Sunday, March 29

Week 195 - The Tortoise and the Hare

Situation: Our blog offers a variety of ways to invest for retirement. Priority is placed on assets having returns that are almost certain to exceed inflation and transaction costs over any given 5-yr period. We also restrict ourselves to highlighting stock/bond combinations that lost no more than 15% during the Lehman Panic (10/07-4/09). Yes, losing 15% over 18 months is painful but its less painful than the 19.3% loss sustained by the lowest-cost 50:50 combination of Vanguard stock and bond index funds (see Line 18 in the Table). We comb through the  Barron's 500 List to find those stocks that return the most money long-term while taking on the least risk (or “volatility” in stock prices over various time periods). Our goal is to find the investor’s unicorn, namely, “net-net-net” combinations that are likely to make money net of transaction costs, net of inflation, and net of taxes (see Week 112).

What's wrong with that? A real estate developer sitting next to me on a ski lift once had this response to my idea of helping people build a low-risk retirement portfolio: "People don't care about saving for retirement! Look at the choices they make." He was right. Our formula for investing has about as much appeal as bland baby food. Think about it. Our favorite bond is the inflation-protected Savings Bond, our favorite stocks are Wal-Mart and McDonald’s, and our favorite mutual fund is the bond-heavy Vanguard Wellesley Income Fund!

Now that we’ve admitted the humor of our situation, let’s compare those 4 choices to 4 similarly high-quality but “swifter” bonds, stocks, and mutual funds. We’ll call our approach “tortoise” and the swifter approach “hare” in honor of Aesop’s Fable (see Table). For a swift mutual fund, we’ll go with MDLOX, the Blackrock Global Allocation Fund. MDLOX is run by a hedge fund company and had a better record during the Lehman Panic than most of the better hedge funds. For a swift bond, we’ll go with CHS Convertible Preferred stock (CHSCP), issued by the largest farmer’s cooperative in the US. For a couple of swift stocks, we’ll go with Biogen Idec (BIIB), a biotech stock, and Dover (DOV), an innovative manufacturing company. These 4 choices are not random but are instead designed to cast an aggressive approach to investing in the best light.

As you can see from the Table, the hare investments come out ahead, mitigating losses during the Lehman Panic with strong performances both before and after that deep recession. If you take a close look, you’ll know which investment style you favor for building a retirement portfolio. Admittedly, our ITR blog doesn’t give readers who like the hare’s style as many meaty articles to read as those who like the tortoise’s style. Why? Because after you pass age 60 there is very little chance you’ll be able to rebuild a retirement portfolio that takes a +20% loss during a deep recession. And, the anxiety factor is much greater for aggressive investors because their transaction costs are higher than with automated online investing, partly because of the need to make frequent trading decisions and partly because many of the stocks that catch your interest can only be obtained through a stockbroker. For example, transaction costs for a $10,000 investment in MDLOX are ~6 times greater than for VWINX over a 10 yr holding period. 

Bottom Line: There is nothing exciting about building a prudent retirement portfolio. Your goal is to have stable returns that exceed transaction costs, inflation and taxes. Inflation-protected US Savings Bonds are the only investment that will accomplish that with near certainty. Why? Because transaction costs are zero, inflation costs are zero, and taxes on accrued interest are only paid when you cash in the bond. But Savings Bonds won’t help you much with retirement expenses. So, you’ll need to take on more risk by adding stocks to your portfolio. You’ll want to minimize that risk by keeping transaction costs low (through online dividend reinvestment plans), taking a buy-and-hold approach to stock ownership, and confining your stock selections to those that have a long history of annual dividend increases that beat inflation. If you are interested in making a hobby of investing, and have enough disposable income, you can take a more aggressive approach to stock ownership by setting up a second, non-retirement portfolio. For that you’ll need to find a stockbroker.

Risk Rating for tortoise: 3; Risk Rating for hare: 6.

Full Disclosure: I dollar-average into inflation-protected Savings Bonds and WMT, and also own shares of MCD for dividend reinvestment.

NOTE: metrics that underperform our key benchmark (VBINX) are highlighted in red; metrics are current as of the Sunday of publication.

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