Sunday, April 6

Week 144 - An All-stock Savings Plan with no Transaction Costs after Initial Set-up

Situation: Here at ITR, we recommend that you plan for retirement by using workplace savings plans supplemented with an IRA composed of online dividend reinvestment plans (DRIPs), i.e., stock in companies that reliably grow their dividends. (Your accountant needs to declare to the IRS that those DRIPs are IRA investments, and you need to stay within the annual limits for IRA investments.) The reasons behind using DRIPs are to minimize cost and risk, since those are the factors that most often trip up investors by eating up returns. This week’s blog takes that idea to its logical conclusion by presenting DRIPs that have no ongoing costs after initial set-up. In other words, the company is paying all of the transaction costs as a way to retain your loyalty. But you might ask, “How does that help me reduce the inherent risk of owning stocks?” That’s the compelling part of the story, because the few companies that are willing to cover your expenses happen to be some of the same companies that we routinely highlight for reducing investor risk over the decades. 

What’s not to like? Well, there are very few such companies. We’re aware of only eight (see Table). The DRIPs for all but 3 of those are serviced by computershare with the 3 exceptions being Hormel Foods (HRL), 3M (MMM), and General Mills (GIS), which are serviced by Wells Fargo. Navigating those websites to discover the option that saves you from paying ongoing costs can be a little tricky. For example, it costs a dollar a month to purchase JNJ shares automatically by having the investment dollars taken from your checking account, but if you go into the website to make a purchase each month, it’s free. 

You’ll notice that 3 of the 8 companies are from the “consumer staples” industry (HRL, GIS, PG). For this reason, we have added an exchange-traded fund (ETF) for that industry to our BENCHMARKS for comparison: VDC. Why do companies in the consumer staples industry do so well? After all, these mature companies have long produced boring products that offer little opportunity for innovation. Where have you heard this before? Oh, yeah! That’s the kind of company Warren Buffett likes. In other words, companies that sell "essential goods" don’t have much to worry about during a recession, and quickly recover from their small losses when the recession ends.

Bottom Line: Company CEOs tend to overlook costs during a bull market but then find they have to rigorously control costs in order to survive a bad recession. Many more of their employees will have to be laid off than would have been the case if those CEOs had rigorously controlled costs during good times. It’s a problem of human nature, not capitalism. We all feel expansive when our savings grow expansively, viewing costs as a small fraction of our gains. But as investors, costs are the only expense we can control (we certainly do not control inflation or taxes). Why not minimize transaction costs and management fees to the extent possible? After all, the average investor gives up over 2% of the net asset value of her holdings each year to those charges. Let’s take a hypothetical example: You’re 70 yrs old now and at age 20 you invested $5,000. If your assets were under management, those assets were documented to have had an average growth rate of 7%/yr over the next 50 yrs. Accordingly, you should have $150,000 to spend. But wait, there’s only $58,500 in that account because you paid an average of 2%/yr for each of those 50 yrs in transaction costs and management fees. Inflation averaged 4.1%/yr, so now you’re left with only 0.9%/yr in real gains (7 - 2 - 4.1 = 0.9). And that isn’t even accounting for taxes. Instead, we suggest that you try online DRIPs that have no ongoing transaction costs or management fees, and charge minimal fees for initial set-up and final sale.     

Risk Rating: 5, unless investment in each of the riskier items (XOM and MMM) is offset with an equal investment in inflation-protected Treasury Notes or Savings Bonds at treasurydirect, which brings the risk rating down to 3. 

Full disclosure of my current investment activity as related to companies in the Table: monthly additions to DRIPs in XOM, PG, JNJ, ABT, and NEE.

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