe and pampered turkeys generate less profit than high-risk turkeys?"

Good question. Keeping in mind that not all investments are turkeys, group #1 represents small-company equities, and group #2 represents large-company stocks. Group #3 represents traditional corporate bonds, and group #4 represents traditional treasury bills. These four groups often comprise a healthy and diversified investment portfolio.

Although the first two groups present higher risk because their environments are less secure, they can also represent higher returns on investment. If they manage to survive the wilds, they will be strong birds. Other investors will want these turkeys, and our investments will increase in value. We like that. The other birds are necessary to balance risks inherent in the first two groups, because the last two groups are guaranteed to come back to us with interest, even if it seems a pittance. If our free-range turkeys are mauled by large mammals or reckless drivers, the loss of a few birds doesn't mean a total loss of investment when we diversify.

The possibilities presented by risk are varied, as any of the turkeys within the first two groups can mature into gigantic white swans (worth much more than turkeys, according to Cora), disappear into the great unknown, or sit in the same spot for the next ten years. Our risk levels decrease if we purchase smart, healthy birds. We also need to keep an eye on these investments so we can help them mature. If one bird contracts a fatal disease, we can remove that turkey before it infects the other birds. In addition, if we purchase our equity investments through BUYandHOLD, we bypass brokerage costs. That last move is not a risk. It's just plain smart.

Cora and I hope you think about all this when you carve into your turkey this weekend. That twenty-five dollar bird represents a monthly payment in your BUYandHOLD portfolio (we are SO persistent). We also hope you have a safe and happy holiday.

Until Next Week,
Linda Goin

1. These average annual return rates include both increases in price and any dividends or interest. Between 1926 and 1999, small-company stocks increased 12.6%, large-company stocks increased 11.3%, traditional corporate bonds increased 5.6% and traditional treasury bills increased 3.8%. Source: Stocks, Bonds, Bills & Influence 2000 Yearbook^tm, Ibbotson Associates, Chicago.