Week 385 - Let’s Dollar-Average Into 10 Stocks From The Vanguard High Dividend Yield Index

Situation: The advantage of dollar-cost averaging into specific stocks vs. dollar-averaging into the reference index is that you can focus on high-quality companies. However, those companies are less dynamic than early-movers. By investing in an index fund you’ll capture the effect that “earnings surprises” have on prices for early-movers. So, let’s compare a portfolio of 10 high quality stocks to the relevant index. Dollar-averaging identical amounts each month into either the index or each of the 10 stocks is just a way to buy more shares whenever the market is down. That way, I can assume that your returns will approximate the published total returns/Yr.

Mission: Pick 10 stocks from the Vanguard High Dividend Yield Index. Then run our Standard Spreadsheet.

Execution: see Table.

Administration: The 10 stocks I’ve picked happen to be the 10 that I dollar-average into.

Bottom Line: From the spreadsheet, I cannot discern a material difference in long-term returns from dollar-averaging in an index fund, such as the SPDR S&P 500 ETF (SPY) or the Vanguard High Dividend Yield ETF (VYM), compared to dollar-averaging into the 10 stocks I’ve picked. However, there is a material difference with respect to transaction costs: VYM has an expense ratio of 0.08%, whereas, the expense ratio for dollar-averaging into my 10 stocks is ~1.2%.

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

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

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Week 370 - Ways To Win At Stock-picking #1: Dollar-cost Average Into 10 Of The 30 DJIA Companies

Situation: You’re troubled by the dominance of the S&P 500 Index. After all, it is a derivative and you wonder whether it is really the safest and most effective way to build retirement savings. Your biggest concern is that it is a capitalization-weighted index, which is a design that favors momentum investing: Mid-Cap companies that garner investor enthusiasm become included in the S&P 500 Index because their stock is appreciating; Mid-Cap companies that have managed to be included in the S&P 500 Index investors are in danger of being excluded because investors have lost their enthusiasm and the stock’s price is falling. Many investors buy/sell shares in a company’s stock because of that trend in sentiment. Fundamental sources of value (revenue, earnings, and cash flow) often have little to do with their enthusiasm, or the fact that it has evaporated. Articles in the business press may carry greater weight, and those articles may be influenced by analyses introduced by short sellers, who are betting on a fall in price, or hedge fund traders with long positions, who are betting on a rise in price. In other words, most retail investors are paying attention to market sentiment when buying or selling shares, not due diligence that comes from a careful study of a company’s prospects and Balance Sheet. 

Your second biggest concern is likely to be that few S&P 500 companies have a good credit rating backing their debts. In other words, they’re paying too high a rate of interest on the bonds they’ve issued, or the bank loans they’ve taken out. The company’s Net Tangible Book Value is therefore likely to be drifting deeper into negative territory because of interest expenses, part of which are no longer tax deductible due to changes in U.S. tax law.

Both of these problems fall by the wayside if you invest in the 30 companies that make up the Dow Jones Industrial Average, either separately or together in the price-weighted Dow Jones Industrial Average Index (DIA at Line 18 in the Table). Investing in the “Dow” may be a little smarter for retirement savers than investing in the S&P 500 Index (SPY at Line 16 in the Table) for two reasons: 1) DIA has a dividend yield that is ~10% greater; 2) DIA pays dividends monthly, whereas, SPY pays dividends quarterly. A higher dividend yield means that your original investment is returned to you more quickly, which translates as a higher net present value, if other factors (e.g. dividend growth and long-term price appreciation) are not materially different.

Mission: Use our Standard Spreadsheet to illustrate how I dollar-cost average into stocks issued by 10 DJIA companies.

Execution: see Table.

Administration: It has been necessary to use 3 separate Dividend Re-Investment Plans (DRIPs) to dollar-cost average into the 10 DJIA stocks I’ve chosen (see Column AE in the Table). Those DRIPs automatically extract $100 each month for each of the 10 stocks; transaction costs average $18.68/yr (see Column AD), which includes automatic reinvestment of dividends. The expense ratio is 1.56% for each year’s investments, but expenses relative to Net Asset Value fall to less than 0.01% after 10-20 years.

Bottom Line: This week’s blog compares my long-standing pick of 10 Dow stocks (for an automatic monthly investment of $100 each using an online DRIP) to investing $1500/qtr in the entire 30-stock index (DIA) using a regional broker-dealer, which is something I’ve just started doing to facilitate comparison going forward. (You’ll see each year’s total returns in future blogs published the first week of July.)  

Risk Rating: 6 (where U.S. Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).

Full Disclosure: If one of the 10 stocks I’ve chosen is dropped from the Dow Jones Industrial Average (DJIA), I’ll sell those shares and use those dollars to start a DRIP with shares issued by another DJIA company.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

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Week 348 - Capitalization-weighted Index of “The 2 and 8 Club”

Situation: Whatever your stock-picking method, you need to decide how to manage large vs. small company stocks. If most of your stocks are issued by S&P 500 companies, your benchmark is the S&P 500 Index. It’s the greyhound you’re trying to catch. You won’t be able to keep up unless you invest more in mega-cap stocks than in the remaining companies of the S&P 500 Index. (I’ll bet you wish you’d owned Boeing stock going into 2017.)

Our stock-picking method is to invest in mega-caps, specifically the S&P 100 Index companies that represent 63% of the market capitalization of the S&P 500. Membership in that Index requires their stocks to have active “exchange-listed options” on the CBOE (Chicago Board Options Exchange). That’s important because a strong market in Put and Call Options means that there will be accurate and prompt price discovery, which is the best way to protect investors from a sudden collapse in price. 

Mission: Use our Standard Spreadsheet to list the 22 S&P 100 companies that are in “The 2 and 8 Club” (see Week 327). 

Execution: see Table listing those 22 stocks by market capitalization.

Administration: We confine our attention to S&P 100 companies among the ~400 companies in the Russell 1000 Index that pay a stable above-market dividend, one that is usually above 2%/yr. The Vanguard High Dividend Yield ETF (VYM) is a capitalization-weighted Index of those 400 companies, and is updated monthly. We reject companies that have not grown their dividend ~8%/yr (or faster) over the most recent 5-Yr period. 

There are currently 22 members of “The 2 and 8 Club”. All 22 companies have BBB+ or better S&P Bond Ratings, and B+/M or better S&P Stock Ratings. Additionally, all 22 have at least the 16-yr trading record that is required for quantitative analysis by the BMW Method, which is based on stock prices that are updated every Sunday. 

Bottom Line: These 22 stocks collectively have greater volatility (see Column M in the Table) but higher long-term total returns (see Column C in the Table), than the S&P 500 Index (see the ETF SPY at Line 32 in the Table). Only 7 of the 22 have less price volatility than the S&P 500 Index (see Column M): KO, PEP, IBM, MO, UPS, NEE, TGT. If you’re not a gambler, stick to investing in those and the benchmark ETFs (SPY and VYM).

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

Full Disclosure: I dollar-cost average into MSFT, JPM, KO and NEE, and also own shares of PFE, CSCO, PEP, IBM, MMM, MO, AMGN, TXN, CAT and TGT.

"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.

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Week 66 - Growing Perpetuity Index (Update)

Situation: In one of our first blogs (Week 4), we created the Growing Perpetuity Index (GPI). This was composed of 12 companies that are listed in the 65-stock Dow Jones Composite Average (DCA) and meet 4 criteria:
   a) dividend yield no less than the yield for the exchange-traded fund (ETF) that mimics the S&P 500 Index (SPY);
   b) 10 or more consecutive years of annual dividend increases;
   c) S&P stock rating of A- or better;
   d) S&P bond rating of BBB+ or better.
Those 12 companies are listed at the top of the accompanying Table, ranked in order of Finance Value (reward minus risk).

This week’s update shows that GPI stocks are outliers, meaning that all 12 companies fell less in value during the Lehman Panic than the S&P 500 Index did and therefore were wiser bets for you to have financed. Taken together, GPI stocks outperformed all but the best hedge funds (see Week 46). Results for a mutual fund (Blackrock Global Allocation Fund-MDLOX) that is issued by a leading hedge fund company serve as a proxy for that industry and are included in the Table for comparison. We also include results for the only mutual fund (VWINX) that allocates assets between stocks and bonds like our Goldilocks Allocation does (Week 3). We also include a leading bond mutual fund (PRCIX) and 4 additional stocks in the Dow Jones Composite Average that either meet our 4 criteria (see above) or soon will (CHRW, SO, MSFT and UNP). 

Bottom Line: There’s no shortage of safe and effective stocks for the long-term investor to own, as long as she owns several. Examples include McDonald’s (MCD), NextEra Energy (NEE), Procter & Gamble (PG), ExxonMobil (XOM), Southern Company (SO), CH Robinson Worldwide (CHRW), Chevron (CVX), and IBM. If you add $$ electronically each month to dividend reinvestment plans (DRIPs) for each of these stocks, you can stop worrying about market swings--you’ll come out right as long as you keep your nerve. But remember to balance your stock investments (other than utilities like SO and NEE) 50:50 with bond investments (e.g. PRCIX), for reasons we’ve discussed previously (see Week 3).

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

Week 33 - Rainy Day Fund in Retirement

Situation: It’s expected that retirement savings will be gradually depleted in retirement. But how do you deal with the unforeseen and unexpected expenditures that can upset an ongoing financial plan and derail your retirement savings?

This situation requires a backup plan--we need a “Super Hero” to step in and help. In an earlier blog (Week 15), we explained the importance of having a Rainy Day Fund and described the type of investments we would use to create such a fund. We can’t emphasize enough the importance of keeping contributions to the Rainy Day Fund on track throughout our prime working years; our 30s, 40s, 50s and right up into retirement.

The Rainy Day Fund that we suggest you establish is equally divided between Lifeboat Stocks and inflation-protected Savings Bonds, or “ISBs” (see Week 15). What this will achieve is that, by 10 yrs into your retirement, at least 50% of your stock holdings will be in Lifeboat Stocks (Weeks 8 & Week 23) instead of the 33% called for in our Goldilocks Allocation retirement savings portfolio (Week 3). This is important because Lifeboat Stocks are also termed “defensive”, meaning they don’t collapse in value during a bear market. Think about it. Having a bear market hit you two years into retirement might mean you’ll have to return to the workforce whether you like it or not.

Looking at the 2012 Master List (Week 27), we find 13 stocks representing “defensive” industries (health care, consumer staples, communication, employment services, utilities):

             ABT, KO, JNJ, MDT, PEP, PG, WAG

             WMT, ADP, BDX, HRL, MKC, and NEE.

And this is good because we can use these 13 stocks as candidates for our Lifeboat Stock designation (as defined in Week 25). Presently 12 of these 13 companies are relatively free of concerns. [The exception is ADP which has been bid up to a price (P/E=20) not justified by its low return on assets (ROA=3.6).] Seven of the remaining 12 are “Buffett Buys” from Week 30 (HRL, JNJ, MDT, WAG, BDX, WMT, NEE) but the remaining 5 also warrant Lifeboat Stock designation (ABT, KO, PEP, PG, MKC).

If used as 10+ yr DRIP investments with regular purchases in fixed amounts, any of these 12 stocks will more likely than not have a total return beating an S&P 500 Index fund AND show less depreciation during a bear market.

Since 7/1/02, for example, only MDT and WAG failed to do as well or better (in terms of regular DRIP investments) than the Vanguard S&P 500 Index Fund (VFINX); PG and JNJ DRIPs returned the same as VFINX (4.6%/yr). That’s 8 wins, 2 losses and 2 ties. With respect to price depreciation during the credit crunch from 10/07 to 4/09, all 12 of these stocks held up better than VFINX, which fell 47.6% vs. 21.6% for the 12 Lifeboat Stocks. Wow. Those ranged from an 18.8% gain (WMT) to a 48.9% loss (MDT).

To give you a concrete idea of what you accomplish by investing in Lifeboat Stocks to create a Rainy Day Fund, I will use my own Rainy Day Fund as an example. I created my fund on 7/1/02 using a quarterly investment of $630. I split this into $300/qtr for ISBs and $330/qtr for Coca-Cola (KO) in a dividend re-investment plan. As of 1/31/12, the $11,700 that I spent buying ISBs had grown to $14,278.34 (3.9%/yr) and the $12,928.55 that I spent on KO had grown to $18,476.95 (6.7%/yr). The result is that my Rainy Day Fund returned 5.4%/yr. For the sake of comparison, if we use a virtual $11,700 investment made in VFINX (Vanguard’s S&P 500 Index Fund) over this same period of time, it would have grown to be $14,847.98 (4.64%/yr). Inflation (Consumer Price Index) grew at a rate of 2.3%/yr. Therefore, my Rainy Day Fund had an after-inflation return of 3.1%/yr. This is a typical after-inflation return for a generic 50:50 stock:bond investment since 1970--after pricing in the tax benefits from owning Savings Bonds (Week 15).

Bottom Line: Every retiree would be smart to not only have a Rainy Day Fund going into retirement but continue adding the usual amounts after retiring. This could be the only unencumbered asset remaining in her portfolio to meet unexpected emergencies. It’s a real Super Hero that can step in and save the day!

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

Week 24 - Equity Summary

Situation: In the previous two blogs, we used virtual investments of $900/mo (beginning on 2/3/97) in representative Core Holdings (XOM, MMM, UTX, NSC) and Lifeboat Stocks (JNJ, WMT, NEE) to illustrate how we’d set up the equity half of a personal portfolio. Of our virtual dollars, two-thirds were invested in Core Holdings ($150/mo in each of 4 stocks, or $600/mo) and one-third in Lifeboat Stocks ($100/mo in each of 3 stocks, or $300/mo). This distribution reflects the ITR Goldilocks Allocation strategy (Week 3).

This week’s blog demonstrates the outcome of making 179 consecutive monthly purchases into those 7 DRIPs, ending on 12/1/11. <see attached spreadsheet> While the total investment was $161,100, the total return was a healthy $324,036 (TR = 7.74%/yr). The benchmark we are using is SPY, the Exchange Traded Fund the mimics the S&P 500 Index. SPY had a total return of 2.55%/yr based on 179 consecutive monthly purchases of $200 (commission of $4 per purchase). The total investment in SPY was $35,800, which then grew to $43,975. Inflation over that same 15 yr period was 2.32%/yr, as measured by the Consumer Price Index. In other words, our 7-stocks beat inflation by 5.42%/yr and beat the market by 5.19%/yr. In a future blog, we will provide a Credit Summary which will detail the outcome from investing $900/mo in bond funds as per a Goldilocks Allocation.

Summary: Do-It-Yourself (DIY) investing has obvious cost savings compared with going through an intermediary, such as a mutual fund manager. More to the point, it requires an investor to take personal responsibility for acquiring a working knowledge of investments and performing a modicum of research using the web. The goal is to “maintain what you’ve obtained” instead of participating in a market panic by selling your shares. Markets are moved more by fear than greed, such as the fear of a “margin call”. Many investors rely on help from borrowed money, i.e., by investing borrowed dollars and using the purchased stock as collateral for the loan. A “margin call” occurs when the broker requests additional capital (cash) from the investor to back an investment that has lost value. That is, the original loan is no longer backed with adequate collateral. As a DRIP investor on auto-pilot, however, you welcome a market panic because you are buying more shares than usual with your monthly investment. So, when should you sell a DRIP chosen from stocks in our Master List? We know of only 4 conditions that would trigger that:
   a) you need the money to retire;
   b) the company has gone 18 months without raising its dividend;
   c) the company has gone 18 months without having a dividend yield higher than the yield on the S&P 500 Index;
   d) the company has resorted to issuing bonds rated lower than BBB+ by S&P.

Bottom Line: Our ITR blog is for value investors who aren’t interested in buying stock with borrowed money or selling stock in a falling market. These are called "Rip van Winkle" investors, in honor of the off-hand comment from an investment guru that he’d have done better by not touching his portfolio for 10 or 20 years.


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Week 22 - Core Holdings

Situation: Seasoned investors will try to strike an investment balance between equities (ownership rights that yield dividends or rent) and credits (loans that pay interest). They also attempt to balance their core holdings with “hedges” that are designed to mitigate potential losses. We introduced an ITR Goldilocks Allocation (Week 3 blog) that is designed to protect against bear markets by investing 67% of the entire portfolio in Lifeboat Stocks (see Week 8 blog) and high grade bonds. The remaining 33% is risk capital--core “cyclical” stocks that rise or fall with world markets.

Goal: Orient the ITR reader to potentially useful core holdings by providing specific examples.

On the equity side, a Goldilocks-type of allocation will assign 33% of holdings to Lifeboat Stocks. An additional 17% is distributed to multinational stocks whose strength is the ability to capture revenue from emerging markets. These two types of holdings mitigate against portfolio losses caused by recession and dollar devaluation, respectively. In fact, recent global market events have demonstrated that emerging markets reflect the US market and are not de-linked, as was once thought. This stands to reason because emerging markets such as Brazil, India and China market goods and services predominantly to the US rather than their own consumers. This then means that companies on the ITR Master List which are dependent on revenue from emerging markets will also fit the classification of “core holdings” (e.g. MCD & MMM). The result is that our equity allocation in the “at risk” category is weighted at 67%, while the remaining 33% is composed of Lifeboat Stocks used to hedge that risk.

For the individual investor, core holdings represent one of the few available opportunities to “beat the market”. As defined, core holdings exaggerate market swings because we’ve excluded the moderating effect of “defensive” (lifeboat-type) stocks. This makes it important to have a strategy in place to reduce and “even out” that risk over time. One means of accomplishing that is to purchase stock in large companies that have the resources to recover from recessions. Reinvesting dividends, and making regular periodic purchases through a DRIP to buy shares that are “on sale”, also helps to attenuate that risk. Examination of the 20 largest companies on the ITR Master List shows that 10 are Lifeboat-type defensive stocks (ABT, JNJ, MDT, WAG, KO, CL, PEP, PG, TGT, WMT). Core holdings can be selected from the remaining 10 companies. Investing in those companies that have a return on equity (ROE) above the S&P 500 Index average (16%), and a Price:Book ratio less than 3.3, leaves:

   3 energy stocks (XOM, CVX, OXY)
   3 manufacturers (GD, EMR, UTX)
   1 conglomerate (MMM)
   1 railroad (NSC)

We’ve made an example pick of 4 stocks that represent core holdings and included an emerging markets play (MMM), an energy producer (XOM), a manufacturer (UTX), and a railroad (NSC). We’ll back-test our example by making a virtual investment of $150/mo in each of the 4 DRIPs from 2/3/97 to the present. We’ll use SPY as a proxy for the S&P 500 Index, and the Consumer Price Index as a proxy for inflation. Having to pay commissions reduces a monthly DRIP investment by $4/purchase for SPY, MMM and NSC, and $2.50 for UTX. The XOM DRIP, however, doesn’t have a commission.

The result of our analysis shows that (as of 11/30/11) SPY had a total return of 2.58%/yr vs. inflation at 2.32%/yr. The stocks used in our example, however, did much better with a return of 5.18%/yr for MMM, 8.70%/yr for UTX, 7.86%/yr for XOM, and 11.3%/yr for NSC. In the aggregate, an investment of $106,800 ($600/mo x 178 mo) grew to $234,352 (8.58%/yr). We are using the above example to prepare a spreadsheet for our readers that will be presented two weeks from now. We are incorporating calculations for two Lifeboat Stocks into this week’s example based on information we will discuss in next week’s blog (Lifeboat Stocks Revisited).

Bottom Line: DRIPs of 4 cyclical stocks (selected from ITR’s Master List) outperformed SPY by 6%/yr over the past 15 years.

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

Week 14 - Retirement on a Shoestring: The Roth IRA

Situation: Many people spend their careers working at jobs that offer slim retirement benefits. Consider this: a year of retirement will cost you about as much as a year of private college. Unlike a child’s college expenses, retirement doesn’t end after 4 years! Many people are now in a situation with big problems looming on the retirement horizon. Those with little money set aside for retirement have only 4 ways to supplement Social Security income (excluding extortion):
   1) convert home equity to a reverse mortgage,
   2) raid their “Rainy Day Fund”,
   3) remain employed for more years,
   4) set up a Roth IRA.

Goal: Explain to a 50 yr old how to start a retirement plan based around a Roth IRA.

Okay, you’ve reached the age of 50 with little by way of retirement savings, and you know you need a sound retirement plan. One thing that Congress got right was to provide middle income workers with a special kind of IRA, called a Roth IRA. With standard IRAs, you receive an annual tax deduction for monies invested but as those monies are spent in retirement you will pay taxes as with ordinary income. A Roth IRA, however, uses monies that are already taxed so that the monies spent in retirement are tax-free. From an accountant’s point of view, a Roth IRA is a bonanza! It shows the lengths to which Congress will go to entice people to save for retirement. 

We want a benchmark to use for the IRA recommendations we’ll be making and have picked the Vanguard Wellesley Fund (VWINX), a bond-centric no-load balanced fund that channels our Goldilocks Allocation to some degree. VWINX had been perking along for several decades without much attention but now investors are taking notice. The reason is that during the recession it posted one of the best records among balanced funds. VWINX has done rather well: investing $200 a month since 2/1/97 would have yielded $57,497 by 10/7/11 for a total return of 5.67%/yr (pretty sweet). This compares favorably to the same investment in the S&P 500 Index, SPY, which would have yielded $40,349 for a total return of 1.69%/yr (not so sweet). The top-performing balanced fund during the recession (MDLOX, the Blackrock Global Allocation Fund that we highlighted in Week 13) yielded $61,233 for a total return of 6.31%/yr (also rocking the house). During that 14.7 year period, inflation averaged 2.5%/yr according to the BLS. 

After age 50, you can pay $6,000/yr into a Roth IRA. We set up a $3,000 allocation to stocks and picked a model portfolio of 3 “low beta” DRIPs. These were chosen because they carry no investment costs if purchased through Computershare. [Please note: the same purchases could be made using Sharebuilder at an accumulated expense of $144/yr, which cuts 0.5%/yr off your total return.] We selected XOM ($75/mo), BDX ($75/mo), and NEE ($100/mo). Over 14.7 yrs (ending 10/7/11), the $75/mo invested in XOM ($13,275) returned $24,592 for a total return of 7%/yr; the $75/mo invested in BDX ($13,275) returned $25,286 for a total return of 7.28%/yr; and the $100/mo invested in NEE ($17,700) returned $34,860 for a total return of 7.61%/yr. All together, $250/mo was invested in 3 DRIPs ($44,250) and returned $84,738 for a total return of 7.33%/yr. This beats SPY by more than 5.6% a yr. It also beats inflation by more than 4.8%/yr. Other DRIP combinations can be selected and may show even better results.

For the bond side of our demonstration Roth IRA ($3,000), we’ll track $250/mo invested in the diversified T. Rowe Price investment-grade fund, PRCIX. For the 14.7 years ending 10/7/11, that monthly investment would have totaled $44250 and yielded $69,984 for a total return of 5.38%/yr. It is a no-load fund, so we have now constructed a no-load Roth IRA fund balanced 50:50 between stocks and bonds. Our fund is composed of 4 assets and carries no investment costs: XOM, BDX, NEE, and PRCIX. Our benchmark balanced fund (VWINX) is also a no-load fund. In addition, we’ll show what would happen if you invested $6000/yr in MDLOX (Blackrock Global Allocation A), which is also a balanced fund but carries a front-end load of 5.25%. That is, you’d be paying $26.25 in fees with each month’s $500 investment. [While there are other share classes that have a lower initial cost, this is compensated by a higher expense ratio. For long-term investors, the A class shares (MDLOX) are the most economical.] Our model balanced fund composed of 3 stocks and one bond fund yielded $154,633 over 14.7 years on a total investment of $88,500, for a total return of 6.42%/yr. This compares well to the 6.31% total return for MDLOX and 5.67% for VWINX. So our key point is that even the best-performing managed stock fund can be bested by regular purchase and dividend reinvestment using DRIPs in combination with a diversified bond fund, without paying any upfront fees or commissions.

In next week’s blog, we’ll provide a spreadsheet of our proposed Roth IRA and also outline a proposed “Rainy Day Fund”. We’ll include appropriate benchmarks and update the spreadsheet periodically, and model additional DRIP choices from the Master List. In an upcoming edition of “The Incubator”, we’ll discuss the process for incorporating DRIPs into a Roth IRA plan.

Bottom Line: If you’re earning less than $100,000/yr and don’t have a pension plan or 401(k) plan through your employer, it’s time to start a Roth IRA. Don’t delay - the pain only increases!!


<click here to continue to Week 15>

Week 4 - Introducing the ITR Growing Perpetuity Index

Goal: To compose a value stock index that tracks the S&P 500 Index over two market cycles but with greater total returns and less risk. In the ITR Mission and Goals statement we define these companies as composing what we call the ITR Growing Perpetuity Index (GPI).

• Companies selected for the GPI must: 
• be members of the 65-stock Dow Jones Composite Index;
• have a dividend yield greater than or equal to the yield for SPY (the exchange-traded fund that mimics the S&P 500 index);
• have increased their dividend for 10+ years;
• issue stock that has an S&P Quality Rating of A- or higher;
• issue bonds that have an S&P Bond Rating of BBB+ or higher.
• Currently, we find there are 12 companies that meet our criteria and thereby make up ITR's GPI:
• ExxonMobil (XOM)
• WalMart (WMT)
• Procter & Gamble (PG)
• Chevron (CHV)
• Johnson & Johnson (JNJ)
• Coca-Cola (KO)
• McDonalds (MCD)
• IBM (IBM)
• United Technologies (UTX)
• 3M (MMM)
• NextEra Energy (NEE)
• Norfolk Southern (NSC)
• We used two benchmarks to test the validity of our selection method. One is the longest-running exchange-traded fund that mimics the S&P 500 Index (SPY). The other is the S&P 500 Index mutual fund that carries the lowest expense ratio (0.06%): Vanguard 500 Index Admiral (VFIAX). SPY is traded like any other stock on the New York Stock Exchange (NYSE), whereas, VFIAX is a no-load mutual fund that requires an initial investment of $100,000 and cannot be traded.
• We need two market cycles to show that stocks selected for the GPI really do outperform SPY. SPY started trading on January 29, 1993, and for the first time it became possible to make "apples to apples" comparisons, i.e., purchase the Index and simultaneously purchase a stock. SPY "went live" two years and 4 months after the (250-day moving average of the) S&P 500 Index hit bottom due to the 1990-92 recession. The next bottom occurred in June '03 and the last in October '09, completing two market cycles. January 31, 2012 will be the two market cycle anniversary for SPY since it began trading exactly 19 years earlier.
• To specifically compare the total return of a GPI stock to SPY, we calculate the total return from an investment of $200/month from 2/1/93 until the present day. Our virtual purchases follow the rules for a DRIP account using the ING website (ShareBuilder): namely, a $4 commission is charged for stock purchases but dividends are re-invested for free. For the 18 years from 1993 to 2011, we find that the total return for SPY was 5.1%/yr, whereas, the total return for each of the selected 12 stocks in the GPI was greater. For example, the total return for WalMart (WMT) was 7.3%/yr, for Coca-Cola (KO) was 5.4%/yr, and for NextEra Energy (NEE) was 7.6%/yr.
• We are developing a methodology for anticipating when a Dow Jones Composite Index company is soon going to meet all 5 criteria for membership in the GPI. For example, it became clear in 2007 that Wal*Mart’s Chief Financial Officer (CFO) intended to rapidly increase dividend payouts such that WMT would soon have a yield greater than that of the S&P 500 Index. Given that WMT already met the other 4 criteria for inclusion in the GPI, we could have predicted that WMT would be added to the GPI by 2010.
• Similarly, we are developing a methodology for anticipating when it will soon be necessary to remove a company from membership in the GPI. For example, the 2008 Panic negatively impacted 4 companies that already met all 5 criteria for the GPI – Caterpillar (CAT), Home Depot (HD), Pfizer (PFE), and General Electric (GE). Those companies were soon forced to withdraw plans to raise their dividend; PFE and GE eventually cut their dividend.
• One of our goals is to highlight companies outside the Dow Jones Composite Index that otherwise meet criteria for inclusion in the GPI. Approximately 20 such companies exist in the S&P 500 Index. Some of these strong performers will eventually replace companies now in the Dow Jones Composite Index, and thereby become members of the ITR GPI. In our blog next week, we will introduce you to the ITR Master List of those companies in the S&P 500 Index.

Bottom line: Here’s 12 stocks that can be comfortably added to a very long term DRIP investment portfolio.


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Week 1 - An Introduction to Our Blog

Who benefits from reading our ITR blog every week?

That would be the recently burned, casual investor - let's say a career woman who thought of herself as being risk averse (until the recent crash). She doesn't hold an MBA or work in a bank but does find investing to be a fascinating and useful hobby. She expects an asset will pay her rental income, interest, or a dividend, so she cannot be called a speculator. She may have owned a capital appreciation stock mutual fund but probably learned her lesson in the recent downturn. You would find her in a casino only to use the bathroom, or have a meal washed down with iced tea, and on a brokerage office Risk Questionnaire, she will score as a solid "growth & income investor". Her investment style is probably "capital preservation", where her main strategy is to protect her core investment monies.

The ITR target investor is one who finds the information provided about stock mutual funds to be inadequate. While bond mutual funds describe investment style in terms of both the credit risk and average time to maturity (risk of loss in value of long-term bonds due to inflation), similar information can be difficult to ascertain with stock mutual funds. Even when a company issues bonds, as most do, it is difficult to access that information. This is probably because many companies issue bonds that carry high credit risk and have long maturation periods. Standard & Poor's (S&P) rates each company's common stock and bond portfolio but that information is not required in a stock mutual fund prospectus. Managers of stock mutual funds like to invest in riskier stocks because in a “bull market” those stocks make the fund perform better than the relevant benchmark index. This is good for advertising because it suggests that the fund manager is a brilliant stock picker. But such is not the case: in a “bear market”, losses will be greater than for the benchmark. This is why the large majority of stock mutual funds lost more in 2008 than the standard benchmark – the S&P 500 Index, which lost a whopping 37%. And that 37% loss is just too great for our ITR reader. Having been burned, she will now shy away from stock mutual funds and wants to learn to invest directly in company stocks on her own.

This is best achieved by using a company's Dividend Re-Investment Plan (DRIP). Using a DRIP keeps trading costs low (you don't pay fees to a broker) and allows you to capture the power of compound interest through automatic re-investment of dividends. A monthly electronic purchase plan results in “dollar-cost averaging”, giving a certainty of buying cheaply during market down-turns. This type of an investment strategy lets our ITR investor develop a portfolio of 5-10 stocks with dividend re-investment, just as a bond mutual fund manager reinvests interest payments.

Now the problem for our investor becomes one of concentration: holding fewer than 50 stocks in a portfolio exposes the portfolio to market risk. There are two things that offer protection. One is to confine purchases to stocks that carry S&P Quality Ratings of A- or above, and the second is to choose only those companies that have increased dividends annually for at least 10 years. Stock in dividend-paying companies has been shown to hold up better in market downturns, thus some "insurance" is obtained by choosing stocks that yield more than an S&P 500 Index Fund (an example is SPY, an exchange-traded fund; current yield 1.8%).

Stock market risk can also be reduced (or hedged) using two other tools: diversification of holdings across industries, and by investing in other markets: foreign stocks, bonds (both US and foreign), rental properties and commodities markets. Problems arise though: commodity futures contracts pay no interest or dividends, and charges are steep, making these instruments suitable only for short-term investing by expert traders. Rental properties also carry significant charges. Unless one owns a Class A apartment building in a growing town, rental income isn't going to help in a stock market crash because occupancy will likely fall. Risks from owning a single apartment building can be diffused by owning a real estate investment trust (REIT) that invests in a number of Class A apartment buildings in different regions of the country, but value will still fall in a difficult economy. Thus, REITs are not a useful asset for someone who emphasizes capital preservation.

Let's take a closer look at companies that produce, package, transport, and market commodities. Some of these have S&P Quality Ratings of A- or better, yield as much or more than SPY, and have increased that payout annually for at least 10 years. (Whoa! Now our investor is tuned in . . .) These companies have found a way to develop raw commodities and consistently produce reliable streams of cash flow for reinvestment (after dividends are paid to stockholders and interest to bondholders). The major traditional commodities with a regulated "futures" market include corn, soybeans, wheat, live cattle, lean hogs, cocoa, coffee, sugar, gold, silver, copper, crude oil, heating oil and natural gas. There are 6 companies meeting our criteria that manage these feedstocks as their primary line of business. A future blog will identify and discuss these companies. All 6 had a 10-year total return of at least 7.7%/year, whereas, the median total return of a Fortune 500 company over that period was 6.7%/year (Fortune Magazine, May 23, 201, volume 163, no. 7, pp F2-F32) and the total return for the S&P 500 Index was 1.3%/year (moneychimp.com). However, commodity producers like these 6 companies suffer during stock market pull-backs, such as the one we've just experienced. A future ITR blog will discuss how to manage this risk.

Commodity markets are priced in dollars and globally sourced, which is the main support for their investment value. Therefore investments that are tied to a commodity represent a hedge against dollar depreciation. For that reason alone, it is worthwhile to buy stock in companies that can pass changes in valuation along to end-users. Future installments of our blog will address other key inputs to the economy that behave similarly, such as electricity.

Bottom Line:  Our weekly ITR blog will provide you with tools that allow you to become your own fund manager. We know it’s a complicated undertaking and difficult for new investors to feel comfortable with these concepts. Each week we will post our take on the topics we’ve introduced to you and provide further analysis and tools for you to use in managing your portfolio.


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