Sunday, August 10

Week 162 - A “Rainy Day Fund” Using DRIPs That Don’t Have Transaction Costs

Situation: We all have occasions when we need to use our Rainy Day Fund to meet non-recurring capital expenditures. Afterward, we hope that our regular contributions will replenish it before we’re blind-sided again. That Fund needs to have some dividend-paying stocks in it, as well as inflation-protected Savings Bonds that can be cashed anytime without risk of loss (at treasurydirect). Why stocks? If chosen well, they’ll grow in value somewhat faster than Savings Bonds, as long as dividends are automatically reinvested. But when the market is down, you don’t want to sell those stocks at a loss. Instead, a better choice is to cash in some Savings Bonds. But the kind of “safe” stocks that are suitable for the Fund don’t grow very fast, so you need to 1) minimize expenses by using an online dividend reinvestment plan (DRIP), and 2) find DRIPs that are cost-free.

The trick is knowing which stocks to pick. This week’s Table has one stock for each of 4 essential industries: healthcare, consumer staples, utilities, and energy. Those 4 stocks are: Abbott Laboratories (ABT), Procter & Gamble (PG), NextEra Energy (NEE) and Exxon Mobil (XOM). In the next bear market, these should hold their value relatively well. DRIPs for all 4 can be obtained through computershare at essentially zero purchasing cost. There are no fees for either the initial set-up of automatic monthly purchases or for dividend reinvestment. Well, there is one exception to that bold statement. Procter & Gamble has a “processing fee” of two cents a share for purchases. The minimum amounts permitted for each automatic monthly investment are: $25 for ABT and inflation-protected Savings Bonds, $50 for XOM and PG, and $100 for NEE. If you make automatic $100 monthly purchases for each, your expense ratio for the year is going to be $0.24/$6000 = 0.004%, which we consider to be negligible. The Savings Bonds you’re accumulating through automatic monthly investment at treasurydirect are not only cost-free but come with tax advantages identical to those of an IRA (along with the same limits on annual purchases).

Bottom Line: Build a resilient and rewarding Rainy Day Fund. The one I’ve described here has the advantage of being cost-free. Peruse the Table for details, and note that red highlights denote underperformance vs. our favorite benchmark for retirement savings, which is the Vanguard Balanced Fund (VBINX). You’ll see that the Rainy Day Fund performs quite well (Columns C & F in the Table) and carries little risk (Columns D & I in the Table) compared to VBINX. However, the Rainy Day Fund won’t keep up with VBINX in a bull market because it designed for safety, not wealth-building.

Risk Rating: 3

Full Disclosure: This is the Rainy Day Fund that I currently employ.

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