Month 112 - WATCH LIST: 28 A-rated Non-financial Companies in the iShares Top 200 Value ETF - October 2020

Situation: Savers eventually come to realize that they need to invest for income, to realize a positive return on investment (ROI). ROI is the most common profitability ratio.

    ROI is calculated by subtracting the initial value of the investment from the final value of the investment (which equals the net return), then dividing this new number (the net return) by the “cost of investment”, and, finally, multiplying by 100. For an asset in an investor’s portfolio, the “cost of investment” equals inflation + transaction costs.

Inflation is the only cost from owning Savings Bonds or an FDIC-insured savings account, there being no transaction costs. But savers typically incur a negative ROI because the interest rate credited to their account is almost always lower than the inflation rate, unless they bought Inflation-protected Savings Bonds.

The woke saver’s goal is to invest in assets that have low transaction costs but also have interest or dividend rates that cover inflation: stocks and bonds. An “investment-grade intermediate-term” bond fund, like the Vanguard Total Bond Market Index ETF (BND), is a suitable choice except during periods of hyperinflation. That’s because the value of bonds already held in the fund, referred to as “legacy” bonds, will fall when inflation is rising briskly. Why? Because the interest rate on legacy bonds will be lower than the rate of inflation. 

The dividend yield on stocks and stock ETFs could also lag behind rising inflation. However, the companies that pay those dividends usually grow their earnings and dividends faster during inflation, partly because the value of the dollar keeps falling. The investor’s ROI will likely remain positive, since it reflects growth in the stock’s price (from faster earnings growth) and growth in the dividend payout. 

Our saver, whom we now call an investor because she knows enough to seek out value (by looking to pay low transaction costs for apparently underpriced assets), will need to shop among different high-yielding assets to sustain ROI growth: 1) a bond-heavy “balanced” mutual fund like the Vanguard Wellesley Income Fund (VWINX), 2) a high-yielding stock index ETF like the Vanguard High Dividend Yield Index Fund (VYM), and 3) individual stocks selected from the VYM portfolio. 

Mission: Analyze stocks in the iShares Top 200 Value Index ETF (IWX) that are also in VYM’s portfolio and meet these 5 criteria: have a) at least a 20-year trading record, b) an S&P bond rating of A- or higher, c) an S&P stock rating of B+/M or higher, d) a positive Book Value for the most recent quarter (mrq), and e) positive earnings for the Trailing Twelve Months (TTM). These criteria narrow your choices to a manageable but high quality Watch List. If you don’t have time to follow all 28 companies, confine your attention to the 21 companies that are also in the S&P 100 Index (see Column AR in the Table) or the 16 companies that are also in the 65-stock Dow Jones Composite Average (see Column AS in the Table).

Execution: see Table.

Administration: For comparison purposes, I list the 9 Financial Services companies separately because the Federal Open Market Committee (FOMC) has promised to keep interest rates near zero through 2023. Financial Services companies profit from the “spread” between what they pay for money and what they make from that money. With interest rates for 15-year home mortgages moving lower than 2.5% and 5-year inflation rates moving higher than 1.8%, there is little profit potential on the horizon.

To calculate the annual ROI of a publicly-traded corporation, divide Earnings Before Interest and Taxes (EBIT line of Net Income statement) by Total Assets (at the bottom of the Balance Sheet statement). You want the most recent information available, which is ROI for the Trailing Twelve Months (TTM). That is similarly calculated using the 4 most recent quarterly Net Income and Balance Sheet statements (see Column AT in the Table). 

Bottom Line: You’ll need to focus on large-capitalization stocks in your retirement account that pay a good and growing dividend. Why? There are 4 reasons: Those companies have 1) multiple product & service lines that likely can be managed to allow the company to continue growing earnings during a recession; 2) multi-billion dollar credit lines are already in place, 3) banking relationships are already in place that make it possible for each company to issue new long-term bonds with low interest rates during a recession, and 4) these companies are what you need to invest in, if you want to achieve total returns that come close to those achieved by the gold standard that we all measure our investment returns against, which are the capitalization-weighted S&P 500 Index ETFs like SPY (see Line 47 in the Table), which large brokers like Fidelity offer at negligible cost. 

Possible BUYs among Value Stocks (i.e. those with green highlights in both Column AD and Column AF of the Table). There are 9 such stocks: Pfizer (PFE), Cisco Systems (CSCO), Intel (INTC), American Electric Power (AEP), Duke Energy (DUK), Comcast (CMCSA), Southern (SO), Eaton PLC (ETN) and International Business Machines (IBM). The “possible BUYs” need to    1) not be overburdened with debt (see red highlights in Columns S-U of the Table);

  2) have a PEG ratio no greater than 2.5 (Column AI), and

  3) have high Returns On Tangible Capital Employed (Column O) and Returns On Investment (Column AT).

Intel (INTC) and Cisco Systems are the only ones that have a Return On Investment (TTM) greater than 15% (see Column AT in the Table). Findings: PFE, CMCSA and IBM are overburdened with debt; AEP, DUK, SO, ETN and IBM have high PEG ratios. The only remaining companies, CSCO and INTC, do have high returns (Earnings Before Interest and Taxes) on Tangible Capital Employed and Total Assets (see Columns O and AT in the Table), and are therefore “possible BUYs.”

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

Full Disclosure: I dollar-average into MRK, PFE, INTC, PG, WMT, CAT, and also own shares of NEE, CSCO, TGT, DUK, KO, JNJ, CMCSA, SO, MMM IBM.

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Month 102 - A-rated Stocks in Vanguard’s Wellesley Income Fund (VWINX) - December 2019

Situation: For retiree savings accounts, most of the financial advisors that I follow prefer that half be allocated to bonds and the rest to stocks that reliably pay an above-market dividend. There is a convenient, low-cost way to anchor one’s portfolio in that direction, which is to invest in VWINX -- Vanguard’s Wellesley Income Fund. The managers allocate almost 60% to bonds and the rest to stocks that have been selected from the FTSE High Dividend Yield Index. Vanguard markets the U.S. version with the stock ticker of VYM. The ~400 stocks in VYM are selected from the Russell 1000 Index of large-capitalization companies (IWB). 

As a prospective retiree, you’ll want a balanced portfolio--one with approximately a 50:50 balance between stocks and bonds. The transaction costs for buying a corporate bond are high so you’ll want a mutual fund with a mix of government bonds and corporates. For stocks, you have the option of picking your own while keeping transaction costs (expense ratio) at ~2%/yr. But the expense ratio is much lower if you leave stock picking to professional managers (or computers) and opt for a mutual fund or Exchange-Traded Fund (ETF). The easy way to start is with VWINX, which has an expense ratio of 0.23%, and a 10-yr total return of 9.7%/yr. That’s 60% bonds, so supplement it with a stock mutual fund, stock ETF, or stocks of your own choosing. The Fidelity Balanced Fund (FBALX) is also weighted 60:40 in favor of bonds, also has a 10-yr total return of 9.7%/yr, but has a higher expense ratio of 0.53%. VWINX lost 9.8% in 2008 while FBALX lost 31.3%. That difference occurs because stock managers at VWINX are required to confine their selections to the ~400 companies in the FTSE High Dividend Yield Index while managers at FBLAX opted for a wide range of stocks typifying the S&P 500 Index. In other words, VWINX lost much less in the 2008 stock market crash because it held bond-like stocks. For a detailed analysis that compares VWINX to other balanced funds, read this Seeking Alpha article.

Mission: Use our Standard Spreadsheet to analyze companies in VWINX that have: 1) an S&P bond rating of A- or better, 2) a S&P stock rating of B+/M or better, 3) the 16+ year trading record needed for quantitative analysis by the BMW Method, and 4) are found in the current list of companies in the Vanguard High Dividend Yield Index. 

Execution: see the 26 companies in this week’s Table.

Administration: We have emphasized the safety features inherent in confining stock selections to companies in the S&P 100 Index. The managers of VWINX apparently agree, given that 17 of their 26 selections (see Column AK in the Table) are in that index. 

Bottom Line: We offer this view of stocks picked by managers at VWINX because that fund serves as a beacon for retirees. It has had only 5 down years in the past 40, and was down only 9.8% in the Great Recession of 2008. Since inception on 7/1/1970, it has returned 9.7%/yr. 

Risk Rating: 4, where 10-year US Treasury Notes = 1; S&P 500 Index = 5; gold bullion = 10.

Full Disclosure: I dollar-average into PFE, NEE, INTC, PG, JPM, JNJ and CAT, and also own shares of CSCO, DUK, KO, PEP, TRV, MMM, BLK and XOM.

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

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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.

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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.

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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

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Week 335 - Invest in “The 2 and 8 Club” Without Gambling

Situation: You’d like to invest in stocks without leaving money on the table. The alternative is to invest in the S&P 500 Index, which is a derivative subject to the kind of Program Trading that caused the “Black Monday” crash on October 19, 1987. Even after 3 decades of refining New York Stock Exchange technology to apply lessons learned from that crash, its recurrence remains a distinct possibility. 

You can invest in stocks without getting swept up in full fury of the next crash by using a few precautions: 1) Avoid stocks that have a statistical likelihood of losing more money than the S&P 500 Index per the BMW Method, i.e., avoid stocks highlighted in red at Column M in our Tables. 2) Use dollar-cost averaging to invest through a Dividend Re-Investment Plan (DRIP) in stocks that aren’t highlighted in red, and continue automatically investing in those each month throughout the next crash. 3) Avoid non-mortgage debt and have at least 25% of your assets in Savings Bonds, 2-10 Year US Treasury Notes, cash and cash equivalents. 

Mission: Looking at the 30 stocks in “The 2 and 8 Club” (see Week 329), set up a spreadsheet of those that do not have red highlights in Column M.

Execution: There are 12 such stocks (see Table).

Administration: Note that Costco Wholesale (COST) is not listed in the FTSE High Dividend Yield Index upon which “The 2 and 8 Club” is based. While dividend growth rate is 13.0%/yr, its dividend yield is only 1.3%, which is much lower than the ~2%/yr required for inclusion in the FTSE High Dividend Yield Index. This overlooks the fact that Costco Wholesale issues special dividends of $5 or more every other year! So, I’ve chosen to make COST an honorary member of “The 2 and 8 Club.”  

Bottom Line: You do have a chance of beating the S&P 500 Index without gambling, by investing in high quality growth stocks that are unlikely to lose as much as that index in the next market crash. But we find only 12 such stocks, which means you’d need to invest in all 12 to avoid selection bias.

Risk Rating is 5, where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold = 10. 

Full Disclosure: I dollar-cost average into IBM, KO, XOM and NEE, and also own shares of MO and TRV.

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

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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

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Week 330 - $150/wk For An Online Retirement Fund

Situation: You’ve heard a lot about saving for retirement, and you’ve probably heard that Social Security plus your workplace retirement plan probably won’t get you to a comfortable retirement any more. Why? Because people only reduce their spending by 15% after they retire, which means you will need a private savings plan to make up for the lost income. This savings plan can take the form of an IRA, payments into a low-cost annuity, proceeds from the sale of your home (if you move to smaller quarters), or perhaps even gold you’ve hidden away, and other choices. But when retirement is more than 5 years in the future, stocks remain your best bet.

We recommend that you minimize costs by using a stock index fund backed by a bond index fund. The Vanguard Balanced Index Fund (VBINX) provides both in one package, allocated 60% to stocks and 40% to bonds. It is rebalanced daily, so you won’t get burned if a stock market bubble bursts. (Most of those stock gains would already have been converted to bonds as part of daily rebalancing, and bonds typically increase in value when stocks crash.) Or, you can choose a low-cost managed fund that uses an excess of bonds to balance both the inherent risk of stocks and the difficulty managers have of knowing when to move away from stocks and into bonds. The Vanguard Wellesley Income Fund (VWINX) has the best record. It is bond-heavy and therefore has less volatility than VBINX but performs about as well.

The third low-cost option is to study the markets yourself and invest in stocks online through a Dividend ReInvestment Plan (DRIP) at computershare, and in bonds at treasurydirect. This third option allows you to pick only the most stable stocks and bonds.

Mission: Detail one example of a personal online retirement fund (mine). I dollar-cost average $100/mo automatically (online) into 5 stocks: NextEra Energy (NEE), Coca-Cola (KO), JP Morgan Chase (JPM), Microsoft (MSFT), and IBM (IBM), then dollar-cost average $150/mo into ISBs--inflation-protected Savings Bonds (treasurydirect). 

Execution: In the Table, note that the iShares 7-10 Year Treasury Bond ETF (IEF) reflects returns from the main asset that the US Treasury uses to back its ISB accounts. Also note that we use red highlights to denote metrics that underperform our benchmark, i.e., the SPDR S&P 500 ETF (SPY). Metrics highlighted in purple indicate issues that accountants will raise with that company’s CFO.

Administration: ISBs are a tax-deferred investment much like an IRA. Contributions from your checking account can be set up for automatic monthly deposits at treasurydirect. You can have your accountant designate the money that you spend to buy stocks online through a DRIP as an IRA. Compare this week’s blog to an earlier blog with the same title (see Week 120).

Bottom Line: Dividend Reinvestment Plans (DRIPs) take time to set up, but are on “automatic pilot” the rest of the time. Savings Bonds are even easier to manage (treasurydirect). So, the key difficulty is deciding exactly which stocks you’d like to own for an extended period.

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

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Week 300 - $185/week For A Low-cost Online Retirement Fund

Situation: Let’s say you make $64,000/yr but don’t have a workplace Retirement Plan. You still need to put 15% of your income (or $9,600/yr or $185/week) into a Retirement Plan. You can’t expect Social Security checks to replace more than 40% of your salary.The lowest cost self-directed plan would be composed of an IRA for stocks and Inflation-protected US Savings Bonds (ISBs) for bonds. We define costs as a) transaction costs, b) taxes, and c) inflation. The annual IRA contribution limit is $5,500/yr ($6,500/yr if you’re over 50). That doesn’t cover the $9,600/yr you need to shield from taxes, which is where ISBs come in handy. Those have a $10,000/yr contribution limit, work like an IRA to defer taxes, and carry the added benefit of shielding you from inflation.

Mission: Set up our standard spreadsheet (see Table) for $6000/yr of online stock purchases which go into an IRA, and $3600/yr of online bond purchases, which go into ISBs.

Execution: see Table, where the Vanguard Interm-Term Bond Index Fund (VBIIX) is a proxy for ISBs to facilitate comparison with stocks, which are neither inflation-protected nor tax-advantaged.

Administration:
Plan A: You can put $100/mo into each of 5 stocks purchased online through computershare, then have your accountant declare that account at computershare to be your IRA. This assumes you’re over 50 years old when you start this plan.

Plan B: You can put $500/mo into a Total Stock Market Index Fund (VTSMX) IRA marketed by the Vanguard Group. VTSMX carries an expense ratio of only 0.16%/yr vs. 0.58%/yr for stocks purchased through computershare (see Column P in the Table). NOTE: Plan B is the smarter option. Why? a) The expense ratio is lower. b) An index fund eliminates the considerable risk of selection bias.

With either Plan, $300/mo is put into ISBs with automatic online withdrawals from your checking account. Less money is put into bonds than into stocks because Social Security payments are made from a US Treasury Bond Fund. The interest payments on ISBs are based off the interest payments for 10-yr Treasury Notes corrected for the value of the tax deferral benefit and inflation correction benefit. Also, remember that ISBs have zero transaction costs and zero inflation risk; interest accrues biannually and cannot be taxed until the bond is redeemed. To better understand why you should confine your bond investments to 10-yr US Treasury Notes, read the fine print:

Caveat emptor: “The hard part of setting up a Retirement Plan is understanding the role of bonds. Those go up in value when stocks go down, so bonds need to form half of the assets meant to sustain you in retirement. Why do bonds go up in value when stocks go down? Because bankruptcy drops bond prices to the liquidation value of collateral, say 70 cents on the dollar, whereas bankruptcy drops stock prices to zero. The easy part to understand is that the risk that a bond will end up in bankruptcy court is specified by the interest rate: no investor will buy a bond that doesn’t pay enough interest to compensate for the risk being assumed. The zero-risk set point for interest rates everywhere is the 10-yr US Treasury Note. A commercial bond has to pay sufficiently more interest to draw in a buyer. On a risk-adjusted basis, all publicly-traded bonds pay the same rate of interest. Given that Treasuries are obtained online at zero cost, there is no reason to own any other type of fixed-income investment (unless you’re a bond trader).”

Bottom Line: Investment-grade bond and total stock market indexes have approximately the same inflation-adjusted total returns over multi-decade periods of ~3%/yr (e.g. see Lines 21 and 22 in the Table). Those returns remain roughly equivalent, otherwise investors would accumulate less money in one in order to favor the other.

Instead of using stock & bond indexes, you can have professionals pick stocks and bonds for you. This is tempting, since most stock and bonds make unattractive investments (because most companies have Balance Sheet problems or a weak Brand). That’s why an actively managed & balanced mutual fund like Vanguard Wellesley Income Fund (VWINX) outperforms a 50:50 mix of stock and bond index funds (compare Line 13 to Line 23 in the Table).

Or you can pick conservative bonds and stocks for yourself and keep transaction costs low by investing online (compare Line 10 to Lines 13 and 23 in the Table). NOTE: transaction costs in Column AB, which come to 0.58%/yr ($56/$9600).

Risk Rating: 4 (where 10-yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)

Full Disclosure: I dollar-average into UNP, KO, IBM, JNJ, NEE, and ISBs.

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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.


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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