Situation: You want to balance your stock portfolio with safe bonds. Right? Well, here’s a news flash: You need to start thinking about balancing your bond portfolio with safe stocks. Why? Because the world is gorging itself on debt--households, municipalities, states, nations, and corporations most of all. Yes, this is understandable because the Great Recession was so disabling that central banks everywhere dropped interest rates lower than the rate of inflation. It was free money, so people borrowed the stuff and invested it. Just as the central bankers had intended. Economic activity gradually returned to normal almost everywhere, now that 10 years have passed since Lehman Brothers declared bankruptcy on September 15, 2008. But the Federal Open Market Committee is removing the punch bowl from the party and raising short-term interest rates by a quarter percent 3-4 times a year. Bondholders are stocking up on Advil due to interest rate risk (duration), meaning that for each 1% rise in short-term interest rates there is a material reduction in the value of an existing bond that is worse for long-term than short-term bonds.
If a company is struggling and has to refinance a maturing issue of long-term debt, it will have to pay a materially higher rate of interest vs. that paid to holders of the expiring bond. This may impact the credit rating of its existing bonds, driving it closer to insolvency. General Electric (GE) is an especially vivid example of how this works. A few short years ago, GE had an S&P rating of AAA for its bonds. That rating is now BBB+ and falling fast. Larry Culp, the CEO, is desperately selling off core divisions of the company in an attempt to avert bankruptcy.
Mission: Use appropriate columns of our Standard Spreadsheet to evaluate the leading bond ETFs, and compare those to the S&P 500 Index ETF (SPY) as well as a stock with an S&P Bond Rating of AA or better.
Execution: see Table.
Bottom Line: To offset the risks in your stock portfolio (bankruptcy, market crashes and sensitivity to fluctuation of interest rates), you need a bond portfolio. Why? Because high quality bonds rise in value during stock market crashes and/or recessions, have much less credit risk, and usually less interest rate risk. Stock prices are more sensitive to short-term interest rates than any but the longest-dated bonds, e.g. 30-Yr US Treasury Bonds. Stock indexes like the S&P 500 Index (SPY) have average S&P Bond Ratings of BBB to BBB+, compared to AA+ for 30-Yr Treasuries. To cover those risks, you’ll need a bond fund that has low-medium interest rate risk and high credit quality. BND and IEF are examples (see Table). BIV differs only in having medium credit quality per Morningstar. TLT has high credit quality but also has high interest rate sensitivity. TLT can be compared to a stock with high credit quality and high interest rate sensitivity, e.g. Pfizer (PFE; see Table). The main thing to remember is that stock market crashes are invariably accompanied by a booming bond market (flight to safety). That’s a good thing because governments will have to take on a lot more debt to finance social programs like unemployment insurance.
Risk Rating: 1 for BND and IEF (where 10-Yr Treasuries = 1, S&P 500 Index = 5, gold = 10)
Full Disclosure: I own bond funds that approximate BIV and TLT.
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Showing posts with label inflation. Show all posts
Showing posts with label inflation. Show all posts
Sunday, December 16
Sunday, October 7
Week 379 - Are “Blue Chip” Stocks Overvalued?
Situation: There are two subjective issues that we need to quantify for “buy and hold” investors: 1) Define a “blue chip” stock. 2) Define an “overvalued” stock.
Our previous effort to define a “blue chip” stock in quantitative terms (see Week 361) left room for subjective interpretation and was more complicated than necessary. Here’s the new and improved definition: Any US-based company in the S&P 100 Index whose stock has been tracked by modern quantitative methods for 30+ years, and enjoys an S&P rating of B+/M or better. The very important final requirement is that the company issues bonds carrying an S&P rating of A- or better.
In last week’s blog, we introduced two different quantitative methods for deciding whether or not a stock is overvalued: 1) the Graham Number, which sets an optimal price by using Book Value for the most recent quarter (mrq) and Earnings Per Share for the trailing 12 months (TTM); 2) the 7-Yr P/E, which removes aberrations that are introduced by “blowout earnings” or the negative impact on earnings that is often introduced by “mergers and acquisitions” and “company restructurings.” Either metric can be misleading if used alone, but that problem is largely negated when both are used together.
Mission: Set up our Standard Spreadsheet for the 40 companies that meet criteria. Show the Graham Number in Columns X and the 7-Yr P/E in Column Z.
Execution: see Table.
Administration: In our original blog about Blue Chip stocks (Week 361), we thought the definition needed to require that companies pay a good and growing dividend. However, there are no objective reasons why a company’s stock will be of more value if profits are paid out piecemeal to investors rather than entirely in the form of capital gains. That’s one of the things you learn in business school from professors of Banking and Finance. Accounting professors also point out that a dividend is a mini-liquidation, as well as a second round of taxation on the company’s profits. There are subjective reasons to prefer companies that pay a good and growing dividend, like building brand value (an intangible asset) and showing that the company is “shareholder friendly.” Dividends also reduce risk by returning some of the original investment quickly with inflation-protected dollars.
Bottom Line: In the aggregate, these company’s shares are overpriced but not to an unreasonable degree (see Columns X-Z in the Table). However, only 8 are bargain-priced: Altria Group (MO), Comcast (CMCSA), Berkshire Hathaway (BRK-B), JP Morgan Chase (JPM), Bank of New York Mellon (BK), Wells Fargo (WFB), US Bancorp (USB), and Exxon Mobil (XOM). You’ll note that all 8 face challenges that will cause investors to pause before snapping up shares.
Shares in 9 companies are overpriced by both metrics (Graham Number and 7-Yr P/E): Home Depot (HD), UnitedHealth (UNH), Lowe’s (LOW), Costco Wholesale (COST), Microsoft (MSFT), Texas Instruments (TXN), Raytheon (RTN), Honeywell International (HON), and Caterpillar (CAT). You’ll need to think about taking profits in those, if you’re a share-owner.
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into MSFT, NEE, KO, JNJ, JPM, UNP, PG, WMT, CAT, XOM, and IBM. I also own shares of COST, MMM, BRK-B, and INTC.
Our previous effort to define a “blue chip” stock in quantitative terms (see Week 361) left room for subjective interpretation and was more complicated than necessary. Here’s the new and improved definition: Any US-based company in the S&P 100 Index whose stock has been tracked by modern quantitative methods for 30+ years, and enjoys an S&P rating of B+/M or better. The very important final requirement is that the company issues bonds carrying an S&P rating of A- or better.
In last week’s blog, we introduced two different quantitative methods for deciding whether or not a stock is overvalued: 1) the Graham Number, which sets an optimal price by using Book Value for the most recent quarter (mrq) and Earnings Per Share for the trailing 12 months (TTM); 2) the 7-Yr P/E, which removes aberrations that are introduced by “blowout earnings” or the negative impact on earnings that is often introduced by “mergers and acquisitions” and “company restructurings.” Either metric can be misleading if used alone, but that problem is largely negated when both are used together.
Mission: Set up our Standard Spreadsheet for the 40 companies that meet criteria. Show the Graham Number in Columns X and the 7-Yr P/E in Column Z.
Execution: see Table.
Administration: In our original blog about Blue Chip stocks (Week 361), we thought the definition needed to require that companies pay a good and growing dividend. However, there are no objective reasons why a company’s stock will be of more value if profits are paid out piecemeal to investors rather than entirely in the form of capital gains. That’s one of the things you learn in business school from professors of Banking and Finance. Accounting professors also point out that a dividend is a mini-liquidation, as well as a second round of taxation on the company’s profits. There are subjective reasons to prefer companies that pay a good and growing dividend, like building brand value (an intangible asset) and showing that the company is “shareholder friendly.” Dividends also reduce risk by returning some of the original investment quickly with inflation-protected dollars.
Bottom Line: In the aggregate, these company’s shares are overpriced but not to an unreasonable degree (see Columns X-Z in the Table). However, only 8 are bargain-priced: Altria Group (MO), Comcast (CMCSA), Berkshire Hathaway (BRK-B), JP Morgan Chase (JPM), Bank of New York Mellon (BK), Wells Fargo (WFB), US Bancorp (USB), and Exxon Mobil (XOM). You’ll note that all 8 face challenges that will cause investors to pause before snapping up shares.
Shares in 9 companies are overpriced by both metrics (Graham Number and 7-Yr P/E): Home Depot (HD), UnitedHealth (UNH), Lowe’s (LOW), Costco Wholesale (COST), Microsoft (MSFT), Texas Instruments (TXN), Raytheon (RTN), Honeywell International (HON), and Caterpillar (CAT). You’ll need to think about taking profits in those, if you’re a share-owner.
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into MSFT, NEE, KO, JNJ, JPM, UNP, PG, WMT, CAT, XOM, and IBM. I also own shares of COST, MMM, BRK-B, and INTC.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 16
Week 376 - What Does A Simple IRA Look Like?
Situation: You’re bombarded with advice about how to save for retirement. But unless you’re already rich, the details are simple. Dollar-cost average 60% of your contribution into a stock index fund and 40% into a short or intermediate-term bond index fund. If you know you’ll never be in “the upper middle class”, opt for the short-term bond index fund. But maybe you have a workplace retirement plan, which makes saving for retirement a little more complicated. Either way, you’ll want to contribute the maximum amount each year to your IRA, which is currently $5500/yr until you reach age 50; then it’s $6500/yr.
Here’s our KISS (Keep It Simple, Stupid) suggestion: Make your IRA payments with Vanguard Group by using a Simple IRA (Vanguard terminology) composed only of the Vanguard High Dividend Yield Index ETF or VYM. Then, contribute 2/3rds of that amount into Inflation-protected US Savings Bonds. These are called ISBs and work just like an IRA. No tax is due from ISBs until you spend the money but there’s a penalty for spending the money early (you’ll lose one interest payment if you cash out before 5 years). The annual contribution limit is $10,000/yr. A convenient proxy for ISBs, with similar total returns, is the Vanguard Short-Term Bond Index ETF or BSV.
Mission: Create a Table showing a 60% allocation to VYM and 40% allocation to BSV. Include appropriate benchmarks, to allow the reader to create her own variation on that theme.
Execution: see Table.
Bottom Line: However you juggle the numbers, it looks like you’ll make ~7%/yr overall through your IRA + ISB retirement plan, with no taxes due until you spend the money. In other words, each year’s contribution will double in value every 10 years. The beauty of this plan is that transaction costs are almost zero, and the chance that it will give you headaches is almost zero.
Risk Rating: 4 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Inflation-protected Savings Bonds and the Dow Jones Industrial Average ETF (DIA).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Here’s our KISS (Keep It Simple, Stupid) suggestion: Make your IRA payments with Vanguard Group by using a Simple IRA (Vanguard terminology) composed only of the Vanguard High Dividend Yield Index ETF or VYM. Then, contribute 2/3rds of that amount into Inflation-protected US Savings Bonds. These are called ISBs and work just like an IRA. No tax is due from ISBs until you spend the money but there’s a penalty for spending the money early (you’ll lose one interest payment if you cash out before 5 years). The annual contribution limit is $10,000/yr. A convenient proxy for ISBs, with similar total returns, is the Vanguard Short-Term Bond Index ETF or BSV.
Mission: Create a Table showing a 60% allocation to VYM and 40% allocation to BSV. Include appropriate benchmarks, to allow the reader to create her own variation on that theme.
Execution: see Table.
Bottom Line: However you juggle the numbers, it looks like you’ll make ~7%/yr overall through your IRA + ISB retirement plan, with no taxes due until you spend the money. In other words, each year’s contribution will double in value every 10 years. The beauty of this plan is that transaction costs are almost zero, and the chance that it will give you headaches is almost zero.
Risk Rating: 4 (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into Inflation-protected Savings Bonds and the Dow Jones Industrial Average ETF (DIA).
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 26
Week 373 - 10 Dividend Achievers In Defensive Industries That Are Suitable For Long-term Dollar-cost Averaging
Situation: Which asset class do you favor? Stocks, bonds, real estate or commodities? On a risk-adjusted basis, none of those are likely to grow your savings faster than inflation over the near term. You might want to hold off making “risk-on” investments, unless you're a speculator, because markets are likely to fluctuate more than usual. If you think a “risk-off” approach is best, then you need to pick “defensive” stocks for monthly (or quarterly) investment of a fixed dollar amount (dollar-cost averaging). To minimize transaction costs, you’ll want to invest automatically in each stock through an online Dividend Re-Investment Plan (DRIP).
Now you will be positioned to ride-out a Bear Market, knowing that you’re accumulating an unusually large amount of shares in those companies as their stocks fall in price. And, those prices won’t fall far enough to scare you because that group of stocks has an above-market dividend yield. So, you’ll stick with the program instead of selling out in a moment of panic.
Mission: Run our Standard Spreadsheet for high-quality stocks issued by companies in defensive industries, i.e., utilities, consumer staples, healthcare, and communication services.
Execution: see Table.
Administration: Companies that don’t have at least an A- S&P rating on their bonds and at least a B+/M rating on their stock are excluded, as are those that don’t have at least a 16-yr trading record suitable for quantitative analysis by using the BMW Method. Companies that aren’t large enough to be on the Barron’s 500 List are also excluded.
Bottom Line: We find that 10 companies meet our requirements. Companies in the Consumer Staples industry dominate the list: Hormel Foods (HRL), Costco Wholesale (COST), PepsiCo (PDP), Coca-Cola (KO), Procter & Gamble (PG), Walmart (WMT), and Archer Daniels Midland (ADM). As a group, these 10 companies have above-market dividend yields and dividend growth (see Columns G & H in the Table). Risk is below-market, as expressed by 5-Yr Beta and predicted loss in a Bear Market (see Columns I & M).
Risk Rating: 4 for the group as a whole (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I dollar-average into NEE, KO, JNJ, PG and WMT, and also own shares of HRL and COST.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Now you will be positioned to ride-out a Bear Market, knowing that you’re accumulating an unusually large amount of shares in those companies as their stocks fall in price. And, those prices won’t fall far enough to scare you because that group of stocks has an above-market dividend yield. So, you’ll stick with the program instead of selling out in a moment of panic.
Mission: Run our Standard Spreadsheet for high-quality stocks issued by companies in defensive industries, i.e., utilities, consumer staples, healthcare, and communication services.
Execution: see Table.
Administration: Companies that don’t have at least an A- S&P rating on their bonds and at least a B+/M rating on their stock are excluded, as are those that don’t have at least a 16-yr trading record suitable for quantitative analysis by using the BMW Method. Companies that aren’t large enough to be on the Barron’s 500 List are also excluded.
Bottom Line: We find that 10 companies meet our requirements. Companies in the Consumer Staples industry dominate the list: Hormel Foods (HRL), Costco Wholesale (COST), PepsiCo (PDP), Coca-Cola (KO), Procter & Gamble (PG), Walmart (WMT), and Archer Daniels Midland (ADM). As a group, these 10 companies have above-market dividend yields and dividend growth (see Columns G & H in the Table). Risk is below-market, as expressed by 5-Yr Beta and predicted loss in a Bear Market (see Columns I & M).
Risk Rating: 4 for the group as a whole (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I dollar-average into NEE, KO, JNJ, PG and WMT, and also own shares of HRL and COST.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 20
Week 359 - Gold Can Be Useful To Own When Markets Are In Turmoil
Situation: On April 2, 2018, a new downtrend began for the US stock market according to Dow Theory. This officially ends the Bull Market that began on March 9, 2009. Gold now becomes one of the go-to destinations for traders, along with other “safe haven” investments like Japanese Yen, Swiss Francs, US dollars, and US Treasury Bonds. When traders stop moving new money into stocks and instead resort to a safe haven, they often move some into SPDR Gold Shares (GLD at Line 15 in the Table).
Why has the US stock market embarked on a primary downtrend? Because the risk of a Trade War has increased. But it’s a perfect storm because the Federal Open Market Committee (FOMC) of the US Treasury has also put the US stock and bond markets at risk by steadily increasing short-term interest rates. Normally when the economy falters, bonds are a good alternative to stocks. The exception happens when the FOMC raises short-term interest rates to ward off inflation: Long-term rates also rise, giving their new investors an asset that is falling in value.
An option to buying gold bullion (GLD) is to buy stock in mining companies. Gold miners are emerging from difficult times, given that the 2014-2016 commodities crash caught them competing on the basis of growth in production, which they had funded with ever-increasing debt. Now they are paying down that debt and instead competing on the basis of free cash flow, in order to reward investors (i.e., buy back stock and increase dividends).
Mission: Run our Standard Spreadsheet to analyze gold-linked investments, as well as short-term bonds. Include manufacturers of mining equipment, and other enablers like railroads and banks.
Execution: see Table.
Administration: Some advisors suggest that gold should represent 3-5% of your retirement savings. However, gold has marked price volatility but remains at approximately the same price it had 30 years ago. If you plan to hold it long-term, you’d best think of it as one of your Rainy Day Fund holdings (see Week 291).
What actions are reasonable to take when Dow Theory declares that stocks are entering a new downtrend? Gold is one of the 5 places to consider routing new money instead of stocks, the others being US dollars, Japanese Yen, Swiss Francs, and US Treasury Bonds. We’ve shown that US Treasury Bonds are not a suitable choice in a rising interest rate environment. For US investors, that leaves gold and US dollars as safe haven investments. The most inflation-resistant way to invest in US dollars is to dollar-average into 2-Yr US Treasury Notes or Inflation-protected US Savings Bonds at no cost through the government website. But for traders who are willing to pay transaction costs, the 1-3 Year Treasury Note ETF (SHY at Line 15 in the Table) is more convenient.
How best to invest in gold? Let’s start with the old lesson about how to profit from gold mining, learned during the California gold rush of 1949: Gold miners don’t make much money but their enablers do. Those are the bankers who loan them money, and the owners of companies that provide them with equipment, consumables and transportation. Go to any open-pit gold mine and the first thing you’ll notice is the massive yellow-painted trucks carrying ore. Those are made by Caterpillar (CAT at Line 6 in the Table).
Now look at the top of the Table. The second company listed is Union Pacific (UNP). This highlights the fact that ores recovered at any mine have to be transported to smelters. The fourth company, Royal Gold (RGLD), is a Financial Services company. This highlights the fact that bankers can profit greatly from loaning money to gold miners, provided they do it in an unusual way, which is issuing loans that don’t have to be repaid in dollars but instead can be repaid by the grant of either a royalty or a specified fraction (“stream”) of gold produced over the lifetime of the mine. Royal Gold (GLD) prefers royalty contracts. The other two Financial Services companies that service gold miners prefer streaming contracts: Franco-Nevada (FNV) and Wheaton Precious Metals (WPM).
Bottom Line: SPDR Gold Shares (GLD) will be in demand until Dow Theory declares that the downtrend in US stocks has been reversed. 2-Yr US Treasury Notes (SHY) will be in demand until the FOMC stops raising short-term interest rates.
Risk Rating: 10 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into CAT, UNP and 2-Yr US Treasury Notes, and also own shares of WPM.
"The 2 and 8 Club" (CR) 20187 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Why has the US stock market embarked on a primary downtrend? Because the risk of a Trade War has increased. But it’s a perfect storm because the Federal Open Market Committee (FOMC) of the US Treasury has also put the US stock and bond markets at risk by steadily increasing short-term interest rates. Normally when the economy falters, bonds are a good alternative to stocks. The exception happens when the FOMC raises short-term interest rates to ward off inflation: Long-term rates also rise, giving their new investors an asset that is falling in value.
An option to buying gold bullion (GLD) is to buy stock in mining companies. Gold miners are emerging from difficult times, given that the 2014-2016 commodities crash caught them competing on the basis of growth in production, which they had funded with ever-increasing debt. Now they are paying down that debt and instead competing on the basis of free cash flow, in order to reward investors (i.e., buy back stock and increase dividends).
Mission: Run our Standard Spreadsheet to analyze gold-linked investments, as well as short-term bonds. Include manufacturers of mining equipment, and other enablers like railroads and banks.
Execution: see Table.
Administration: Some advisors suggest that gold should represent 3-5% of your retirement savings. However, gold has marked price volatility but remains at approximately the same price it had 30 years ago. If you plan to hold it long-term, you’d best think of it as one of your Rainy Day Fund holdings (see Week 291).
What actions are reasonable to take when Dow Theory declares that stocks are entering a new downtrend? Gold is one of the 5 places to consider routing new money instead of stocks, the others being US dollars, Japanese Yen, Swiss Francs, and US Treasury Bonds. We’ve shown that US Treasury Bonds are not a suitable choice in a rising interest rate environment. For US investors, that leaves gold and US dollars as safe haven investments. The most inflation-resistant way to invest in US dollars is to dollar-average into 2-Yr US Treasury Notes or Inflation-protected US Savings Bonds at no cost through the government website. But for traders who are willing to pay transaction costs, the 1-3 Year Treasury Note ETF (SHY at Line 15 in the Table) is more convenient.
How best to invest in gold? Let’s start with the old lesson about how to profit from gold mining, learned during the California gold rush of 1949: Gold miners don’t make much money but their enablers do. Those are the bankers who loan them money, and the owners of companies that provide them with equipment, consumables and transportation. Go to any open-pit gold mine and the first thing you’ll notice is the massive yellow-painted trucks carrying ore. Those are made by Caterpillar (CAT at Line 6 in the Table).
Now look at the top of the Table. The second company listed is Union Pacific (UNP). This highlights the fact that ores recovered at any mine have to be transported to smelters. The fourth company, Royal Gold (RGLD), is a Financial Services company. This highlights the fact that bankers can profit greatly from loaning money to gold miners, provided they do it in an unusual way, which is issuing loans that don’t have to be repaid in dollars but instead can be repaid by the grant of either a royalty or a specified fraction (“stream”) of gold produced over the lifetime of the mine. Royal Gold (GLD) prefers royalty contracts. The other two Financial Services companies that service gold miners prefer streaming contracts: Franco-Nevada (FNV) and Wheaton Precious Metals (WPM).
Bottom Line: SPDR Gold Shares (GLD) will be in demand until Dow Theory declares that the downtrend in US stocks has been reversed. 2-Yr US Treasury Notes (SHY) will be in demand until the FOMC stops raising short-term interest rates.
Risk Rating: 10 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into CAT, UNP and 2-Yr US Treasury Notes, and also own shares of WPM.
"The 2 and 8 Club" (CR) 20187 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 28
Week 343 - Raise Cash For The Crash
Situation: By now, you know that many are predicting that we are in the late stages of a bull market. Euphoria is the last stage, and in the present climate, one would expect that euphoria will begin happening as the new tax bill takes effect. Two or 3 years later, the stock market will over-correct to the downside and recession will likely soon follow. Now would be a good time for small investors to begin to protect themselves. One way to do that would be to “bulk up” on cash equivalents and Treasuries. The money you still have in equities will need to move in the direction of high-yielding Dividend Achiever type stocks.
Why should we start making these changes now? Because the yield curve is flattening (see Appendix below), which is the best indicator that Financial Services professionals have to predict a market crash.
Mission: Draw up a portfolio of stocks and bonds that will carry you through a market crash relatively unscathed.
Execution: see Table.
Administration: There are 4 ways to raise cash for a crash.
1) Have a Rainy Day Fund that covers 6 months of expenses and is inflation-protected. All of us resist maintaining this “Dead Money Account.” Why? Because it keeps taking money away from spending as our income increases. The trick is to make it painless by a) eliminating transaction costs, tax payments, and inflation risk, and b) paying into the Account automatically. Sounds great, but how? By going to the US Treasury website and directing that a transfer of $25+/mo be made from your checking account into an Inflation-Protected Savings Bond (ISB). Follow a First In/First Out (FIFO) policy when cashing-out your Rainy Day Fund, since you’ll lose an interest payment if you cash-out sooner than 5 years. Taxes are only due after you’ve drawn down the Account.
2) Increase your Cash-Equivalents Allocation: dollar-average into 2-Yr Treasury Notes. Normally, this allocation is whatever cash cushion you like to maintain in your Savings, Checking, and Brokerage Accounts. But now isn’t a normal time. You need to plus-up those cash holdings and build a “backstop.” Why? Because there’s a material risk that your household will soon be living on less income (that is, a reduction upwards of 5%/yr). The easiest way to build a temporary backstop is to go back into www.treasurydirect.com and invest $1000 every 2 months in a 2-Yr Treasury Note. After 2 years, you’re done. You’ve allocated $12,000 that will start paying $1000 into your Checking Account every 2 months. Meantime, you can track the value of this investment through the ticker SHY (iShares 1-3 Year Treasury Bond ETF -- see Line 20 in the Table),
3) Reduce your Equity Allocation but retain Dividend Achievers with above-market yields. This week’s Table has suggestions that may assist you. Those stocks were chosen largely on the basis of a) high ratings from S&P, b) above-market yields, c) the likelihood of payouts continuing to increase in a recession, d) P/E ratios at or below market, and e) predicted losses in a bear market (see Column M in the Table) that are less than or equal to those predicted for the S&P 500 Index (at Line 20). When the crash hits, you will be tempted to sell these (your most crash-resistant stocks) because you’re afraid they’ll fall further. Don’t. Instead of reinvesting dividends, just have the dividend checks sent to your mailbox. If you aren’t a stock picker, simply invest in VYM (Vanguard High Dividend Yield ETF at Line 17 in Table) and XLU (SPDR Utilities Select Sector ETF at Line 14).
4) Increase your Fixed-Income Allocation: dollar-average into 20+ Yr Treasury Bonds. In a Bear Market, you may need to raise cash by selling assets. You might want to sell assets that have temporarily spiked upward in value because stocks are crashing. Only one asset that will predictably do that for you: 20+ Year Treasury Bonds, which are already being bought up and flattening the yield curve (see Appendix below). These are the Treasuries you’ll be buying, and later turning around to sell. So, you’ll need to have a brokerage account that is fee-based (that is, you’re charged ~1% of Net Asset Value/yr in return for transaction costs being waived). Then dollar-average into TLT (iShares 20+ Year Treasury Bond ETF at Line 15 in the Table). Sell those when you think the stock market has bottomed, and spend the proceeds on stocks in that Fire Sale.
Bottom Line: To avoid sleepless nights and migraine headaches, pull in your horns now. Stop gambling (but restart after the market collapses). Build up your Rainy Day Fund, and invest in cash equivalents, high-yielding high-quality stocks, and long-term Treasuries. When the crash hits, people will tell you to stop buying stocks altogether. Why do they say that? Because nobody can say for sure how long the market will keep going down. But Walmart (WMT) and McDonald’s (MCD) will be booming, even while layoffs in the Industrial Sector continue to make headlines. The End of the World isn’t happening. Get over it. Read the Wall Street Journal. When the Bear looks to be getting tired, call your stock broker and buy.
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into NEE and TGT, and also own shares of PEP, PFE, HRL, and MO. I am executing on the 4 suggestions above for raising cash.
APPENDIX: The yield curve is Flattening. What does that jargon term mean? Savvy investors are moving money out of growth stocks and into Long-Term Treasuries, even while the Federal Reserve is raising Short-Term interest rates. It doesn’t make sense. Long-Term rates would typically move up in tandem with Short-Term rates, provided the economy is truly gaining strength.
You can follow that increase in Long-Term Treasury Bond prices (which move in the opposite direction of interest rates) by going to Yahoo Finance and entering TLT (for iShares 20+ Yr Treasury Bond ETF). Click on “chart” and select the 2 Year chart. Then on “indicator” and choose a 200-day moving average. That will show the steady upward movement in the price of those bonds—because buyers outnumber sellers. That results in a steady downward movement in the rate of interest being earned by new buyers, which flattens the yield curve.
There are several explanations why Long-Term interest rates might fall even as Short-Term rates are rising: “the likeliest...is the simplest: markets are losing confidence in the Fed’s ability to raise [Short-Term] rates without inflation sagging.” You might want to learn more about the falling yield curve, so read on.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Why should we start making these changes now? Because the yield curve is flattening (see Appendix below), which is the best indicator that Financial Services professionals have to predict a market crash.
Mission: Draw up a portfolio of stocks and bonds that will carry you through a market crash relatively unscathed.
Execution: see Table.
Administration: There are 4 ways to raise cash for a crash.
1) Have a Rainy Day Fund that covers 6 months of expenses and is inflation-protected. All of us resist maintaining this “Dead Money Account.” Why? Because it keeps taking money away from spending as our income increases. The trick is to make it painless by a) eliminating transaction costs, tax payments, and inflation risk, and b) paying into the Account automatically. Sounds great, but how? By going to the US Treasury website and directing that a transfer of $25+/mo be made from your checking account into an Inflation-Protected Savings Bond (ISB). Follow a First In/First Out (FIFO) policy when cashing-out your Rainy Day Fund, since you’ll lose an interest payment if you cash-out sooner than 5 years. Taxes are only due after you’ve drawn down the Account.
2) Increase your Cash-Equivalents Allocation: dollar-average into 2-Yr Treasury Notes. Normally, this allocation is whatever cash cushion you like to maintain in your Savings, Checking, and Brokerage Accounts. But now isn’t a normal time. You need to plus-up those cash holdings and build a “backstop.” Why? Because there’s a material risk that your household will soon be living on less income (that is, a reduction upwards of 5%/yr). The easiest way to build a temporary backstop is to go back into www.treasurydirect.com and invest $1000 every 2 months in a 2-Yr Treasury Note. After 2 years, you’re done. You’ve allocated $12,000 that will start paying $1000 into your Checking Account every 2 months. Meantime, you can track the value of this investment through the ticker SHY (iShares 1-3 Year Treasury Bond ETF -- see Line 20 in the Table),
3) Reduce your Equity Allocation but retain Dividend Achievers with above-market yields. This week’s Table has suggestions that may assist you. Those stocks were chosen largely on the basis of a) high ratings from S&P, b) above-market yields, c) the likelihood of payouts continuing to increase in a recession, d) P/E ratios at or below market, and e) predicted losses in a bear market (see Column M in the Table) that are less than or equal to those predicted for the S&P 500 Index (at Line 20). When the crash hits, you will be tempted to sell these (your most crash-resistant stocks) because you’re afraid they’ll fall further. Don’t. Instead of reinvesting dividends, just have the dividend checks sent to your mailbox. If you aren’t a stock picker, simply invest in VYM (Vanguard High Dividend Yield ETF at Line 17 in Table) and XLU (SPDR Utilities Select Sector ETF at Line 14).
4) Increase your Fixed-Income Allocation: dollar-average into 20+ Yr Treasury Bonds. In a Bear Market, you may need to raise cash by selling assets. You might want to sell assets that have temporarily spiked upward in value because stocks are crashing. Only one asset that will predictably do that for you: 20+ Year Treasury Bonds, which are already being bought up and flattening the yield curve (see Appendix below). These are the Treasuries you’ll be buying, and later turning around to sell. So, you’ll need to have a brokerage account that is fee-based (that is, you’re charged ~1% of Net Asset Value/yr in return for transaction costs being waived). Then dollar-average into TLT (iShares 20+ Year Treasury Bond ETF at Line 15 in the Table). Sell those when you think the stock market has bottomed, and spend the proceeds on stocks in that Fire Sale.
Bottom Line: To avoid sleepless nights and migraine headaches, pull in your horns now. Stop gambling (but restart after the market collapses). Build up your Rainy Day Fund, and invest in cash equivalents, high-yielding high-quality stocks, and long-term Treasuries. When the crash hits, people will tell you to stop buying stocks altogether. Why do they say that? Because nobody can say for sure how long the market will keep going down. But Walmart (WMT) and McDonald’s (MCD) will be booming, even while layoffs in the Industrial Sector continue to make headlines. The End of the World isn’t happening. Get over it. Read the Wall Street Journal. When the Bear looks to be getting tired, call your stock broker and buy.
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into NEE and TGT, and also own shares of PEP, PFE, HRL, and MO. I am executing on the 4 suggestions above for raising cash.
APPENDIX: The yield curve is Flattening. What does that jargon term mean? Savvy investors are moving money out of growth stocks and into Long-Term Treasuries, even while the Federal Reserve is raising Short-Term interest rates. It doesn’t make sense. Long-Term rates would typically move up in tandem with Short-Term rates, provided the economy is truly gaining strength.
You can follow that increase in Long-Term Treasury Bond prices (which move in the opposite direction of interest rates) by going to Yahoo Finance and entering TLT (for iShares 20+ Yr Treasury Bond ETF). Click on “chart” and select the 2 Year chart. Then on “indicator” and choose a 200-day moving average. That will show the steady upward movement in the price of those bonds—because buyers outnumber sellers. That results in a steady downward movement in the rate of interest being earned by new buyers, which flattens the yield curve.
There are several explanations why Long-Term interest rates might fall even as Short-Term rates are rising: “the likeliest...is the simplest: markets are losing confidence in the Fed’s ability to raise [Short-Term] rates without inflation sagging.” You might want to learn more about the falling yield curve, so read on.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, November 19
Week 333 - $175/wk For An IRA That Uses DRIPs Backed By Savings Bonds
Situation: If you don’t have a workplace retirement plan, then you most likely have concerns that you won’t have enough savings to support retirement. You should be able to replace at least 85% of your final year’s salary by withdrawing 4%/yr from your retirement savings, which amount is increased in subsequent years to allow for inflation. But the median Social Security payout only replaces 46% of median household income. If you don’t have a workplace retirement plan, you’ll have to set savings goals, eliminate non-mortgage debt, and start cutting costs long before retiring. For example, move to an apartment after your children finish high school.
Most of us don’t think about allocating money to Savings Bonds and an IRA until we’re 50. So, let’s be realistic. How much could you augment your retirement income by contributing the maximum $6500/yr starting at age 50 to an IRA consisting of Dividend ReInvestment Plans (DRIPs) for stocks, and backing that up by contributing $2600/yr to tax-deferred Inflation-protected Savings Bonds (ISBs). You’d be saving $175/wk ($9100/yr), which is 15% of median household income for 2016 ($59,039). This plan is approximately one part Treasury Bonds and 2 parts stocks. Over the past 20 years, the lowest-cost S&P 500 Index fund has returned 7.0%/yr. The lowest-cost intermediate-term investment-grade bond index fund (composed mainly of the same 7-10 year US Treasury Bonds used for ISBs) has returned 5.4%/yr. Overall return for the 2:1 private retirement plan would have been 6.5%/yr, but 2.1%/yr of that would have been lost to inflation.
Starting at age 50, IRA contributions of $6500/yr to stocks in a DRIP IRA, and ISB contributions of $2600/yr, would have built up a private retirement account worth $314,101 by the time you retire at age 67. Spending 4% of that in your first year of retirement would add $1047/mo to the $2260/mo provided by Social Security, if you and your spouse have a the 2016 median household income of $59,039. A complicated formula will determine your exact benefit, so start learning the basics.
Mission: Develop our standard spreadsheet for 6 DRIPs using stocks issued by companies in the FTSE High Dividend Yield Index, specifically those that grow dividends 8% or more per year. In other words, pick stocks from the Extended Version of “The 2 and 8 Club” (see Week 327 and Week 329).
Execution: (see Table).
Administration: To augment your Social Security income by using a private retirement account, you’ll need to build an IRA for stocks that is backed by Inflation-protected Savings Bonds (ISBs). Make sure your accountant declares to the Internal Revenue Service that 6 DRIPs above represent your IRA, noting that annual contributions to those will not exceed $6500/yr unless the US Treasury raises the contribution limit.
We have used high-quality stocks instead of index funds in our example above, given that index funds are now thought to carry the same risks as other derivatives.
Bottom Line: It is practically impossible for you to fund your retirement without contributing at least 15%/yr to a workplace retirement plan for 25+ years. The private retirement plan outlined above envisions contributing the maximum amount allowed for an IRA, supplemented by Savings Bonds, to channel 15% of your income into tax-deferred savings for the 17 years after you turn 50, which is when you can start making the largest annual contributions to your IRA. But if you’d started that plan 17 years ago (when you were 50), you’d now receive ~$1050/mo in your first year of retirement, which is less than half your Social Security check.
Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold = 10).
Full Disclosure: I dollar-average into all 6 stocks, as well as ISBs.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Most of us don’t think about allocating money to Savings Bonds and an IRA until we’re 50. So, let’s be realistic. How much could you augment your retirement income by contributing the maximum $6500/yr starting at age 50 to an IRA consisting of Dividend ReInvestment Plans (DRIPs) for stocks, and backing that up by contributing $2600/yr to tax-deferred Inflation-protected Savings Bonds (ISBs). You’d be saving $175/wk ($9100/yr), which is 15% of median household income for 2016 ($59,039). This plan is approximately one part Treasury Bonds and 2 parts stocks. Over the past 20 years, the lowest-cost S&P 500 Index fund has returned 7.0%/yr. The lowest-cost intermediate-term investment-grade bond index fund (composed mainly of the same 7-10 year US Treasury Bonds used for ISBs) has returned 5.4%/yr. Overall return for the 2:1 private retirement plan would have been 6.5%/yr, but 2.1%/yr of that would have been lost to inflation.
Starting at age 50, IRA contributions of $6500/yr to stocks in a DRIP IRA, and ISB contributions of $2600/yr, would have built up a private retirement account worth $314,101 by the time you retire at age 67. Spending 4% of that in your first year of retirement would add $1047/mo to the $2260/mo provided by Social Security, if you and your spouse have a the 2016 median household income of $59,039. A complicated formula will determine your exact benefit, so start learning the basics.
Mission: Develop our standard spreadsheet for 6 DRIPs using stocks issued by companies in the FTSE High Dividend Yield Index, specifically those that grow dividends 8% or more per year. In other words, pick stocks from the Extended Version of “The 2 and 8 Club” (see Week 327 and Week 329).
Execution: (see Table).
Administration: To augment your Social Security income by using a private retirement account, you’ll need to build an IRA for stocks that is backed by Inflation-protected Savings Bonds (ISBs). Make sure your accountant declares to the Internal Revenue Service that 6 DRIPs above represent your IRA, noting that annual contributions to those will not exceed $6500/yr unless the US Treasury raises the contribution limit.
We have used high-quality stocks instead of index funds in our example above, given that index funds are now thought to carry the same risks as other derivatives.
Bottom Line: It is practically impossible for you to fund your retirement without contributing at least 15%/yr to a workplace retirement plan for 25+ years. The private retirement plan outlined above envisions contributing the maximum amount allowed for an IRA, supplemented by Savings Bonds, to channel 15% of your income into tax-deferred savings for the 17 years after you turn 50, which is when you can start making the largest annual contributions to your IRA. But if you’d started that plan 17 years ago (when you were 50), you’d now receive ~$1050/mo in your first year of retirement, which is less than half your Social Security check.
Risk Rating: 5 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold = 10).
Full Disclosure: I dollar-average into all 6 stocks, as well as ISBs.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 19
Week 294 - Don’t Leave Money On Table: Invest Online
Situation: Let’s use a hypothetical situation to make our case. You’ve retired and sold your house to pay off debts. For many people that would mean that you are now living in a rental that fits your needs and income. In addition, you may have a lot of money left over from the sale of your home and would like to invest it in a prudent manner. But cash is fungible. It can disappear into anything that someone thinks has an equivalent value. (Your minister might think tithing is equivalent, even though you’ve already paid tithing on the income that created your retirement plan.)
As a retiree, you need to develop a budget that will cut your living costs and execute on that plan. Aside from spending money, as directed by your budget, what kind of expenses are going to deplete your nest egg? The main factors to consider are inflation, taxes and transaction costs. There’s little you can do about inflation, other than to stay 50% invested in stocks and 50% in inflation-protected bonds, e.g. inflation-protected 10-Yr Treasury Notes, ISB Savings Bonds and inflation-protected bond funds like Vanguard Inflation-Protected Securities (VIPSX). There’s little you can do about taxes, other than own Treasury Bonds and Savings Bonds (because those pay interest that cannot be taxed by the state where you live). Also, you can avoid both Federal and state taxes by owning municipal bonds issued in the state where you live. But that is risky unless you happen to live in one of the 7 states that offer a AAA bond with investor-friendly covenants. You might also consider a low-cost, state-specific municipal bond fund if you live in a populous state that is in good fiscal condition and has a AAA credit rating, but Florida is the only state that fits that description.
Now we’re left to talk about transaction costs. You’ll like doing business with the US Treasury over the internet because there are no transaction costs. But with stocks, it gets more complicated. To reduce transaction costs, there are two routes you can take: 1) Invest in low-cost mutual funds. Vanguard Group has the best deals. Avoid Exchange-Traded Funds unless you want to throw a little business to your stock-broker in return for the research materials she’s been providing. 2) Make low-cost investments online, monthly and automatically. You can do this with any of the Vanguard mutual funds but also with individual stocks. There are 3 main websites: Computershare, Wells Fargo, and American Stock Transfer & Trust.
Mission: Set up a spreadsheet (see Table) with metrics for a sample of stocks that are available for dollar-cost averaging (monthly and online using automatic withdrawals from your checking account). Pick examples from a single source (Computershare) and list the annual transaction cost for investing $100/mo. Balance stocks with 10-Yr Treasury Notes obtained through TreasuryDirect. Inflation-protected versions of those Notes are available, as are IRA-like versions called ISBs (Inflation-Protected Savings Bonds). Those fixed-income assets need to represent 1/3rd of your monthly investment, stocks from each of the 4 S&P Defensive Industries 1/3rd, and stocks from each of the 4 S&P Growth Industries 1/3rd.
In the BENCHMARKS section, include low-cost mutual funds referencing a Standard Retirement Plan. NOTE: The 4 S&P Defensive Industries are Utilities, HealthCare, Communication Services and Consumer Staples. The 4 S&P Growth Industries are Financials, Information Technology, Industrials and Consumer Discretionary. The two commodity-related Industries (Basic Materials and Energy) are omitted. Why? Because even the few A-rated stocks have excess volatility. As a retiree, investing in those Industries would amount to gambling with your “nest egg.”
Execution: see Table.
Bottom Line: Transaction costs consume 2.5%/yr of most investor’s savings. But the internet allows you to reduce transaction costs to less than 1%/yr. Over a 10 yr holding period, that 1.5% difference would increase your return on a $10,000 investment by $1,600. In Column U of this week’s Table, we show that if you pick a dozen high-quality stocks and bonds from the main internet sources, and automatically invest $100/mo in each, your annual expenses would come to ~$135 for that investment of $12,000 (0.94%). But read the fine print first:
Caveat emptor: Owning individual stocks is a gamble unless a) you own at least 30 stocks, and b) your picks reflect the impact of each S&P Industry on the economy. Otherwise, you’ll lose money at some point because of selection bias. To avoid that risk altogether, invest in stock index funds that cover the entire economy, e.g. the Vanguard 500 Index Fund (VFINX), the Vanguard Total Stock Market Index Fund (VTSMX), and the SPDR S&P MidCap 400 ETF (MDY).
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: In dollar-average into UNP, JNJ, T, NKE and KO, as well as ISBs (Inflation-Protected Savings Bonds).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 20.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
As a retiree, you need to develop a budget that will cut your living costs and execute on that plan. Aside from spending money, as directed by your budget, what kind of expenses are going to deplete your nest egg? The main factors to consider are inflation, taxes and transaction costs. There’s little you can do about inflation, other than to stay 50% invested in stocks and 50% in inflation-protected bonds, e.g. inflation-protected 10-Yr Treasury Notes, ISB Savings Bonds and inflation-protected bond funds like Vanguard Inflation-Protected Securities (VIPSX). There’s little you can do about taxes, other than own Treasury Bonds and Savings Bonds (because those pay interest that cannot be taxed by the state where you live). Also, you can avoid both Federal and state taxes by owning municipal bonds issued in the state where you live. But that is risky unless you happen to live in one of the 7 states that offer a AAA bond with investor-friendly covenants. You might also consider a low-cost, state-specific municipal bond fund if you live in a populous state that is in good fiscal condition and has a AAA credit rating, but Florida is the only state that fits that description.
Now we’re left to talk about transaction costs. You’ll like doing business with the US Treasury over the internet because there are no transaction costs. But with stocks, it gets more complicated. To reduce transaction costs, there are two routes you can take: 1) Invest in low-cost mutual funds. Vanguard Group has the best deals. Avoid Exchange-Traded Funds unless you want to throw a little business to your stock-broker in return for the research materials she’s been providing. 2) Make low-cost investments online, monthly and automatically. You can do this with any of the Vanguard mutual funds but also with individual stocks. There are 3 main websites: Computershare, Wells Fargo, and American Stock Transfer & Trust.
Mission: Set up a spreadsheet (see Table) with metrics for a sample of stocks that are available for dollar-cost averaging (monthly and online using automatic withdrawals from your checking account). Pick examples from a single source (Computershare) and list the annual transaction cost for investing $100/mo. Balance stocks with 10-Yr Treasury Notes obtained through TreasuryDirect. Inflation-protected versions of those Notes are available, as are IRA-like versions called ISBs (Inflation-Protected Savings Bonds). Those fixed-income assets need to represent 1/3rd of your monthly investment, stocks from each of the 4 S&P Defensive Industries 1/3rd, and stocks from each of the 4 S&P Growth Industries 1/3rd.
In the BENCHMARKS section, include low-cost mutual funds referencing a Standard Retirement Plan. NOTE: The 4 S&P Defensive Industries are Utilities, HealthCare, Communication Services and Consumer Staples. The 4 S&P Growth Industries are Financials, Information Technology, Industrials and Consumer Discretionary. The two commodity-related Industries (Basic Materials and Energy) are omitted. Why? Because even the few A-rated stocks have excess volatility. As a retiree, investing in those Industries would amount to gambling with your “nest egg.”
Execution: see Table.
Bottom Line: Transaction costs consume 2.5%/yr of most investor’s savings. But the internet allows you to reduce transaction costs to less than 1%/yr. Over a 10 yr holding period, that 1.5% difference would increase your return on a $10,000 investment by $1,600. In Column U of this week’s Table, we show that if you pick a dozen high-quality stocks and bonds from the main internet sources, and automatically invest $100/mo in each, your annual expenses would come to ~$135 for that investment of $12,000 (0.94%). But read the fine print first:
Caveat emptor: Owning individual stocks is a gamble unless a) you own at least 30 stocks, and b) your picks reflect the impact of each S&P Industry on the economy. Otherwise, you’ll lose money at some point because of selection bias. To avoid that risk altogether, invest in stock index funds that cover the entire economy, e.g. the Vanguard 500 Index Fund (VFINX), the Vanguard Total Stock Market Index Fund (VTSMX), and the SPDR S&P MidCap 400 ETF (MDY).
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: In dollar-average into UNP, JNJ, T, NKE and KO, as well as ISBs (Inflation-Protected Savings Bonds).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 21 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 5-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 20.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 22
Week 291 - Back-up Your Rainy Day Fund With A-rated Defensive Stocks That Are Dividend Achievers With Clean Balance Sheets
Situation: After retirement, you’ll have a stream of fixed income, ideally from several sources, namely annuities, a pension or Reverse Mortgage, Social Security, an IRA, a 401(k) or 403(b), and RMDs (Required Minimum Distributions) on any of those you haven’t converted to annuities. For 30-40% of you, Social Security and perhaps a Reverse Mortgage will be the extent of your retirement income. You’ll budget that income, perhaps with the help of Food Stamps. But also need to have an FDIC-insured Savings Account for emergencies. That Rainy Day Fund will be eroded by inflation, travel, and non-recurring capital expenditures, mainly co-payments and deductibles on your health insurance. To keep ahead of inflation, we recommend that you stuff your Rainy Day Fund with Inflation-Protected Savings Bonds (ISBs), which currently yield 2.76%. You can cash those bonds in after 5 yrs without incurring a penalty, but would lose only one interest payment if you were to cash in earlier.
The money you take out of your Rainy Day Fund has to be replaced, so as to have at least a one-year year buffer, i.e., in order to keep it from disappearing. Those replacement dollars will have to come from a part-time job, renting out a room in your house, or severe budgeting. But there is a better way, which is to arrange (before you retire) to have a growing income. To help achieve this, back up your Rainy Day Fund by investing in “defensive” stocks, using the cheapest way possible, which is to purchase shares online and use “dollar-cost averaging” via automatic withdrawals from your checking account--into stocks of one or two companies among S&P’s defensive industries. These are: Health Care, Utilities, Consumer Staples, and Telecommunication Services.
Mission: Set up a spreadsheet of A-rated Dividend Achievers in the 4 S&P defensive industries.
Administration: This week’s Table has 8 such Dividend Achievers, and the shares of all but Procter & Gamble (PG) and McCormick (MKC) can be purchased from Computershare; PG and MKC shares are offered by Wells & Fargo. The annual cost of investing $100/mo online in each is shown in Column AB of the Table. The average cost for investing $1200/yr in monthly installments is $8.00, giving an Expense Ratio of 0.67% (8/1200). There are also exchange-traded funds (ETFs) available for each S&P Industry but those would need to be purchased through a broker. The average dividend yield for all 8 is a little less than 3% (see Column G in the Table), and the average long-term price appreciation of the stocks is ~9.5% (see Column K in the Table). All 8 have less risk of loss in the next Bear Market than the S&P 500 Index (see Column M in the Table).
Bottom Line: After you retire, your only sources of income growth are Social Security and dividend-paying stocks. The best way to safely capture dividend growth is to invest in a low-cost managed mutual fund like Vanguard Wellesley Income Fund (VWINX), where the managers mainly use safe bonds but thread in dividend-paying stocks to represent 30-40% of assets. The next best way is to have a computer hold stocks at 60% and bonds at 40%, e.g. the Vanguard Balanced Index Fund (VBINX). Finally, if you have the time and interest, pick relatively safe “defensive” stocks on the basis of dividend growth (see Column H in the Table) and historically low volatility (see Column M in the Table). Today’s blog focuses on that option.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG, JNJ and NEE, and also own shares of KO, WMT, ABT and MKC.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 17.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The money you take out of your Rainy Day Fund has to be replaced, so as to have at least a one-year year buffer, i.e., in order to keep it from disappearing. Those replacement dollars will have to come from a part-time job, renting out a room in your house, or severe budgeting. But there is a better way, which is to arrange (before you retire) to have a growing income. To help achieve this, back up your Rainy Day Fund by investing in “defensive” stocks, using the cheapest way possible, which is to purchase shares online and use “dollar-cost averaging” via automatic withdrawals from your checking account--into stocks of one or two companies among S&P’s defensive industries. These are: Health Care, Utilities, Consumer Staples, and Telecommunication Services.
Mission: Set up a spreadsheet of A-rated Dividend Achievers in the 4 S&P defensive industries.
Administration: This week’s Table has 8 such Dividend Achievers, and the shares of all but Procter & Gamble (PG) and McCormick (MKC) can be purchased from Computershare; PG and MKC shares are offered by Wells & Fargo. The annual cost of investing $100/mo online in each is shown in Column AB of the Table. The average cost for investing $1200/yr in monthly installments is $8.00, giving an Expense Ratio of 0.67% (8/1200). There are also exchange-traded funds (ETFs) available for each S&P Industry but those would need to be purchased through a broker. The average dividend yield for all 8 is a little less than 3% (see Column G in the Table), and the average long-term price appreciation of the stocks is ~9.5% (see Column K in the Table). All 8 have less risk of loss in the next Bear Market than the S&P 500 Index (see Column M in the Table).
Bottom Line: After you retire, your only sources of income growth are Social Security and dividend-paying stocks. The best way to safely capture dividend growth is to invest in a low-cost managed mutual fund like Vanguard Wellesley Income Fund (VWINX), where the managers mainly use safe bonds but thread in dividend-paying stocks to represent 30-40% of assets. The next best way is to have a computer hold stocks at 60% and bonds at 40%, e.g. the Vanguard Balanced Index Fund (VBINX). Finally, if you have the time and interest, pick relatively safe “defensive” stocks on the basis of dividend growth (see Column H in the Table) and historically low volatility (see Column M in the Table). Today’s blog focuses on that option.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG, JNJ and NEE, and also own shares of KO, WMT, ABT and MKC.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 17.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 25
Week 286 - Should You Take Out A Reverse Mortgage?
Situation: Young couples are often advised to make payments each month on 1) a home mortgage, and 2) a “whole life” insurance policy. Homes are not good investments, and neither are “whole life” policies. They’re a form of compelled savings. If we later find ourselves unprepared for retirement, we may be guided to recoup those savings by “taking out” a reverse mortgage or “borrowing against” a whole life policy. The government joins the party by compelling us to save during our working years (under the Federal Insurance Contributions Act of 1935), and then guides us to recoup our “Social Security” savings in retirement.
Mission: Look at the costs and benefits of reverse mortgages. NOTE: To obtain more detailed information, I suggest reading this article that appeared in USA Today on October 28.
Execution: “On the plus side, reverse mortgages are considered loan advances to you, not income you earned. Thus, the payments you receive are not taxable. Moreover, they usually don't affect your Social Security or Medicare benefits.” Emotional benefits play a role, given that 1) you get to keep living in your home without paying rent, and 2) your children get to inherit a house that retains considerable equity. And, reverse mortgages make a great Rainy Day Fund.
On the negative side, there is “opportunity cost”: You are giving up the opportunity to invest a large sum of your own money, if you sell the house and rent a place more suited to your needs. Transaction costs on the sale are the same as those for taking out a reverse mortgage (6%), which leaves 94% for you to invest. We provide an example (see Table) of how you might set up an online investment in bonds and stocks that pays out at least 2%/yr (after transaction costs) and grows those payments at least 2%/yr.
Administration: The investment example has an asset allocation of 50% bonds/50% stocks. The bonds are “zero risk/zero cost” 10-Yr Treasury Notes accessed through the government website; that site also offers inflation-protected Treasury Notes. You can invest in KO, JNJ and WMT online but have to use a different website to invest in PG. Each pays a good and growing dividend, and had Total Returns/yr during the Housing Crisis that were better than those for our key benchmark, the Vanguard Balanced Index Fund (VBINX; see Column D in the Table).
It is best to make these investments over time, starting with 40% of your proceeds then adding $100/mo to each of the 4 stocks and $1200/qtr to T-Notes. So, 60% of the proceeds from selling your house would initially go to an FDIC-insured savings account paying little interest. Part of that 60% will never be invested because it serves as your Rainy Day Fund. Nonetheless, you’ll be in a position to withdraw $9600/yr for electronic transfers to bond and stock accounts. Annual transaction costs come to ~$72/yr (see Column N in the Table).
Bottom Line: Reverse mortgages can be a good idea, if you’ve paid off your home mortgage and have almost no source of retirement income outside of Social Security. But inflation will always be with us, so it might be better to sell your house and move to a place that is not designed for raising children. Then, you can invest the proceeds from selling your house in a manner that costs you little and provides an opportunity to protect yourself from inflation.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG and JNJ, as well as inflation-protected Savings Bonds (which are an IRA-like version of 10-Yr Treasury Notes). I also own shares of KO and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Look at the costs and benefits of reverse mortgages. NOTE: To obtain more detailed information, I suggest reading this article that appeared in USA Today on October 28.
Execution: “On the plus side, reverse mortgages are considered loan advances to you, not income you earned. Thus, the payments you receive are not taxable. Moreover, they usually don't affect your Social Security or Medicare benefits.” Emotional benefits play a role, given that 1) you get to keep living in your home without paying rent, and 2) your children get to inherit a house that retains considerable equity. And, reverse mortgages make a great Rainy Day Fund.
On the negative side, there is “opportunity cost”: You are giving up the opportunity to invest a large sum of your own money, if you sell the house and rent a place more suited to your needs. Transaction costs on the sale are the same as those for taking out a reverse mortgage (6%), which leaves 94% for you to invest. We provide an example (see Table) of how you might set up an online investment in bonds and stocks that pays out at least 2%/yr (after transaction costs) and grows those payments at least 2%/yr.
Administration: The investment example has an asset allocation of 50% bonds/50% stocks. The bonds are “zero risk/zero cost” 10-Yr Treasury Notes accessed through the government website; that site also offers inflation-protected Treasury Notes. You can invest in KO, JNJ and WMT online but have to use a different website to invest in PG. Each pays a good and growing dividend, and had Total Returns/yr during the Housing Crisis that were better than those for our key benchmark, the Vanguard Balanced Index Fund (VBINX; see Column D in the Table).
It is best to make these investments over time, starting with 40% of your proceeds then adding $100/mo to each of the 4 stocks and $1200/qtr to T-Notes. So, 60% of the proceeds from selling your house would initially go to an FDIC-insured savings account paying little interest. Part of that 60% will never be invested because it serves as your Rainy Day Fund. Nonetheless, you’ll be in a position to withdraw $9600/yr for electronic transfers to bond and stock accounts. Annual transaction costs come to ~$72/yr (see Column N in the Table).
Bottom Line: Reverse mortgages can be a good idea, if you’ve paid off your home mortgage and have almost no source of retirement income outside of Social Security. But inflation will always be with us, so it might be better to sell your house and move to a place that is not designed for raising children. Then, you can invest the proceeds from selling your house in a manner that costs you little and provides an opportunity to protect yourself from inflation.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG and JNJ, as well as inflation-protected Savings Bonds (which are an IRA-like version of 10-Yr Treasury Notes). I also own shares of KO and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, August 28
Week 269 - “Buy and Hold” Barron’s 500 Defensive Companies
Situation: You will become a “risk-off” investor the day you retire. The most you’ll be able to draw from your retirement savings is 4%/yr, preferably 3.5%. That amount has to be re-calculated each year by adding enough to compensate for inflation. You’ll also need to match revenues with expenses, with the goal of spending 1/12th of that yearly income each month. Inflation won’t be your main problem, as long as 50% of your retirement savings are in the stock market, where prices inflate at about the same rate as your food and utility bills. In normal economic times, the interest paid on bonds you own will also track inflation. For example, the yield on 10-yr Treasuries has stayed at 2.3%/yr ahead of inflation since 2000, and over the past 140 yrs. Your problem will be living on a fixed income with an inflexible budget. Money to buy new clothes or take a vacation will have to come from a savings account that you’ve set up for non-recurring capital expenditures, an account that you contribute to every month.
To increase your spending power, three options are relatively common: 1) rent out part of your house and raise the rent faster than inflation raises your expenses; 2) find a part-time job where your after-tax income is likely to grow faster than inflation; and/or 3) benefit from “risk-off” stocks that you bought before retiring, stocks that you never plan to sell (because they pay a good and growing dividend). Let’s dig deeper on Option 3, living off dividend income.
Mission: Provide fundamental information about each company that pays “risk-off” dividends likely to grow faster than inflation.
Execution: I know what you’re thinking: this is alchemy. And you’re right. In a world that arbitrages every financial asset every day, there is no such thing as free money after accounting for inflation and transaction costs. So, let’s start with how finance professionals do it. They invest in AAA sovereign bonds. These days, they have to pay for that privilege. In other words, the safest bonds (German Bunds) pay negative interest. You’re not going to do that, so you’ll have to take a little bit of risk.
What is a “risk-off” dividend-growing stock? The risk that a dividend won’t increase continuously relates to the health of that company’s Balance Sheet. You’ve heard the phrase: “Bullet-proof Balance Sheet.” That means the company keeps cash (and cash-equivalents like US Treasury Bills) in a bank vault or with the US Treasury, and also has non-strategic assets that traders know can be sold for a good price, even during a recession. In recent blogs, we’ve talked about companies that have a “clean Balance Sheet” and have boiled that term down to tracking 4 ratios:
1. Total Debt:Equity is under 100% (or under 200% if the company is a regulated public utility). That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is the most important marker of a company’s “general financial condition." That ratio needs to be under 30% (35% if a regulated public utility). Long-term debt has to either be renewed at maturity or returned to the lender. In a financial crisis, the rate of interest that bankers charge for a renewal (“rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling assets or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies mainly in the perceived value of their brand, which accountants call “goodwill” when the company is sold for more than its book value. But remember that property, plant and equipment are carried at historic cost when calculating book value. So, goodwill is more than just the perceived value of the brand. It’s the buyer’s perception of current value for property, plant, and equipment. TBV may be negative for a short period after a company restructures, e.g. by selling non-strategic assets to pay down LT debt as Procter & Gamble (at Line 7 in the Table) did recently. If the other 3 ratios indicate a clean Balance Sheet, the TBV will likely continue to be raised on schedule.
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow (i.e., “cash from operations” minus capital expenditures).
Administration: Most companies with A-rated stocks pay good and growing dividends. S&P calls those with a 10+ yr record of annual dividend boosts Dividend Achievers. Another quick way to find relatively safe stocks is to take a close look at those issued by companies in “defensive” industries (Consumer Staples, HealthCare, Utilities, and Communications Services). Why? Because they sell essential goods and services. Unfortunately, that extra bulwark against bankruptcy leads many of those companies away from maintaining a clean Balance Sheet and toward a reliance on borrowed money. And banks will comply. Even during the Lehman Panic, Johnson & Johnson (with its AAA credit rating) had no difficulty borrowing money at attractive interest rates. We also use another safety factor when looking for “risk-off” companies, which is to confine our search to Barron’s 500 companies. Why? Because those companies have large revenue streams, capturing revenue from multiple product lines. One or two of those lines will continue to grow during a recession, reducing the impact from lines that loose sales.
We find 7 Dividend Achievers in defensive industries that are sufficiently “risk-off” to be suitable for inclusion in a “buy and hold” retirement savings plan (see Table).
Bottom Line: It’s a nice idea, to find “safe companies” that pay a good and growing dividend. A retiree who paid $50,000 for stock in such companies over a 10 yr period prior to retirement will not be confined to living on a fixed income. By the time she retires, those stocks will be yielding 4-5% of their initial cost, and that $2000+/yr of income can be expected to grow 9+%/yr going forward. Ten yrs into retirement, she’ll be receiving dividend checks totaling ~$5000/yr. We’ve turned up 7 Dividend Achievers that are good bets for accomplishing that feat. In the aggregate, they’ve increased their dividend 12%/yr over the past 16 yrs (see Column H in the Table). None have a statistical risk of price loss in a Bear Market that exceeds the 31% loss projected for the S&P 500 Index, and their average projected loss is only 25% (see Column M in the Table).
Risk Rating: 4 (where Treasuries
= 1 and gold = 10)
Full Disclosure: I dollar-average monthly (www.computershare.com) into NEE, PG and JNJ, and also own shares in WMT and HRL.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is 16-Yr CAGR. Price Growth Rate is the mean or trendline 16-Yr Price CAGR (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
To increase your spending power, three options are relatively common: 1) rent out part of your house and raise the rent faster than inflation raises your expenses; 2) find a part-time job where your after-tax income is likely to grow faster than inflation; and/or 3) benefit from “risk-off” stocks that you bought before retiring, stocks that you never plan to sell (because they pay a good and growing dividend). Let’s dig deeper on Option 3, living off dividend income.
Mission: Provide fundamental information about each company that pays “risk-off” dividends likely to grow faster than inflation.
Execution: I know what you’re thinking: this is alchemy. And you’re right. In a world that arbitrages every financial asset every day, there is no such thing as free money after accounting for inflation and transaction costs. So, let’s start with how finance professionals do it. They invest in AAA sovereign bonds. These days, they have to pay for that privilege. In other words, the safest bonds (German Bunds) pay negative interest. You’re not going to do that, so you’ll have to take a little bit of risk.
What is a “risk-off” dividend-growing stock? The risk that a dividend won’t increase continuously relates to the health of that company’s Balance Sheet. You’ve heard the phrase: “Bullet-proof Balance Sheet.” That means the company keeps cash (and cash-equivalents like US Treasury Bills) in a bank vault or with the US Treasury, and also has non-strategic assets that traders know can be sold for a good price, even during a recession. In recent blogs, we’ve talked about companies that have a “clean Balance Sheet” and have boiled that term down to tracking 4 ratios:
1. Total Debt:Equity is under 100% (or under 200% if the company is a regulated public utility). That means senior managers will still “call the shots” in a crisis, not the bankers.
2. Long-Term Debt:Total Assets is the most important marker of a company’s “general financial condition." That ratio needs to be under 30% (35% if a regulated public utility). Long-term debt has to either be renewed at maturity or returned to the lender. In a financial crisis, the rate of interest that bankers charge for a renewal (“rollover”) will likely be higher than for the original loan. In the Lehman Panic, many companies found that rollovers were unavailable at any rate of interest. To avoid declaring bankruptcy, those companies had to either repay maturing loans by selling assets or find a “White Knight,” such as another company willing to assume that obligation as part of an acquisition.
3. TBV:Px is a positive number. You want the stock’s price to include Tangible Book Value. Most S&P 500 companies don’t have TBV. Their book value lies mainly in the perceived value of their brand, which accountants call “goodwill” when the company is sold for more than its book value. But remember that property, plant and equipment are carried at historic cost when calculating book value. So, goodwill is more than just the perceived value of the brand. It’s the buyer’s perception of current value for property, plant, and equipment. TBV may be negative for a short period after a company restructures, e.g. by selling non-strategic assets to pay down LT debt as Procter & Gamble (at Line 7 in the Table) did recently. If the other 3 ratios indicate a clean Balance Sheet, the TBV will likely continue to be raised on schedule.
4. Div:FCF is a positive number. Going into a Bear Market, you don’t want to own stock in companies that make a habit of borrowing money to pay their dividend. Always be suspicious of companies that don’t pay their dividend out of Free Cash Flow (i.e., “cash from operations” minus capital expenditures).
Administration: Most companies with A-rated stocks pay good and growing dividends. S&P calls those with a 10+ yr record of annual dividend boosts Dividend Achievers. Another quick way to find relatively safe stocks is to take a close look at those issued by companies in “defensive” industries (Consumer Staples, HealthCare, Utilities, and Communications Services). Why? Because they sell essential goods and services. Unfortunately, that extra bulwark against bankruptcy leads many of those companies away from maintaining a clean Balance Sheet and toward a reliance on borrowed money. And banks will comply. Even during the Lehman Panic, Johnson & Johnson (with its AAA credit rating) had no difficulty borrowing money at attractive interest rates. We also use another safety factor when looking for “risk-off” companies, which is to confine our search to Barron’s 500 companies. Why? Because those companies have large revenue streams, capturing revenue from multiple product lines. One or two of those lines will continue to grow during a recession, reducing the impact from lines that loose sales.
We find 7 Dividend Achievers in defensive industries that are sufficiently “risk-off” to be suitable for inclusion in a “buy and hold” retirement savings plan (see Table).
Bottom Line: It’s a nice idea, to find “safe companies” that pay a good and growing dividend. A retiree who paid $50,000 for stock in such companies over a 10 yr period prior to retirement will not be confined to living on a fixed income. By the time she retires, those stocks will be yielding 4-5% of their initial cost, and that $2000+/yr of income can be expected to grow 9+%/yr going forward. Ten yrs into retirement, she’ll be receiving dividend checks totaling ~$5000/yr. We’ve turned up 7 Dividend Achievers that are good bets for accomplishing that feat. In the aggregate, they’ve increased their dividend 12%/yr over the past 16 yrs (see Column H in the Table). None have a statistical risk of price loss in a Bear Market that exceeds the 31% loss projected for the S&P 500 Index, and their average projected loss is only 25% (see Column M in the Table).
Risk Rating: 4 (where Treasuries
= 1 and gold = 10)
Full Disclosure: I dollar-average monthly (www.computershare.com) into NEE, PG and JNJ, and also own shares in WMT and HRL.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 14 in the Table. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = the moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is 16-Yr CAGR. Price Growth Rate is the mean or trendline 16-Yr Price CAGR (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The NPV template is found at (http://www.investopedia.com/calculator/netpresentvalue.aspx).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 8
Week 253 - Gold
Situation: For many of us, our concept of personal financial security meshes with our concept of personal safety. Recent TV commercials highlighting the benefits of owning gold are a case in point. The idea is that an investor may not need to worry so much about government debt, and its effect on inflation, if his or her retirement plan includes a “Gold IRA.” Given that the IRS classifies gold as a “collectible” (because it doesn’t pay interest and can’t be rented), its dollar value is defined by the eagerness of prospective owners, i.e., gold’s value increases only if there are more buyers than sellers. The main reason to buy into a “crowded trade” is to hedge against the likelihood of a future event that would negatively affect the buyer’s personal financial security.
One possible event is that the US government’s debt per capita would increase to the point of “currency debasement.” The more people become concerned about that possibility, the more valuable gold becomes. The fact that the US government’s debt per capita has been falling since the Great Recession doesn't remove this concern. Why? Because the US government is increasingly seen as the “payer of last resort.” For example, Puerto Rico is no longer solvent and needs an $80B bailout. Another example: thousands of municipal water systems have lead pipes that urgently need replacing. Finally, such a large number of senior citizens (“baby boomers”) are retiring that Medicare expenditures will increase dramatically.
To sum up, there is too much government, corporate, and household debt worldwide. The tendency of Central Banks to drive interest rates ever lower (to “jump-start” their economies) only makes borrowing more attractive, and the likely result of that will be greater indebtedness.
Mission: Look at 12-yr returns for GLD, an exchange-traded fund (ETF) for gold bullion, as well as the Market Vectors Gold Miners ETF (GDX) and Newmont Mining (NEM), the largest US gold miner. Two other large mining companies are also important to consider: Agnico Eagle Mines Ltd (AEM) and Barrick Gold (ABX). Gold mining is accomplished by getting rock out of the ground and using massive electric-drive Caterpillar (CAT) trucks to carry it out of the mine. That stock’s price is a good barometer of mining activity. It is also important to consider the only Dividend Achiever among gold stocks, Royal Gold (RGLD), which is a company that obtains royalties on gold production in exchange for financing gold mines. Compare those returns (see Table) to more typical US stocks in the commodity space, such as NextEra Energy (NEE), Union Pacific (UNP) and Exxon Mobil (XOM).
Bottom Line: By owning gold you’re giving up the opportunity to make another investment that provides you with a steady income from interest, dividends or rent. You also miss out on paying the low capital gains tax for income-producing investments. Gold is a “collectible” and the proceeds are taxed as income. This may not matter, if you think hyperinflation is a looming threat. Just remember, gold is the most speculative of investments because of its price volatility and lack of income.
Risk Rating: 10
Full Disclosure: I dollar-average into NEE, UNP, and XOM.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
One possible event is that the US government’s debt per capita would increase to the point of “currency debasement.” The more people become concerned about that possibility, the more valuable gold becomes. The fact that the US government’s debt per capita has been falling since the Great Recession doesn't remove this concern. Why? Because the US government is increasingly seen as the “payer of last resort.” For example, Puerto Rico is no longer solvent and needs an $80B bailout. Another example: thousands of municipal water systems have lead pipes that urgently need replacing. Finally, such a large number of senior citizens (“baby boomers”) are retiring that Medicare expenditures will increase dramatically.
To sum up, there is too much government, corporate, and household debt worldwide. The tendency of Central Banks to drive interest rates ever lower (to “jump-start” their economies) only makes borrowing more attractive, and the likely result of that will be greater indebtedness.
Mission: Look at 12-yr returns for GLD, an exchange-traded fund (ETF) for gold bullion, as well as the Market Vectors Gold Miners ETF (GDX) and Newmont Mining (NEM), the largest US gold miner. Two other large mining companies are also important to consider: Agnico Eagle Mines Ltd (AEM) and Barrick Gold (ABX). Gold mining is accomplished by getting rock out of the ground and using massive electric-drive Caterpillar (CAT) trucks to carry it out of the mine. That stock’s price is a good barometer of mining activity. It is also important to consider the only Dividend Achiever among gold stocks, Royal Gold (RGLD), which is a company that obtains royalties on gold production in exchange for financing gold mines. Compare those returns (see Table) to more typical US stocks in the commodity space, such as NextEra Energy (NEE), Union Pacific (UNP) and Exxon Mobil (XOM).
Bottom Line: By owning gold you’re giving up the opportunity to make another investment that provides you with a steady income from interest, dividends or rent. You also miss out on paying the low capital gains tax for income-producing investments. Gold is a “collectible” and the proceeds are taxed as income. This may not matter, if you think hyperinflation is a looming threat. Just remember, gold is the most speculative of investments because of its price volatility and lack of income.
Risk Rating: 10
Full Disclosure: I dollar-average into NEE, UNP, and XOM.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. the Vanguard Balanced Index Fund (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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