Sunday, October 8

Week 327 - The 2 and 8 Club: A Strategy To Beat The S&P 500

Situation: You enjoy learning about economics through investing in specific companies but then you learn that you are “leaving money on the table.” How does that happen? Because Warren Buffett has explained to us that the Vanguard S&P 500 Admiral Fund (VFIAX) will beat professional stock-pickers 90% of the time. Why? Because a) it has an expense ratio of only 0.04%, b) it reaches all sectors of the economy, and c) capital gains taxes are negligible because there’s no point selling VFIAX shares before you retire. Instead, you can continue to dollar-average into your VFIAX account until you retire, regardless of market fluctuations.

But we can suggest a strategy for picking stocks without losing much money vs. VFIAX. Firstly, you’d need a watch list positioned in all 11 S&P sectors. Secondly, you’d need a fee-based trading account at your brokerage, one costing ~1%/yr of net asset value that allows you to buy and sell shares as needed without paying transaction costs. Alternatively, you can employ a Dividend Re-Investment Plan when transaction costs are lower. For example, computershare’s DRIP for NextEra Energy (NEE) carries no transaction costs. Thirdly, you’d need to have plan for picking stocks from your watch list, and the discipline to stick with that plan.

Our blog for this week has a workable plan that we call “The 2 and 8 Club.” It sticks to a watch list of the largest and most frequently traded companies, i.e., those in the S&P 100 Index. It picks companies that pay more than a market yield (~2%) by using the S&P 100 companies listed in the FTSE High Dividend Yield Index, which most investors in the US know as VYM, the Vanguard High Dividend Yield ETF. Not all high-yielding companies in the S&P 100 Index are found there because companies have to meet international standards of dividend predictability. 

Now you know the “2” part of The 2 and 8 Club, i.e., 2% market yield. The “8” part is a requirement that selected companies pay a dividend that has had a Compound Annual Growth Rate (CAGR) over the past 5 yrs of at least 8.0%/yr. Companies whose bonds are rated lower than A- by S&P are excluded, as are those whose stock is rated lower than B+/M.

Mission: List the current members of The 2 and 8 Club.

Execution: see Table.

Administration: To use this Plan, you simply keep track of the current members of The 2 and 8 Club, then dollar-average into half of those. Some will reach a point where they no longer qualify for membership. Chances are you will decide to stop investing in those companies but we suggest you consider replacing them with newly qualified companies. Each position is predicted to have at least a 10%/yr return (2+8=10), which is 3%/yr more than the long-term return for the S&P 500 Index. That 3% safety factor will likely be nibbled away by transaction costs of at least 1%/yr and capital gains taxes of at least 2%/yr.

Bottom Line: There are fewer than a dozen finance professionals in history with a record of beating the S&P 500 Index every year for more than 2 market cycles. So, a stock-picker like you or me is essentially a gambler. For example, 11 of the 16 companies in the Table that qualify for inclusion in The 2 and 8 Club have shown more extreme fluctuations in market price over the past 16 years than has the S&P 500 Index (see red highlights in Column M of the Table). As finance professors like to say, there are only two ways to beat the S&P 500 Index: 1) use insider information (which is illegal), or 2) have a portfolio that carries more risk of loss than the S&P 500 Index. 

But you’re more than a gambler. You’re participating in an experiential school that teaches you (through trial and error) how the economy operates, and you’re learning more about the behavior of groups (sociology) and the governance of countries (politics).

Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold = 10).

Full Disclosure: I dollar-average into MSFT, IBM, MMM, CAT, JPM, AMGN, UNP and NEE.

NOTE: Candidates for The 2 and 8 Club are listed at the bottom of the Table. These are S&P 100 companies that have recently been paying an above-market (SPY) dividend yield and have grown that dividend faster than 8%/yr over the past 5 years, but are not yet included in the US version of the FTSE High Dividend Yield Index (https://advisors.vanguard.com/VGApp/iip/site/advisor/investments/portfoliodetails?fundId=0923).

Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com

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