Week 365 - “Dogs of the Dow” (Mid-Year Review)

Situation: The 10 highest-yielding stocks in the Dow Jones Industrial Average are called The Dogs of the Dow (see Week 305 and Week 346). The only time-tested formula for beating an index fund (specifically the Dow Jones Industrial Average) is based on investing equal dollar amounts in each Dog at the start of the year. That would have worked in 6 of the past 8 years. Why? Because those are high quality stocks that have suffered a price decline and are likely to recover within ~2 years, which would lower their dividend yield and release them from the “Dog pen.” 

Mission: Predict which Dogs will emerge from the Dog pen by the end of 2018, using our Standard Spreadsheet.

Execution: see Table.

Administration: For various reasons, the 2018 Dogs are unlikely to post greater total returns this year than the Dow Jones Industrial Average (DIA). But we can still try to play the game by predicting which of this year’s Dogs will be missing from next year’s Dog pen. Those will probably come from those posting lower dividend yields at the mid-year point (see Column G in the Table): Coca-Cola (KO), Cisco Systems (CSCO), General Electric (GE), Merck (MRK) and Chevron (CVX).

Bottom Line: Given current trends, Cisco Systems (CSCO) and Chevron (CVX) are likely to be released from the Dog pen at the end of the year.

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

Full Disclosure: I dollar-average into KO, PG, XOM and IBM, and also own shares of CSCO.

"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

Week 220 - Diversification Among Core Assets

Situation: Individual stocks are not a core asset unless you’ve created your own diversified mutual fund (i.e., 40+ stocks covering all 10 S&P Industries). The reason why individual stocks are considered a liability and not a core asset is because competition (aided by unforeseen technological advancements) can doom the prospects of any one company. There are 5 Core Assets, and your investment portfolio will need representation from some of each:
   1) diversified US stock mutual funds, especially index funds like VFINX and VEXMX (see the Table).
   2) Bonds, mainly US Treasuries but also intermediate-term investment-grade bond index funds like VBIIX (see the Table).
   3) Commodity-related investments. The relevant index fund is a “broad basket” collateralized futures ETF composed of iShares S&P GSCI Commodity Indexed Trust (GSG in the Table).
   4) Real estate. Most of us already have too much invested in real estate (i.e., the equity in our homes). The relevant REIT index fund is VGSIX in the Table.
   5) Cash-equivalents such as Savings Bonds, a Savings Account at an FDIC-insured bank, a short-term Treasury fund like VFISX (see the Table) or 3-6 month Treasury Bills purchased for zero cost at treasurydirect.

Mission: Set up a reasonable asset allocation, i.e., one that has worked well for me, using index funds as examples. This allocation needs to meet the standards of an acceptable personal retirement investment fund, and it does. However, opinions vary across a large spectrum. At one extreme, we have Warren Buffett who recommends that his relatives rely on a low-cost S&P 500 Index fund for 90% of their asset allocation, with the other 10% being invested in a short-term US Treasury fund. However, most investment advisors stress the importance of balancing among the 5 Core Assets listed above. In other words, hedge your bet on stocks even though the S&P 500 is well known to have outperformed all other asset classes over all rolling 20-yr periods on record. Warren Buffett takes a dim view of hedging strategies and continues to make bets that the S&P 500 Index will outperform international indexes as well as an esteemed group of hedge funds. The main reason for you to hedge your bets is that you’re not as rich as Warren Buffett’s relatives and could be financially devastated by a crash in the S&P 500 Index (if that’s where 90% of your retirement assets reside). So, hedging is a form of insurance and you’ll be glad you have it. (I never feel bad about dollar-averaging 30% of my new investment dollars into 10-yr Treasuries and Inflation-Protected Savings Bonds.) 

What lies at the other end of the spectrum of advice being offered by investment advisors? Well, if you include accountants and business school professors as “advisors” you’ll find a sizeable minority who recommend that most of your retirement savings be in US Treasury Notes and Bonds having as average of ~5 yrs remaining until maturity. You can do that yourself simply by dollar-averaging into 10-yr Treasury Notes through the zero-cost Treasury website. When I was living in New York City (while going to medical school), I had a personal accountant who made that exact recommendation when I asked for his views on asset allocation. I had great respect for him as a wise and prudent man but thought his recommendation bordered on the absurd. Then, a few years ago, I went to business school and started hearing the same view again, first from an accountant in my study group and then from a professor of Banking and Finance. Finally, I read Henry Paulson’s book about his experiences as US Treasury Secretary, titled “On the Brink.” Prior to that posting, he’d been the CEO of Goldman Sachs. In the book he mentions that his personal savings are limited to bonds. In other words, the message you’re hearing at this end of the spectrum is that bonds are backed by the assets of the institution issuing them, whereas, stocks are backed by nothing other than a faith in future earnings.

Execution: We recommend that you balance stock and fixed-income investments 50:50. Real Estate Investment Trusts (REITs) are a hybrid between stocks and bonds but (when assembled into and REIT) they’re essentially a type of bond called a “growing perpetuity” and I allocate 15% there. Cash equivalents are also bonds and I allocate 5% to those. Then I allocate 15% to intermediate-term bond index funds and 15% to Treasury bonds and notes, which brings me up to 50% allocated to fixed-income. For stocks, I allocate 30% to S&P 500 stocks (which represent 75% of the US market) and 10% to smaller capitalization stock mutual funds. Commodity-related stocks represent 10% of my portfolio, though the recent underperformance of many “long cycle” investments has caused many advisors (including me) to cut back to 5%. In summary, you now have a formula for allocating 50% to stocks and 50% to bonds or bond hybrids (see Table).  

Bottom Line: Core assets are vital to your financial well being. There are 5 categories, and this week’s Table gives index fund examples using an allocation that has worked well for me. By mixing 5 core assets you create your own hedge fund, the idea being to match returns of the S&P 500 Index over time while taking on less risk of a serious loss. Note: risk-adjusted returns for index funds in the commodity-linked and smaller capitalization stock categories typically underperform actively managed mutual funds. 

Risk Rating: 5

Full Disclosure: I dollar-average into 10-yr Treasury Notes, and have VFINX-like and VEXMX-like investments in my 401(k).

Note: Metrics highlighted in red denote underperformance relative to VBINX. Metrics are current for the Sunday of publication.

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

Week 98 - Mutual Funds

Situation: Mutual fund managers invest your hard-earned money in assets traded on exchanges around the world. Those assets are assembled and sold to you on the basis of Net Asset Value (NAV) per share. Your money is being invested in a derivative product that is priced by assembling the prices of exchange-traded assets. Mutual funds are marketed on the basis of past performance and their current expense ratio (transaction costs/NAV).

Because the stock market is rising 2/3rds of the time, managers tend to assemble their mutual fund from stock in companies that outperform the S&P 500 Index during a “bull market” (i.e., have a 5-yr Beta greater than 1.00). That bias is eliminated in the case of an index fund where a computer does the managing (usually rebalancing the portfolio to maintain capitalization weighting). That means the “managed” mutual fund will perform worse than average 1/3rd of the time, i.e., during a “bear market.” Long-term performance graphs will look better though. But no one is interested in owning stocks that do worse than the indices during a bear market. You’ve been there, done that.  

We encourage you to own a stock portfolio that is less risky than the S&P 500 Index, one with a capitalization-weighted 5-yr Beta of 0.65 or less. That means that in a bad year, like 2008 when the S&P 500 Index lost 37.4%, your stock portfolio would lose no more than 25%. Since that is a greater loss than anyone can stomach if over 55, bonds need to be added for safety, not profit. Remember: stocks are “dead money” 2/3rds of the time. This is because the first half of a bull market only makes up for losses incurred during the previous bear market. Investment-grade bonds allow you to bridge that “valley” because they pay interest twice a year at a fixed (or inflation-adjusted) rate until the bond matures and principal is returned to the investor. There are no “ifs” and you’ll even beat inflation by 1-2% over the long haul. The key problem for shareholders is that after a 25% loss, a 50% gain is needed just to break even. That's how math works.

Looking at Lehman Panic returns (Column D of this week's Table), if you had half your money in the lowest-cost investment-grade bond index fund (VBMFX) and half in the lowest-cost S&P 500 stock index fund (VFINX) your loss was only 19% instead of 45.6% for VFINX alone. If you had money in the lowest-cost bond-heavy balanced mutual fund (Vanguard Wellesley Income Fund or VWINX), your loss fell to 16% (Table).

But what about long-term growth? Over the past two market cycles (since the S&P 500 Index peak on March 24, 2000), the 50:50 stock:bond index combination has returned 4.1%/yr, which is 1.7% more than inflation. VWINX has returned 8.1%/yr because it is 60% bonds and 40% stocks. Remember, bonds keep paying interest the whole time that stocks are down in the “valley.” Bonds also rise in price during recessions, so managers of VWINX can sell those at a profit. If you’d held only the S&P 500 Index (VFINX), your returns would only have been 2.3%/yr meaning you’d have lost 0.1%/yr to inflation.

So what is the point we are making? If you like the convenience of mutual funds, play defense by holding a bond-heavy, actively-managed balanced fund like Vanguard’s Wellesley Income Fund (VWINX). It's a hedge fund in disguise, since it has a low 5-yr Beta (0.58) and outperforms the S&P 500 Index on rolling 5-yr periods. (The managers aren’t allowed to use the main tool of a hedge fund, which is short sales, a risky tactic that often backfires.)

What we’d all like to find is a low-cost stock mutual fund that has mediocre performance during bull markets but outstanding performance during bear markets, i.e., a hedge fund for the masses. For the foreseeable future, hedge funds will continue to be private investment contracts available to the wealthy. Why? Because the retail investor (you and me) won’t buy something that has a sales pitch of mediocre performance during a bull market. We’re thinking: Why invest my money in a fund that is limping along 2/3rds of the time? Hedge funds get around this by saying: “Well, we think we can beat the S&P 500 Index over the long term because of our superior performance during bear markets.” According to Warren Buffett (Week 46), that is impossible because of their high fees: a typical hedge fund keeps 20% of any money it makes for a client as well as charging her a 2% annual fee.

Hedge funds use various strategies (check Wikipedia for an excellent entry explaining these). The best hedge funds have been able to beat the S&P 500 Index over a 5-10 yr period while losing less than 65% as much during a bear market (Week 46). It is hard to know just when a bear market is going to transpire, so hedge funds tend to maintain a 5-yr Beta of 0.65 or less during the run-up to a bear market. It all gets pretty complicated but the better hedge funds tend to be stuffed with bonds and shorted stocks (i.e., betting against stocks). The bonds are often risky, paying several % more interest than a 10-yr Treasury Note, which is all right since a risky bond is less risky than a “safe” stock because the risk of default is less and the money recovered in a default is substantial (vs. the total loss that a shareholder must endure).

There is a very low cost mutual fund for Treasury Notes (VFITX in the Table). Or you can buy US Treasuries in amounts as small as $100. There’s no cost, just point-and-click (go to treasurydirect). The money will be withdrawn from your checking account and every 6 months an interest payment will be sent back. At the end of the bond’s term, your original investment is returned.

You’ll complain that “the current interest rate is lower than the rates for corporate bonds or bond funds.” Correct, because you’re buying a “zero-risk” product that will keep paying interest during a bear market and even during Armageddon assuming the U.S. Marine Corps still exists. The extra interest paid (called the “spread”) on non-Treasury bonds compensates you for their extra risk (i.e., the risk of default). It's still true that there is no free lunch.

In the end, you are best off selecting some low-risk DRIPs for your stocks and balancing those with Treasury Notes or Savings Bonds, which are the same as Treasury Notes except that interest accrues automatically and is lower because you’ll pay no tax on the accrued interest until you sell.  

What is a low-risk DRIP? For safety’s sake we will use an extreme example and call it a virtual mutual fund (Table): the 8 Dividend Aristocrats that have not only increased their dividend annually for at least 25 yrs and are also “blue chips”, i.e., members of the 30-stock Dow Jones Industrial Average. These are: Wal-Mart Stores (WMT), McDonald’s (MCD), Johnson & Johnson (JNJ), Procter & Gamble (PG), Coca-Cola (KO), Exxon Mobil (XOM), Chevron (CVX) and 3M (MMM). Four of those (WMT, MCD, JNJ, KO) are what we call “hedge stocks” because they fell less than 65% as far as the S&P 500 Index during the Lehman Panic, have beaten the S&P 500 Index over the past two market cycles, and have a 5-yr Beta of 0.65 or less. Those 4 stocks are enough like bonds that you don’t have to backstop their risk with an equal investment in Treasury Notes or Savings Bonds. The other 4 stocks (CVX, XOM, MMM, PG) include two (PG and XOM) that almost qualify as hedge stocks, have the highest S&P stock rating (A+/L, with the “L” denoting low risk), and have high credit ratings (AA- and AAA, respectively). There is no chance of either going bankrupt or falling as fast in value as the S&P 500 Index during a bear market, so you won't need Treasuries as a backstop.

To sum up: Your virtual mutual fund is 60% in 6 “safe” DRIPs, 20% in 2 riskier DRIPs (CVX and MMM), and 20% in a Treasury Note fund (VFITX) to backstop CVX and MMM. There are 10 units (8 DRIPs plus 2 units of VFITX). Assigning $50/mo to each results in an investment of $6,000/yr. Costs for investing  $50/mo electronically from your checking account for WMT and JNJ are $1/mo. Costs are higher for KO, CVX, MMM and MCD, so annual or semiannual investments have to be made: one-off electronic transfers into those DRIPs. There are no costs for the XOM and PG DRIPs, or the $100 that goes into VFITX each month (aside from the expense ratio of  0.2%).

Your virtual mutual fund lost 10.3% during the 18-mo Lehman Panic bear market but returned an average of 8.6%/yr over the past 13+ yrs and beat both the S&P 500 Index and inflation by 6.2%/yr. The 5-yr Beta is 0.5, indicating that your virtual mutual fund is perfectly balanced between stock and bond risk.

Bottom Line: For the most part, stocks are a gamble but bonds aren’t. Make sure your retirement savings are balanced between stocks and bonds in terms of the aggregate 5-yr Beta, i.e., close to 0.5. You can design a balanced stock and bond portfolio by using DRIPs for the stock investments balanced with Treasury Notes, or a bond mutual fund that only holds Treasury Notes (VFITX). From a tax-savings standpoint, you’re better off using Inflation-protected Savings Bonds.

Risk Rating: 3.

Full Disclosure: I use this plan to supplement my workplace retirement savings.

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

Week 78 - Master List Update (Q1 2013)

Situation: The time has come to provide sober guidance about saving for retirement. For most people, mutual funds are the best route to take and we’ve listed our 5 favorites in the accompanying Table. We remind you that you should not have more than 20% of your assets in a single fund, or 5% in a single stock. As noted in our Week 3 blog (see Goldilocks Allocations), it is also important to balance your stock investments 1:1 with bonds. Our 5 mutual funds do that when you have 20% of your retirement savings in each.

Whew! Now for the fun stuff, which is to generate a list of stock picks that meet our investment criteria. Previously, we’ve agonized over company fundamentals like efficiency (ROIC), long-term debt, and having enough free cash flow to pay for dividend increases (FCF/div). In this blog, we’re going to let you do that for yourself by using red warning flags in the 3 right hand columns of the Table (courtesy of data from the WSJ). This way, you’ll see the entire “universe of data” we analyze, starting with the 199 companies at the Buyupside website called Dividend Achievers. Those companies have had 10 or more consecutive years of dividend increases. We’ve added Occidental Petroleum (OXY) which will qualify come January first.

Next, we eliminate any company with a dividend yield less than the 15-yr moving average for the S&P 500 Index (1.8%). Then we eliminate any company that doesn’t have an S&P stock rating of A/M or better AND an S&P bond rating of BBB+ or better.

The remaining 49 companies can be split into two groups, those whose stocks lost less than 65% as much as the S&P 500 Index during the Lehman Panic AND had a 5-yr Beta of less than 0.65. Those 19 companies are less risky that the others, and make up the first group at the top of the Table. The 30 remaining companies are in the second group, and the 5 mutual funds (mentioned above) compose the third group.

Which of the top 19 stocks are particularly attractive to the risk-averse investor? We think those are the ones that pay a higher dividend than most others AND grow that dividend faster. I use a 3:7:10:50 standard for finding those good "income" stocks. By this I mean there is at least a 3% dividend yield, at least a 7% dividend growth rate, at least a 10% ROIC (5% for a regulated utility), and less than 50% capitalization from bonds. Six in the top 19 meet that standard: JNJ, ABT, PEP, PG, NEE, MCD. However, we eliminate Abbott Labs (ABT) because it is breaking up into two companies, so we’re down to 5.

Those readers who are over 55 and have little in the way of retirement savings should pay attention to these 5 reliable income producing stocks. We’ll aggregate the data from those, to augment our guidance for late-stage investors (see Retirement on a Shoestring Week 14 & Week 15). These 5 stocks are so bond-like that you needn't bother hedging them with an equal investment in bonds or bond funds. But you do need to “dollar-average” equally into all 5 DRIPs. We'll call this group "Stand Alone Stocks" and put their aggregate data at the bottom of the Table for comparison with aggregate data for the 5 mutual funds we mentioned.

Bottom Line: Recent academic studies show that returns from less risky (more bond-like) stocks are as great as returns from more risky stocks. Read this recent analysis by Mark Hulbert to open your eyes to the importance of holding such stocks in your portfolio.

Risk Rating: 4.

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

Week 19 - Really Simple Savings

Situation: Many investors want to spend about as much time planning for retirement as they would spend planning for a vacation. They can’t afford to be “dollared to death” by fees and commissions. At the same time, they need a balanced portfolio which means that the “balancer” (or hedge) will increase in value when the stock market tanks.

Goal: Find a straightforward way for a 50 yr old investor to begin to seriously plan for retirement at age 65, without an exorbitant outlay of time or money to set up the portfolio.

Most probably this type of investor doesn’t follow the markets or invest each month in separate DRIP accounts. And we would also guess that $500/mo is the most our investor will commit to setting aside. These caveats leave a Roth IRA composed of no-load mutual funds as the best investment option. The reason is because a Roth IRA is unique among retirement investment options due to its tax-free status with no taxes levied on withdrawals ever, even for the unused money that goes to heirs.

Half the monthly money allotted by our investor ($250/mo) should be used to purchase shares of an S&P 500 Index Fund. The other half should be invested in an intermediate-term US Treasury Fund (i.e., a fund that essentially buys 10-yr Treasury Notes and holds those to collect interest until the principal is returned). Why these two particular choices? Related to stock purchases, this type of investor cannot assume the risk of under-performing compared to the market. Related to bond purchases (i.e., the hedge), this type of investor needs to be in the safest possible market. That would be the asset that the entire world wants to own when financial markets collapse: US Treasury Notes.

All “no-load” mutual fund companies offer both S&P 500 and T-Note funds with low expense ratios. We’ll use T Rowe Price funds to calculate outcomes for monthly purchases made from 2/3/97 through 11/1/11 (14.8 yrs). PREIX is the S&P 500 Index Fund and PRTIX is the intermediate-term US Treasury Fund. Investing $250/mo in each would result in $52,975 in the stock fund (total return = 2.2%/yr) and $69,853 in the bond fund (total return = 5.3%/yr) for a compound annual growth rate (CAGR) of 3.9%/yr (1.5%/yr after inflation). Our investor’s out-of-pocket investment over this time would have been $86,500 and total value would be $122,828. The S&P 500 fund paid out $472 in dividends over the past 6 months and the T-Note fund paid $783 in interest (i.e., the two together currently yield a little over 2%). Since the beginning of good record-keeping practices (1926), the CAGR after inflation is 2.3% for T-Notes and 6.7% for the S&P 500 Index without factoring in expenses. The rule-of-thumb for advising investors (as to what they can expect for planning purposes) is 2% and 4%, respectively. So a 50:50 combination is expected to yield 3%/yr. However, that overlooks the fact that the CAGR drifts upward when leverage (or borrowed money) is used to fuel investments. The opposite occurs with de-leveraging. In other words, when governments/companies/individuals borrow money to make improvements in their investments, those investments grow in value at a more rapid rate than if revenues alone are used to make improvements. When that borrowed money is returned to the lender, revenues are depleted so severely that little is left for “growth” (just google “Italy” for a timely example).

Saving for retirement doesn’t have to be complicated but it does have to be sincere. If you religiously set aside $500/mo beginning at age 50, you’ll have around $125,000 at age 65 in the example above. After retiring, you can spend the $200+/mo of dividends and interest and leave the principal intact. That would allow your spending power to keep up with inflation and your heirs will be titillated. Or you can cash out the funds and purchase an annuity that pays ~$800/mo but won’t keep up with inflation or leave anything for heirs.

Bottom Line: This 50:50 Stock/Bond example is a benchmark for a simple, safe and cheap Roth IRA plan. Interestingly, the initial $500 invested on 2/3/97 held its value throughout two bear markets, though it did fall back to parity ($500) at the depths of the last bear market on 3/9/09. We’ll use that feature to help gauge the safety of other Roth IRA strategies.

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

Week 3 - Goldilocks Allocations

Goal: To introduce asset allocation choices (the main drivers of investment returns) that minimize the risk of temporary loss while maintaining strong returns over two market cycles.


The internet makes it possible for investors to simply point and click their way to a balanced portfolio and cut out paying the middle man. This is important in the maintenance of a balanced portfolio for several reasons. First, it is less expensive—management fees are eliminated and commissions are reduced to less than a dollar a share. Second, use of an intermediary agent, such as a mutual fund portfolio manager, introduces what are called agency issues. Agents carry additional costs besides fund management fees: your investment can be allocated in ways that subject your funds to excessive risk of loss, and you will know nothing about it until it is too late. You own the cash you entrust to financial intermediaries but they are not required to act in your best interest. For example, the manager of a mutual fund may select risky stocks in an attempt to out-perform the relevant benchmark. This fund could achieve that during an “up market” but would surely underperform during a “down market” because stock market “risk” is what statisticians call “variance”: it cuts both ways. Risk, with respect to stocks, translates into the risk of bankruptcy for that company. For example, a stock that is unable to pay a dividend and is issued by a company that is deeply in debt is risky—its expenses exceed its earnings. The price of that stock will vary depending on whether the economy is strong enough for its products to be sold at a profit. Its price swings will be exaggerated because the chance it will have to declare bankruptcy is about the same as the chance it will earn enough to pay its debts. Another example is that of companies that are publicly owned but mainly operated by employees who are not shareholders (Berkshire Hathaway and Microsoft being notable exceptions). Those employees are being paid to act as the owner’s agents but they will probably act first to secure their own jobs and enhance their own remuneration.


An individual investor can best minimize the conflict between her needs and agency issues by eliminating this middleman, diversifying her holdings, and investing in companies that value shareholders by paying a reasonable dividend (25-50% of earnings) that increases every year. Direct ownership of stocks is done through Dividend Re-Investment Plans (DRIPs). Almost every S&P 500 company has a DRIP; some companies even waive all expenses. Computershare (computershare) services the largest number of DRIPs. The US Treasury issues the largest number of investment-grade bonds (treasurydirect) and also waives all commissions.


Changes in the macro economy (such as recession and inflation) are externalities that we try to anticipate through asset allocation decisions. For example, commodity-related stocks keep step with inflation and consumer-staples stocks retain value during a recession. Our ITR asset allocation plan is designed to weather these storms without sacrificing upside potential.


In future blogs, we will explore the ITR Investment Strategy:

• Use do-it-yourself point-and-click investment in assets that generate dividends or interest (computershare);
• Use a 50:50 balance of stocks and bonds;
• Select stocks that yield as much or more than the S&P 500 Index (SPY);
• Select stock in companies that have increased annual dividends for at least 10 years;
• Avoid derivatives (assets linked to other assets) except for a global allocation stock fund and two bond mutual funds;
• Stock allocations: 50% industrial & commodity-related, 33% defensive (consumer staples and health care related), and 17% in a global allocation mutual fund;
• Bond allocations: 17% in 10-year US Treasury notes (treasurydirect); 33% in an international bond mutual fund, and 50% in a diversified investment-grade bond mutual fund. A future blog will provide detailed information about purchasing no-load bond funds online.

Bottom Line: Conserve assets, minimize expenses, and maintain what you’ve obtained. Forget about the big kill but instead seek a portfolio similar to one which investors call a “Goldilocks Economy”— not too hot and not too cold.


Click here to move to Week 4

Week 1 - An Introduction to Our Blog

Who benefits from reading our ITR blog every week?

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

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

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

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

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

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

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

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


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