MY SMART COUSIN THE TORTOISE

I have three cousins, and the oldest and youngest are so different that it's hard to believe they come from the same parents. The only thing they have in common is an interest in the financial markets. The oldest thinks he's astute in the equity markets, while the youngest feels he can accurately predict interest rates.

Four years ago they each inherited $100,000 from their grandparents and were anxious to make their money grow. The oldest cousin invested aggressively in the stock market and had a couple of pretty good years. In his first year his portfolio was up an impressive 80%. His second year wasn't as profitable - he was down 50%. He rebounded in the third year with a 20% increase and last year he was down only 5% in a very bad market. My uncle was very proud of his oldest son.

The youngest had trouble predicting interest rates. He continued to believe rates would rise, so he parked his money in a tax-free money market and averaged about 3% over the last four years. My uncle was not so proud of him.

Look closely at the numbers

But, as I told my uncle, you must closely analyze the numbers. The value of my oldest cousin's portfolio after one year was $180,000, after two years it was $90,000, after three years it was $108,000 and after four years it was $102,600.

My youngest cousin turned his $100,000 to $103,000 after one year, $106,090 after two years, $109,273 after three years and $112,551 after four years.

Who profited the most? My middle cousin, who came to me and bought insured tax-free bonds at 6%. Not only did she outdistance her brothers by accumulating $24,000 in tax-free income, but because interest rates declined over the period,  her bonds appreciated to $107,000.00, bringing the total value of her holdings to $131,000.

The tortoise still wins

My uncle was surprised at the relative success of my cousins because he forgot simple arithmetic: if you buy a stock for $100 per share and it falls 50% to $50 per share, it will then take a 100% gain just to get back to where you started. In other words, it's easier to roll downhill than it is to climb back uphill. This fundamental point is often overlooked as we watch the extreme gyrations in the equity markets.

The axiom is still true: if you're a long-term investor looking for a safe, secure investment whose returns are guaranteed, tax-free bonds should be an important part of your portfolio. You will profit regardless of the economic climate - and perhaps teach your siblings a thing or two.