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.

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