Sunday, February 23

Week 138 - 20 Retirement Stocks for You to Consider, and Why

Situation: Owning 8 or 10 stocks in your Personal Retirement Plan can feel a bit weighty, so why do it? The main reason is that after you retire your take-home pay (dividend checks mailed to your home) goes up twice as fast as your expenses. But how can that be, you might ask? Well, if you invest $75 a month for 15+ yrs into an online dividend reinvestment plan (DRIP) for stock in a company that has increased dividends annually for 10+ yrs, you’ll build up a tidy sum. The tax rate for dividends is 15%, or 20% if you’re in the highest bracket, and the transaction cost for having a dividend check mailed (or electronically transferred) is typically less than 1% for DRIPs if you use computershare. That comes to 16% in fixed costs. Your only variable cost is inflation (historically 3%/yr). So, you’ll get to call ~81% of a dividend check "profit" (i.e., return on investment). But the cool thing is that the amount of future checks will grow at a rate of 5-25%/yr (see Column H in our Table). And, if the rate of inflation grows more than usual, so will the amount of your dividend check. 

What’s not to like? Mainly, you have to take great care in choosing which stocks to include in your DRIP portfolio. Here at ITR, we give only 20 companies our *Retirement Stock* Award. Our method is to “winnow down” the list of 146 Dividend Achievers. Remember, that’s Standard & Poor’s designation for companies that have increased their dividend payout annually for 10 or more years. Look at Column C in the Table. There you’ll see that the 20 *Retirement Stock* companies at the top have returned ~8%/yr more to investors since the last market peak in 2000 than the S&P 100 Index (OEF) at the bottom. That tells us what a difference dividend growth makes. 

We take 3 additional steps to remove stocks from the list that are too risky for inclusion in a portfolio designed to last ~40 yrs:

Step #1: Exclude any company that isn’t on the Barron’s 500 List. Why? Because that list ranks companies by the record of growth over the past 3 yrs in cash-flow based return on investment, and the most recent year’s sales growth. Once a company is on the list, it is unlikely to fall off. The list is a remarkable summation of the ability of a company’s managers to execute on a sustainable Business Plan. If a company isn’t on the list, you have received a clear message: don’t make a long-term investment in that company’s stock.

Step #2: Exclude any company that has less than an A- credit rating from S&P. Why? Because the risk of owning stock in a company = the risk of bankruptcy. You’ll lose your entire investment, without recourse. When investing retirement income from quarterly dividend checks, you don’t want to risk the loss or reduction in that income that would be posed by owning stock in companies that aren’t A-rated.

Step #3: Exclude any company that isn’t in the S&P 100 stock index. Why? The biggest companies are in that index, and they’re too big to grow earnings fast. But they all have more than one line of goods or services, and they all maintain reserves that will tide them over during a prolonged recession. That’s the reason to choose your DRIPs from that Index. Many of these companies have the size, the flexibility, the balance sheet, and the ability to ward off competitors that makes it possible for them to increase their dividend every year without interruption.  

Bottom Line: This week’s blog is about dividend growth rates (Column H in the Table). The 1% of companies that increase their dividend annually provide a unique opportunity for long-term savers to make a real profit (return on investment) after accounting for transaction costs, taxes, and inflation. Some investments, like a home mortgage and “whole” life insurance, have value mainly because they force you to save. Others give you the chance of making a big profit offset by a similar chance of taking a big loss (commodity futures, non-dividend paying stocks, emerging market stocks, gold). Investment-grade bonds protect you against loss during an economic recession but then present you with a risk of loss during an economic expansion. 

Academic studies have shown that investors stand the best chance of doing well in the stock market if they focus on owning dividend-paying stocks. Here at ITR, we take that a step further by focusing on Dividend Achievers (10 or more yrs of increases) and Dividend Aristocrats (25 or more yrs of increases). Those companies typically have a sustainable Business Plan that blocks out competitors so well that earnings increase much faster than inflation and taxes. Each chooses to return 20-50% of its earnings to stockholders as dividends. By owning stock in several such companies, you can expect part of your retirement income to beat inflation every year, whereas income from pensions and annuities (other than Social Security, which contains a cost of living adjustment) will have less buying power. If you retire at age 62 and inflation averages 3% thereafter, the buying power of your income from fixed-rate pensions and annuities will have fallen 60% by the time you’re 92. 

Risk Rating: 3

Full Disclosure of related investment activity: I dollar-average into DRIPs for WMT, PG, KO, ABT, JNJ, IBM, and NKE.

Post questions and comments in the box below or send email to:

Sunday, February 16

Week 137 - Be Careful! Retirement Options Can Change Drastically After Divorce

Situation: There was a great discussion related to divorce after the age of 50 on NPR (here’s the link if you’d like to read it). There is even a new term coined! It’s called “Gray Divorce.” The reason we remember this NPR show is due to one particular statistic. In 2009, one in four persons who divorced was over the age of 50. Why is this information showing up in a blog about investing? Because if you are among the Gray Divorced, and you live in a state where marital assets are divided 50:50 in property settlement agreements, then your retirement savings just took a direct hit with a 50% loss. If you’ve been following this blog for very long, you also know that recovering from such a loss when you are beyond the age of 50 is going to be impossible for most people. Today’s blog is going to be a case study on managing divorce after age 50 and calls for focused attention on personal finances, so that you’ll have at least some resources available after the age of 70.

In our case example, we will discuss the circumstances of a wife who was a homemaker and caregiver for almost 30 years. She quite probably has at least some college, maybe even a degree, but in all likelihood her job skills are out-of-date. When her divorce property settlement was determined, she found out that there were some retirement monies saved but there were also bills and lawyers fees that had to be paid. If her husband was making $80,000/yr, she could receive $40,000/yr of alimony for let’s say 5 yrs but that money may not go very far after monthly bills are paid. Let’s see, if you estimate 20% in taxes, then $40,000/yr becomes about $2,700/mo to live on and pay bills. Frequently, a family home will be sold to pay debts and divide the equity but in the past few years many mortgages have been underwater, creating even more financial nightmares.  Quite probably our Gray Divorcee is now living in an apartment and will have to find a  job. 

Most of us understand already that 50 is a watershed year for retirement plans. By reading information on the internet related to retirement planning, one quickly realizes that to remain on target, by age 50 one should already have four times her salary stashed away in retirement plans. And, even though the kids are on their own, many will face financial needs, including help with a down payment for a home or paying college bills.

The task is daunting at best and overwhelming at worst. How to get started? Let’s begin by writing down a plan. First of all, look at yourself as a complete and whole person. Examine your personal relationships, identify those that are fulfilling and energizing, and find ways to be more involved with your neighbors and community. Secondly, build and strengthen your spiritual practices. Thirdly, get fit, eat healthy, sleep soundly, and keep your medical appointments.

The next area to examine will be finding a job, brushing up on your job skills, perhaps even taking a college course two evenings a week. While jobs in retail can be relatively easy to turn up, and can be a way to start back to work, there are a number of reasons why those jobs are not your best long term option. Those reasons include poor or no benefits, as well as unfavorable scheduled hours. Better jobs are to be found in healthcare, education, or industry. Use your acquired people skills, maturity, and work ethic as selling points. You can turn your community, school, and church organizational activities into a job reference by having an upstanding member of the community write you a letter of reference. And keep knocking on doors! Don’t take “no” for an answer!

Now we are at the heart of this blog’s discussion: what about my financial situation? How do I pay bills and pull off retirement savings at the same time? We strongly recommend keeping two separate savings plans, each with a different function. Firstly, set up a “slush fund” that is to be used for emergencies. Secondly, develop a separate fund that is for retirement. The slush fund will probably see several withdrawals occur over the next few years so having it based in a savings account at your bank makes sense. “How much money do I set aside for the slush fund?” We recommend that you start by creating a budget. Make a list of everything you spend money on for one month then categorize and add up the amounts. Monies left-over at the end of the month, or monies spent on non-essentials, are candidate dollars for savings. Later, when the account builds some value, there are better options to consider than a savings account, and those involve learning some rudimentary investing skills (see Week 15, Week 33).

Now on the subject of the retirement plan, we suggest putting in place two particular practices. The first is that of secrecy. Shhh! Don’t talk about it, and just forget that the money even exists. The nest egg you are creating is for the future, when you are fully retired. By forgetting that it exists now, you avoid the temptation to spend it. Emergencies are why the slush fund was created. And this ties in to the second practice we recommend adopting, that of discipline. It will require discipline to set aside retirement money and not spend it. It will also require discipline to add a monthly amount to the slush fund for use in emergencies.

There are a variety of forms that your retirement plan can take (see Table). The simplest discipline is to put $50/mo in your fund as an automatic deposit from your checking account. We recommend that you use one of the lowest-cost and lowest-risk “balanced” mutual funds: Vanguard Balanced Index Fund (VBINX) or Vanguard Wellesley Income Fund (VWINX). Those are safe and well-managed funds but a potential drawback is that Vanguard requires you to open your account with a $3,000 initial deposit. If you can’t swing the initial deposit, an even easier way is to buy stock in a AAA-rated corporation and set up a dividend reinvestment plan (DRIP), with zero ongoing costs at The companies we suggest you look at first are Johnson & Johnson (JNJ) and Exxon Mobil (XOM), and you can open your account for no more than the $250 initial investment followed by monthly $50 withdrawals from your checking account in the case of XOM. With JNJ, that automatic feature costs $1.00/mo but you can do it yourself at no cost by entering the website and making a $50 purchase each month. 

Never heard of a DRIP before? It stands for Dividend Re-Investment Plan. It automatically reinvests quarterly dividends by purchasing more of the same stock automatically (and typically at no cost to you). The reason why we recommend you use a DRIP is because 40% of the total returns from stock purchases come from reinvesting the dividends. More importantly, the companies we highlight in our blog grow their dividends approximately 10%/yr, regardless of economic conditions. As a retiree, you won’t be reinvesting dividends; instead, you’ll opt to receive the quarterly checks in the mail. In other words, YOUR PAY will be growing around 7%/yr faster than inflation.

Even though you start your Personal Retirement Plan at $50/mo, we strongly encourage you to constantly re-evaluate your spending and try to keep bumping the $50 upwards. What would $50/mo going to JNJ over the next 20 years give you, assuming 3% inflation and 15% taxes on the quarterly dividend payments that you re-invest? In other words, where does 5%/yr of real profit leave you in today’s dollars? The answer is $20,857, and by then you’d be receiving about $600/yr in dividends (which is the same amount you would have been putting in each year) that will grow faster than inflation. Looked at a different way, if you’d started investing $100/mo in JNJ 11.7 yrs ago (Table), you would now have a nest egg of $26,560. 

As you become more comfortable with your savings plan, you will eventually want to add a DRIP for the highest-quality electric utility: NextEra Energy (NEE). A savings plan made up of those 3 stocks, XOM, JNJ, NEE, will give you a profit (after inflation and taxes on dividends) of 6%/yr over time. Another sound practice is to have some retirement money in 10-yr US Treasury Notes. Those won’t leave you with any profit (after taxes on interest and inflation) but that asset class does increase in value during a recession. Recessions are a tricky time, particularly for those of you who are getting close to retirement age. Why? Because that’s when it is easy to get caught short of cash. You might be laid off, your kids might be in a bind, etc.. You don’t want to sell stocks to raise cash, because the stock market goes down an average of 31% in recessions. So sell your Treasury Notes.

Bottom Line: Life after divorce requires that you manage your money properly, and becoming a Gray Divorcee after age 50 doubly requires you to pay attention to retirement savings.

Risk Rating: 3

Full Disclosure: I purchase 10-yr Treasury Notes quarterly and contribute monthly to DRIPs in XOM, NEE, and JNJ.

Post questions and comments in the box below or send email to:

Sunday, February 9

Week 136 - How to Invest in the Growing Perpetuity Index

Situation: What is new that can we say about our Growing Perpetuity Index (see Week 118, Week 80, Week 66, Week 32, Week 4)? For one thing, we can explain those 12 companies came out of the Stockpicker’s Secret Fishing Hole (Week 68, Week 29), our name for the Dow Jones Composite Index of 65 stocks. Those are mainly “old line” companies that build things, move things, and provide electricity although some trendy companies (Nike, Visa, and Walt Disney) were recently added to better reflect the post-industrial economy. Still, Warren Buffett looks first to invest in old line companies that are well-established and have a wide moat to fend off copycats, e.g. his two largest purchases for Berkshire Hathaway in recent years were MidAmerican Energy Holdings and Burlington Northern Santa Fe. For another thing, we can explain how you might invest in the 12 stocks of the Growing Perpetuity Index while keeping costs under 1%.

When we started the ITR blog 3 years ago, we looked at the 65 companies in the Dow Jones Composite Index and cut that list down to those that were Dividend Achievers--Standard & Poor’s name for companies that have raised dividends for 10+ years in a row. Then we picked companies with a market capitalization greater than $10B that paid at least a 2% dividend and increased it at least 7%/yr. We called that list of 12 stocks our Growing Perpetuity Index because the companies posed no material risk of a) bankruptcy individually, or b) failing to raise dividends at least 9%/yr collectively. For a retired person who depends on quarterly dividend checks for much of her support, those are the main concerns.

Looking at the list (see Table), we see 6 hedge stocks (see Week 126): JNJ, WMT, PG, KO, MCD, NEE. Those carry so little risk of crashing during a recession that they don’t need to be backed 1:1 with 10-yr Treasury Notes. To have an investment plan for the Growing Perpetuity Index, 18 items need to be listed (bottom of Table): 6 hedge stocks, 6 risky stocks, and 6 T-Notes to back the risky stocks. There are dividend reinvestment plans (DRIPs) for all 12 stocks; 10 through computershare; NSC is purchased through American Stock Transfer & Trust Company and MMM is purchased through Wells Fargo. The ongoing cost for these 12 plans comes to $11/mo (Column N in the Table). Treasury Notes cannot be set up for automatic purchase or dividend (interest) reinvestment; you’ll need to enter the site each month or quarter to buy your T-notes (either the inflation-protected or standard version) and reinvest accumulated interest into Savings Bonds (either the inflation-protected or standard version). The Table has an example of investing $1800/mo ($100 per item) that carries far less risk than our benchmark (VBINX): losses during the 18-month Lehman Panic came to 8.2% for our plan vs. 28% for VBINX; the 5-yr Beta for our plan is 0.47 vs. 0.93 for VBINX. Long-term total returns for our plan (Column C) are slightly greater than for VBINX after subtracting 0.6% for the transaction costs of our plan, i.e., the “expense ratio” of $11/mo in transaction costs divided by $1800/mo invested = 0.61%. If you cut the monthly investment for each item from $100 to $50, the expense ratio is doubled (1.2%) and VBINX would come out ahead.

Bottom Line: You can invest in the Growing Perpetuity Index online (using appropriate hedges) and get the same rewards as you would by investing in our benchmark (VBINX) while exposing yourself to much less risk of loss in a recession. Safety needs to be your watchword now that we all know how fast a 401(k) plan can turn into a “201(k)” plan.

Risk Rating: 3

Full Disclosure: I dollar-average monthly into DRIPs for WMT, KO, PG, JNJ, NEE, IBM, and XOM, and hedge expenditures for IBM and XOM with equal expenditures for 10-yr Treasury Notes.

Post questions and comments in the box below or send email to:

Sunday, February 2

Week 135 - There are 42 Companies in the S&P 500 Index with a Durable Competitive Advantage

Situation: This blog is dedicated to the idea that the best way to save for retirement is to invest in stocks of companies that have a long history of increasing their dividend ~10%/yr. That places us in the “value” camp, which carries with it a need to minimize transaction costs. We recommend that you purchase stocks online, dollar-averaging into a dividend reinvestment plan (DRIP). But let’s not forget the “growth” camp, where the idea is to avoid owning stock in companies that make significant dividend payouts. Why? Because that is a waste of free cash flow and represents double taxation (company + shareholder). So, we periodically put out a blog like this week's that screens for companies likely to have sustainable growth. Few such companies pay a good dividend and most have a 5-yr Beta in the red zone, but some are appropriate retirement vehicles.

We use Warren Buffett’s approach (see Week 94 and Week 59), which is to find companies that have grown their Tangible Book Value steadily over the past 10 yrs (with no more than 2 down yrs). If that growth meets the "business case" of doubling the initial investment inside of 10 yrs (i.e., a total return of +7.2%/yr), the company is said to have a Durable Competitive Advantage (DCA). Then, we calculate the compound annual growth rate (CAGR) for "core earnings” over the past 8-10 yrs and extrapolate that line to give an estimate of earnings 10 yrs from now. Over that future decade, we then assume that a) the P/E remains stuck at the lowest level seen in the past 10 yrs and b) the company is unable to raise its dividend (if it pays one). Juggling those numbers gives a conservative estimate for the stock’s price 10 yrs from now. Comparing that to today’s stock price gives a projected total return/yr, termed the Buffett Buy Analysis (BBA). Those 3 metrics (DCA, CAGR, and BBA) are in columns F, G, and H of the Table. You’ll notice that there are no values under 7.2%/yr. All of the companies are creditworthy, i.e., have investment-grade bond ratings or get less than 1% of their total capitalization from long-term bonds.

Many of the companies (i.e., 15) are linked to the extraction of raw commodities, and we’ve broken those out as a separate category at the bottom of the Table. Red highlights denote metrics that underperform our key benchmark for a retirement savings plan--the Vanguard Balanced Index Fund (VBINX). Red highlights are also used to warn you away from the 10 stocks that Standard & Poor’s considers to be high risk (Column I in the Table). Long-term total returns in Column C date to 9/30/02, which is when the stock market bottomed in the “ recession.”

It is remarkable that we can still identify 42 companies with a DCA, the same number found the last time we did this exercise (see Week 94). Why? Because when the stock market is overpriced like it is now (in anticipation of higher earnings "just around the corner"), the price we project 10 yrs from now often isn’t that much greater than the current price, i.e., the total return/yr (BBA) will be less than 7.2%/yr. Note that some stocks appear in all 3 of our DCA blogs: AAPL, QCOM, FAST, CERN, FLIR, TROW, EXPD, COH, ROST, XOM, HP, DO, CAM and NOV

Bottom Line: If stocks excite you enough to take away all fear of market crashes, then our  3 DCA blogs will be your favorites. Invest heartily and prosper. But hold "growth" stocks in a different account from your retirement savings, except for those that also appear in our "universe" of 55 companies geared to retirement plans (see Week 122). This week's Table has 8 such companies: MON, PX, CVX, XOM, WMT, ROST, SYK, MSFT. Three companies are notable in meeting high criteria for overall investment value, i.e., Long-term Finance Value (Column E), recent acceleration in growth of sales and cash flow (Column J vs. Column K), and an S&P stock rating of A- or better (Column I): Monsanto (MON), Ross Stores (ROST), and Baxter International (BAX). 

Risk Rating: 7

Full Disclosure: I have stock in WMT, CVX, XOM, ACN, MON, and MSFT.

Post questions and comments in the box below or send email to: