Situation: You’re troubled by the dominance of the S&P 500 Index. After all, it is a derivative and you wonder whether it is really the safest and most effective way to build retirement savings. Your biggest concern is that it is a capitalization-weighted index, which is a design that favors momentum investing: Mid-Cap companies that garner investor enthusiasm become included in the S&P 500 Index because their stock is appreciating; Mid-Cap companies that have managed to be included in the S&P 500 Index investors are in danger of being excluded because investors have lost their enthusiasm and the stock’s price is falling. Many investors buy/sell shares in a company’s stock because of that trend in sentiment. Fundamental sources of value (revenue, earnings, and cash flow) often have little to do with their enthusiasm, or the fact that it has evaporated. Articles in the business press may carry greater weight, and those articles may be influenced by analyses introduced by short sellers, who are betting on a fall in price, or hedge fund traders with long positions, who are betting on a rise in price. In other words, most retail investors are paying attention to market sentiment when buying or selling shares, not due diligence that comes from a careful study of a company’s prospects and Balance Sheet.
Your second biggest concern is likely to be that few S&P 500 companies have a good credit rating backing their debts. In other words, they’re paying too high a rate of interest on the bonds they’ve issued, or the bank loans they’ve taken out. The company’s Net Tangible Book Value is therefore likely to be drifting deeper into negative territory because of interest expenses, part of which are no longer tax deductible due to changes in U.S. tax law.
Both of these problems fall by the wayside if you invest in the 30 companies that make up the Dow Jones Industrial Average, either separately or together in the price-weighted Dow Jones Industrial Average Index (DIA at Line 18 in the Table). Investing in the “Dow” may be a little smarter for retirement savers than investing in the S&P 500 Index (SPY at Line 16 in the Table) for two reasons: 1) DIA has a dividend yield that is ~10% greater; 2) DIA pays dividends monthly, whereas, SPY pays dividends quarterly. A higher dividend yield means that your original investment is returned to you more quickly, which translates as a higher net present value, if other factors (e.g. dividend growth and long-term price appreciation) are not materially different.
Mission: Use our Standard Spreadsheet to illustrate how I dollar-cost average into stocks issued by 10 DJIA companies.
Execution: see Table.
Administration: It has been necessary to use 3 separate Dividend Re-Investment Plans (DRIPs) to dollar-cost average into the 10 DJIA stocks I’ve chosen (see Column AE in the Table). Those DRIPs automatically extract $100 each month for each of the 10 stocks; transaction costs average $18.68/yr (see Column AD), which includes automatic reinvestment of dividends. The expense ratio is 1.56% for each year’s investments, but expenses relative to Net Asset Value fall to less than 0.01% after 10-20 years.
Bottom Line: This week’s blog compares my long-standing pick of 10 Dow stocks (for an automatic monthly investment of $100 each using an online DRIP) to investing $1500/qtr in the entire 30-stock index (DIA) using a regional broker-dealer, which is something I’ve just started doing to facilitate comparison going forward. (You’ll see each year’s total returns in future blogs published the first week of July.)
Risk Rating: 6 (where U.S. Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: If one of the 10 stocks I’ve chosen is dropped from the Dow Jones Industrial Average (DJIA), I’ll sell those shares and use those dollars to start a DRIP with shares issued by another DJIA company.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Showing posts with label opportunity risk. Show all posts
Showing posts with label opportunity risk. Show all posts
Sunday, August 5
Sunday, March 12
Week 297 - Sugary Soft Drinks And Milk Lead The Food & Beverage Sector In Sales
Situation: Milk is still the leading category of food expenditures for the 80% of households that pay with cash or credit/debit cards, but the 20% of households that pay with Food Stamps bring sugary soft drink sales up to first place nationwide. Milk is perhaps the single most nutritious food (see Week 254), whereas, refined sugar is the only “food” found in sugary soft drinks. Those drinks are being held responsible for the strong link between poverty and obesity, as well as the strong link between obesity and Type II diabetes.
So, let’s revisit the large and well-established Food & Beverage companies to see which are doing well from an investor’s standpoint. We need to know how much refined sugar contributes to their prosperity, as opposed to milk, those being the top revenue producers. Has publicity about the detrimental effects of refined sugar been effective? In other words, are sugary soft drink sales still rising and milk sales still falling?
Mission: Apply our standard spreadsheet analysis to Food & Beverage companies on the 2016 Barron’s 500 List that have had their stock traded long enough to appear on the 16-Yr BMW Method list.
Execution: see Table.
Administration: We find that 19 companies meet the requirements for size and longevity. But only 8 are Dividend Achievers (see Column AD in the Table), and only 4 of the 16 dividend payers have clean Balance Sheets, HRL, INGR, KO and ADM (see Columns P-R). This tells me that the largest and best-established food companies are struggling. Their managers must be having a hard time figuring out how to grow sales faster than the rate of population growth. A favorite tactic is to have a large advertising budget to promote products that the consumer is expected to like (based on marketing studies). That strategy has pushed Coca-Cola and PepsiCo to the top of the pack, with market capitalizations more than 4 times higher than the next largest food processor: General Mills (GIS; see Column AA in the Table).
Bottom Line: Food & Beverage stocks are thought to be “defensive” because of being in the S&P Consumer Staples industry. However, they’re commodity-related (high risk/high reward) because of being tied to global weather cycles. In my opinion, only 2 of the 19 companies in the Table are sufficiently safe and effective for your retirement portfolio (HRL and KO). Procter & Gamble (PG) is perhaps a better way to invest in Consumer Staples (see Line 23 in the Table).
Coca-Cola (KO) and/or PepsiCo (PEP) dominate sales for sugary soft drinks in every country, even though the sales of such drinks have fallen for 11 yrs in a row, and great efforts have been made to find healthy alternatives. Coca-Cola still derives 70% of its revenue from sugary soft drinks, even though it has diversified into milk (Fairlife), fruit juice (Minute Maid, Simply Orange), sugary vegetable drinks (Suja Juice, Fuze, Odwalla), energy drinks (Monster), and Coca-Cola Life that uses the natural sweetener Stevia. The good news is that the detrimental effects of sugary soft drinks have become well known and consumers expect companies do something about it. Both PepsiCo and Coca-Cola appear to be making every effort to comply, while continuing to rely on the aggressive marketing of sugary soft drinks. In summary, the trendline for sugary soft drink sales is tilting downward while milk continues to fall without pausing.
With regard to milk sales here in the US, the main processor, Dean Foods (DF), almost faced bankruptcy because sales have fallen 30% since 1975. Dean Foods survived by splitting off its most successful subsidiary, WhiteWave Foods, the producer of Horizon Organic milk and Silk soy milk. “The move was designed to get investors to pay more for shares in a business unit with higher profit margins and faster growth prospects than conventional milk.”
Kroger (KR) operates 16 dairies that distribute milk to 34 states, and Coca-Cola (KO) has assembled a large group of dairy co-operatives to produce “ultra-filtered milk.” That new technology separates milk ingredients then recombines those selectively to produce a more nutritious product called "Fairlife," which has half the sugar and twice the protein. Fairlife Milk is distributed to grocery stores nationwide by the Minute Maid division, and is currently priced at an 11% premium to Parmalat Milk in Wal-Mart Stores. Fairlife Milk has been available for less than two years; people who shop with food stamps presumably don’t yet know its benefits and would perhaps shy away from paying the 11% premium price even if they knew.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-cost average into KO, and also own shares of HRL and PG.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 28 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 (no dividends accrue in 10th year), 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 10-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 a small number of large-cap stocks, where risk is mainly due to “selection bias.” That stock index is the S&P MidCap 400 Index at Line 33 in the Table. The ETF for that index is MDY at Line 27.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
So, let’s revisit the large and well-established Food & Beverage companies to see which are doing well from an investor’s standpoint. We need to know how much refined sugar contributes to their prosperity, as opposed to milk, those being the top revenue producers. Has publicity about the detrimental effects of refined sugar been effective? In other words, are sugary soft drink sales still rising and milk sales still falling?
Mission: Apply our standard spreadsheet analysis to Food & Beverage companies on the 2016 Barron’s 500 List that have had their stock traded long enough to appear on the 16-Yr BMW Method list.
Execution: see Table.
Administration: We find that 19 companies meet the requirements for size and longevity. But only 8 are Dividend Achievers (see Column AD in the Table), and only 4 of the 16 dividend payers have clean Balance Sheets, HRL, INGR, KO and ADM (see Columns P-R). This tells me that the largest and best-established food companies are struggling. Their managers must be having a hard time figuring out how to grow sales faster than the rate of population growth. A favorite tactic is to have a large advertising budget to promote products that the consumer is expected to like (based on marketing studies). That strategy has pushed Coca-Cola and PepsiCo to the top of the pack, with market capitalizations more than 4 times higher than the next largest food processor: General Mills (GIS; see Column AA in the Table).
Bottom Line: Food & Beverage stocks are thought to be “defensive” because of being in the S&P Consumer Staples industry. However, they’re commodity-related (high risk/high reward) because of being tied to global weather cycles. In my opinion, only 2 of the 19 companies in the Table are sufficiently safe and effective for your retirement portfolio (HRL and KO). Procter & Gamble (PG) is perhaps a better way to invest in Consumer Staples (see Line 23 in the Table).
Coca-Cola (KO) and/or PepsiCo (PEP) dominate sales for sugary soft drinks in every country, even though the sales of such drinks have fallen for 11 yrs in a row, and great efforts have been made to find healthy alternatives. Coca-Cola still derives 70% of its revenue from sugary soft drinks, even though it has diversified into milk (Fairlife), fruit juice (Minute Maid, Simply Orange), sugary vegetable drinks (Suja Juice, Fuze, Odwalla), energy drinks (Monster), and Coca-Cola Life that uses the natural sweetener Stevia. The good news is that the detrimental effects of sugary soft drinks have become well known and consumers expect companies do something about it. Both PepsiCo and Coca-Cola appear to be making every effort to comply, while continuing to rely on the aggressive marketing of sugary soft drinks. In summary, the trendline for sugary soft drink sales is tilting downward while milk continues to fall without pausing.
With regard to milk sales here in the US, the main processor, Dean Foods (DF), almost faced bankruptcy because sales have fallen 30% since 1975. Dean Foods survived by splitting off its most successful subsidiary, WhiteWave Foods, the producer of Horizon Organic milk and Silk soy milk. “The move was designed to get investors to pay more for shares in a business unit with higher profit margins and faster growth prospects than conventional milk.”
Kroger (KR) operates 16 dairies that distribute milk to 34 states, and Coca-Cola (KO) has assembled a large group of dairy co-operatives to produce “ultra-filtered milk.” That new technology separates milk ingredients then recombines those selectively to produce a more nutritious product called "Fairlife," which has half the sugar and twice the protein. Fairlife Milk is distributed to grocery stores nationwide by the Minute Maid division, and is currently priced at an 11% premium to Parmalat Milk in Wal-Mart Stores. Fairlife Milk has been available for less than two years; people who shop with food stamps presumably don’t yet know its benefits and would perhaps shy away from paying the 11% premium price even if they knew.
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-cost average into KO, and also own shares of HRL and PG.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 28 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 (no dividends accrue in 10th year), 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 10-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 a small number of large-cap stocks, where risk is mainly due to “selection bias.” That stock index is the S&P MidCap 400 Index at Line 33 in the Table. The ETF for that index is MDY at Line 27.
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, January 19
Week 133 - Here’s a “Safety First” Retirement Plan With Expenses Under $7/yr
Situation: We all know that investing for retirement is problematic, uncertain, and expensive. We’ve all thought about what it would feel like to depend solely on Social Security for retirement income. And, we all know that the current level of government financing for Social Security is unsustainable due to the relentless growth in the numbers and longevity of retirees, combined with ever fewer workers per retiree contributing to fund the program. Anyone over 50 who doesn’t understand the effect this could have on her sunset years hasn’t been paying attention the past few decades.
Mission: Design a personal retirement plan to supplement Social Security and workplace retirement plans. The plan must minimize transaction costs, bankruptcy risk, and inflation/deflation risk to whatever extent possible.
Here’s how we suggest setting up such a plan. Stocks grow in value during inflation while bonds grow in value during recession. You’ll need both. If you dollar-average by investing small amounts of money 50:50 into bonds and stocks on a regular basis, your retirement savings will grow regardless of inflation and deflation.
As an aside, Central Banks (such as our Federal Reserve) have so many ways to disguise and allay deflation that we only know they are doing so when interest rates fall to absurdly low levels. Pundits call it “printing money” but the technical term is Financial Repression (see Week 79). We’re in a period of financial repression now, meaning that money is so cheap for corporations and banks to obtain that prices for stocks and real estate rise faster than earnings or rents can justify. The Fed’s idea is to “jump start” the economy enough--by encouraging private investment with free money--that it will grow on its own. Once victory is declared and financial repression ends, the favor is returned. Stock and real estate prices will then slow their growth while earnings and rents catch up. Since free money will no longer be available, interest rates will rise to normal or temporarily inflated levels. When will financial repression end? Judging from precedent, that won’t be soon. To prevent deflation following World War II, it lasted from 1947 until 1980.
To eliminate the risk of bankruptcy, purchases for this plan are confined to stocks and bonds that have a AAA credit rating from Standard and Poor’s. When we checked the candidates, we found that 4 companies qualified, along with 10-yr US Treasury Notes. The stocks are Microsoft (MSFT), Johnson & Johnson (JNJ), Exxon Mobil (XOM), and Automatic Data Processing (ADP). Treasuries can be obtained at zero cost at treasurydirect; we recommend inflation-protected 10-yr Notes which are sold in January and July of each year. XOM and JNJ can be obtained at no cost through computershare, although you’ll be charged $1 for each JNJ purchase if you use automatic withdrawals from your checking account. (There is no charge for separate point-and-click JNJ purchases through computershare.) Purchases of MSFT shares through Microsoft’s online transfer agent are expensive, and there’s no online transfer agent for ADP. So, it is best to use a low-cost online broker for those. For example, you can use TD Ameritrade or Capital One. The cost per trade at those sites is currently $6.95.
JNJ is a hedge stock (see Week 126), so you don’t need to back up those purchases with an equal purchase of 10-yr Treasury Notes. That leaves 3 stocks (MSFT, XOM, ADP) to be balanced with Treasuries (or listed as 7 items in all, see the Table). For example, you could decide to invest $4,200/yr. That is, $600/yr per line item which is the same as $300/half, $150/qtr, or $50/mo. For XOM, automatic withdrawals from your checking account in the amount of $50/mo is both free and convenient using computershare. For zero-cost investments in JNJ and 10-yr Treasuries, go online every 6 months to invest $300 in JNJ at computershare and $900 in 10-yr Treasuries at treasurydirect. For lowest-cost investing ($6.95/yr) in ADP and MSFT, make alternate-year purchases of $1200 each through an online broker like Capital One or TD Ameritrade. In summary, T-Notes, JNJ and XOM are free; MSFT and ADP are purchased on alternate years for $6.95. Your out-of-pocket cost is $6.95/yr. This plan carries considerably less risk than VWINX, the safest low-cost balanced mutual fund (see Columns D and J in the Table), even though 10-yr returns are almost identical (Column F). Note: metrics in red indicate underperformance relative to our benchmark, the Vanguard Balanced Index Fund (VBINX).
When you retire, change from automatic reinvestment of quarterly dividends to having the dividends mailed to you. For Treasuries, there is no automatic reinvestment of interest. You receive interest payments twice a year deposited into your checking account, and return of the principal amount ($900) after 10 yrs. When you retire, stop making any “rollover” purchases, which you may have scheduled for T-Notes that are maturing every 6 months. Then you simply receive the principal amount of maturing T-Notes in your checking account. Reinvest T-Note interest payments in inflation-protected Savings Bonds at treasurydirect and hold those for at least 5 yrs before cashing them in, at which time you’ll be taxed for the accumulated interest payments.
Bottom Line: It’s always a good idea to have a personal retirement savings account, even if you already contribute the maximum allowed amount to a company-sponsored retirement plan. Why? Because corporations can change or discontinue their employee retirement plans. And, the Federal government will no doubt be changing long-standing Social Security policies for future retirees. You can have a tax-advantaged aspect of your personal, point-and-click retirement savings account simply by having your accountant declare it to be an IRA, as long as the annual limit for contributions isn’t exceeded.
To avoid gambling with your personal retirement savings plan, you’ll need to include investments with AAA credit ratings. That way you don’t have to worry about bankruptcy. And make sure you hedge against the risk of recession because anytime that stocks go down, T-Notes go up. Finally, don’t spend any money on transaction costs that you don’t absolutely have to spend.
Risk Rating: 3
Full Disclosure: I regularly buy 10-yr T-Notes, MSFT, JNJ, and XOM.
Mission: Design a personal retirement plan to supplement Social Security and workplace retirement plans. The plan must minimize transaction costs, bankruptcy risk, and inflation/deflation risk to whatever extent possible.
Here’s how we suggest setting up such a plan. Stocks grow in value during inflation while bonds grow in value during recession. You’ll need both. If you dollar-average by investing small amounts of money 50:50 into bonds and stocks on a regular basis, your retirement savings will grow regardless of inflation and deflation.
As an aside, Central Banks (such as our Federal Reserve) have so many ways to disguise and allay deflation that we only know they are doing so when interest rates fall to absurdly low levels. Pundits call it “printing money” but the technical term is Financial Repression (see Week 79). We’re in a period of financial repression now, meaning that money is so cheap for corporations and banks to obtain that prices for stocks and real estate rise faster than earnings or rents can justify. The Fed’s idea is to “jump start” the economy enough--by encouraging private investment with free money--that it will grow on its own. Once victory is declared and financial repression ends, the favor is returned. Stock and real estate prices will then slow their growth while earnings and rents catch up. Since free money will no longer be available, interest rates will rise to normal or temporarily inflated levels. When will financial repression end? Judging from precedent, that won’t be soon. To prevent deflation following World War II, it lasted from 1947 until 1980.
To eliminate the risk of bankruptcy, purchases for this plan are confined to stocks and bonds that have a AAA credit rating from Standard and Poor’s. When we checked the candidates, we found that 4 companies qualified, along with 10-yr US Treasury Notes. The stocks are Microsoft (MSFT), Johnson & Johnson (JNJ), Exxon Mobil (XOM), and Automatic Data Processing (ADP). Treasuries can be obtained at zero cost at treasurydirect; we recommend inflation-protected 10-yr Notes which are sold in January and July of each year. XOM and JNJ can be obtained at no cost through computershare, although you’ll be charged $1 for each JNJ purchase if you use automatic withdrawals from your checking account. (There is no charge for separate point-and-click JNJ purchases through computershare.) Purchases of MSFT shares through Microsoft’s online transfer agent are expensive, and there’s no online transfer agent for ADP. So, it is best to use a low-cost online broker for those. For example, you can use TD Ameritrade or Capital One. The cost per trade at those sites is currently $6.95.
JNJ is a hedge stock (see Week 126), so you don’t need to back up those purchases with an equal purchase of 10-yr Treasury Notes. That leaves 3 stocks (MSFT, XOM, ADP) to be balanced with Treasuries (or listed as 7 items in all, see the Table). For example, you could decide to invest $4,200/yr. That is, $600/yr per line item which is the same as $300/half, $150/qtr, or $50/mo. For XOM, automatic withdrawals from your checking account in the amount of $50/mo is both free and convenient using computershare. For zero-cost investments in JNJ and 10-yr Treasuries, go online every 6 months to invest $300 in JNJ at computershare and $900 in 10-yr Treasuries at treasurydirect. For lowest-cost investing ($6.95/yr) in ADP and MSFT, make alternate-year purchases of $1200 each through an online broker like Capital One or TD Ameritrade. In summary, T-Notes, JNJ and XOM are free; MSFT and ADP are purchased on alternate years for $6.95. Your out-of-pocket cost is $6.95/yr. This plan carries considerably less risk than VWINX, the safest low-cost balanced mutual fund (see Columns D and J in the Table), even though 10-yr returns are almost identical (Column F). Note: metrics in red indicate underperformance relative to our benchmark, the Vanguard Balanced Index Fund (VBINX).
When you retire, change from automatic reinvestment of quarterly dividends to having the dividends mailed to you. For Treasuries, there is no automatic reinvestment of interest. You receive interest payments twice a year deposited into your checking account, and return of the principal amount ($900) after 10 yrs. When you retire, stop making any “rollover” purchases, which you may have scheduled for T-Notes that are maturing every 6 months. Then you simply receive the principal amount of maturing T-Notes in your checking account. Reinvest T-Note interest payments in inflation-protected Savings Bonds at treasurydirect and hold those for at least 5 yrs before cashing them in, at which time you’ll be taxed for the accumulated interest payments.
Bottom Line: It’s always a good idea to have a personal retirement savings account, even if you already contribute the maximum allowed amount to a company-sponsored retirement plan. Why? Because corporations can change or discontinue their employee retirement plans. And, the Federal government will no doubt be changing long-standing Social Security policies for future retirees. You can have a tax-advantaged aspect of your personal, point-and-click retirement savings account simply by having your accountant declare it to be an IRA, as long as the annual limit for contributions isn’t exceeded.
To avoid gambling with your personal retirement savings plan, you’ll need to include investments with AAA credit ratings. That way you don’t have to worry about bankruptcy. And make sure you hedge against the risk of recession because anytime that stocks go down, T-Notes go up. Finally, don’t spend any money on transaction costs that you don’t absolutely have to spend.
Risk Rating: 3
Full Disclosure: I regularly buy 10-yr T-Notes, MSFT, JNJ, and XOM.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 10
Week 84 - Dividend Achievers that focus on International Sales
Situation: Last week we started a conversation about growth that is anchored around the concept of Opportunity Risk (see Week 83). The idea is that no one saving for retirement, no family saving for college, no company saving to build a broader competitive advantage, or government saving to build a broader comparative advantage can avoid RISK, since stagnation is the only alternative. They all have to consider Opportunity Risk, i.e., the risk that an expenditure will unnecessarily go toward supporting stagnation rather than growth.
Last week we talked about investing in the smaller (i.e., faster growing) companies that aren't in the S&P 500 Index. This week we’ll turn our attention to companies that capture most of their revenues from faster growing countries. Same as last week, we’ll confine our attention to Dividend Achievers--companies that have increased their dividend annually for at least 10 yrs. We’ve come up with 27 companies, all having an S&P “A” rating of both their stock and bond issues (see Table). The 17 companies in the upper part of the Table lost less than 65% as much as the S&P 500 Index during the Lehman Panic; companies that lost more are red-flagged with respect to Risk (Column D) and take their place in the lower part of the Table. Why less than 65%? Because a group of above-average hedge funds lost slightly less than 65% as much as the S&P 500 Index during the Lehman Panic (see Week 46).
Of those 17 companies in the upper part of the Table, 9 are “hedge" companies (see Week 82). In other words, they have a 5-yr Beta of less than 0.65 (indicating that even today they’d likely lose less than 65% as much as the S&P 500 Index in a bear market) AND beat the S&P 500 Index over the past 15 yrs:
McDonald’s (MCD)
Hormel Foods (HRL)
Abbott Laboratories (ABT)
International Business Machines (IBM)
Colgate-Palmolive (CL)
Johnson & Johnson (JNJ)
Kimberly-Clark (KMB)
PepsiCo (PEP)
Procter & Gamble (PG)
Investment in any of these 9 stocks doesn’t need to be backed 1:1 by a high-grade bond like an inflation-protected US Savings Bond. Do be careful to pick several rather than rely on just one because even the best stocks eventually become overpriced and have to "correct" (witness Apple’s fall from grace).
In the benchmarks at the bottom section of the Table we’ve included one of the best mutual funds focusing on international stocks (ARTIX). This table is a handy illustration of how stock selection can be used to beat mutual funds. Mutual fund managers drum up business by taking outsize risks. This results in good performance over the long haul but comes at the expense of terrible losses during bear markets. You don’t want that (or you wouldn’t be reading this blog).
Bottom Line: Companies that focus on sales from international markets are smart: they’ll grow earnings faster than the average S&P 500 company (which gets only 40% of its sales from outside the US). But it’s a hard row to hoe, so you will have to be very selective.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Last week we talked about investing in the smaller (i.e., faster growing) companies that aren't in the S&P 500 Index. This week we’ll turn our attention to companies that capture most of their revenues from faster growing countries. Same as last week, we’ll confine our attention to Dividend Achievers--companies that have increased their dividend annually for at least 10 yrs. We’ve come up with 27 companies, all having an S&P “A” rating of both their stock and bond issues (see Table). The 17 companies in the upper part of the Table lost less than 65% as much as the S&P 500 Index during the Lehman Panic; companies that lost more are red-flagged with respect to Risk (Column D) and take their place in the lower part of the Table. Why less than 65%? Because a group of above-average hedge funds lost slightly less than 65% as much as the S&P 500 Index during the Lehman Panic (see Week 46).
Of those 17 companies in the upper part of the Table, 9 are “hedge" companies (see Week 82). In other words, they have a 5-yr Beta of less than 0.65 (indicating that even today they’d likely lose less than 65% as much as the S&P 500 Index in a bear market) AND beat the S&P 500 Index over the past 15 yrs:
McDonald’s (MCD)
Hormel Foods (HRL)
Abbott Laboratories (ABT)
International Business Machines (IBM)
Colgate-Palmolive (CL)
Johnson & Johnson (JNJ)
Kimberly-Clark (KMB)
PepsiCo (PEP)
Procter & Gamble (PG)
Investment in any of these 9 stocks doesn’t need to be backed 1:1 by a high-grade bond like an inflation-protected US Savings Bond. Do be careful to pick several rather than rely on just one because even the best stocks eventually become overpriced and have to "correct" (witness Apple’s fall from grace).
In the benchmarks at the bottom section of the Table we’ve included one of the best mutual funds focusing on international stocks (ARTIX). This table is a handy illustration of how stock selection can be used to beat mutual funds. Mutual fund managers drum up business by taking outsize risks. This results in good performance over the long haul but comes at the expense of terrible losses during bear markets. You don’t want that (or you wouldn’t be reading this blog).
Bottom Line: Companies that focus on sales from international markets are smart: they’ll grow earnings faster than the average S&P 500 company (which gets only 40% of its sales from outside the US). But it’s a hard row to hoe, so you will have to be very selective.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 3
Week 83 - Low-Risk Small- and Mid-Cap Dividend Achievers
Situation: “Opportunity risk” is a phrase used by investors to denote the last consideration they check off their list before parting with hard-earned money. Spending on any investment means there will be less money available to support an even better opportunity. “Opportunity risk” is a reminder to all of us not to avoid making the chancy investments that eventually produce growth. We define these chancy investments as small & mid-cap stocks, emerging market stocks & bonds, oil & gas exploration and production companies, pipeline companies, diversified engineering companies that support infrastructure development, and food producers that support the growing world population. There is also opportunity risk for governments when they shy away from expensive but rewarding infrastructure projects that are so essential for GDP growth, like 10 gigabit/sec internet connectivity for every home and office.
Smaller companies can grow rapidly but usually have more cash flow problems and less resilience than large companies, often taking on too much debt. But even without troublesome debt and cash flow problems their stocks are often volatile. This is because investors hop on the bandwagon expecting that growth to get even more exciting but it inevitably slows. These “momentum investors” then sell at a loss, even though growth remains impressive. Apple stock (AAPL) is a current example of how the bandwagon works, and shows that even the largest companies can fall prey.
Companies that offer a good and growing dividend can usually avoid large price swings, so we have consulted the buyupside list of 199 Dividend Achievers (companies that have raised dividends annually for 10+ yrs), excluding those in the S&P 500 Index. We also require that stocks on our list meet our definition of a hedge stock (see Week 82):
a) a 15-yr annualized total return that beats the S&P 500 Index (VFINX);
b) a Lehman Panic (10/07-4/09) total return that is less than 65% as bad as the 45.6% loss in the S&P 500 Index;
c) a 5-yr Beta of less than 0.65.
Our survey has turned up 28 companies (see attached Table) but only 7 are free of red flags in metrics for efficiency (ROIC), debt (LT debt/total capitalization), and cash flow (FCF/div). Those 7 companies include two food producers (LANC & SAFM), two property & casualty insurers (HCC & WRB), one company that sells cleaning products (CHD), one that builds pipelines and collects tolls for oil & gas transportation (PAA), and one that provides conventional electricity (MGEE). Close study of the table will show that all 28 companies have remarkably strong and steady profitability.
Bottom Line: These days economic growth is constrained, so investors need to carefully take on more risk to adequately prepare for retirement. The “new normal” is a term you’ve seen by now, used to describe globally weak economic growth (due to vast amounts of debt that have to be serviced or repaid). The “new normal” clearly sums up present reality. What is less clear is that the financiers who came up with the term also think it sums up future reality. Why? Because the underlying reasons are long-term: a) governments, companies and families have borrowed too much in the expectation that the heady growth of the 1990s will come back and pay off those loans. b) But GDP growth at those 90s rates is unlikely to return because commodity prices (for oil, iron, copper, corn, soybeans, etc.) are likely to grow faster than “core inflation” when over a hundred million people/yr are emerging from poverty and wanting a better life.
Let’s take oil as an example. Think about the expense and risk of a) drilling in deep water, b) hydro-fracking for oil and gas that is locked in deeply buried shale deposits, c) bulldozing and boiling tar sands into bitumen, and d) drilling under the Arctic Ocean. Then remember that oil is the main up-front cost for running a modern economy. When energy is cheap, GDP growth is readily achieved: the growth rates for both GDP and the price of oil have been the same since 1960 at 3.1%/yr (adjusted for inflation). But oil was cheap for only the first half of that 52-yr stretch (its been tripling in price every 10 yrs for the last half). You can see the problem, and its not going to go away until cheaper and cleaner energy substitutes are developed. The only near-term solution is conservation (driven by heavy taxation of electricity, vehicles, and fuels), such as Denmark has been doing for decades.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Smaller companies can grow rapidly but usually have more cash flow problems and less resilience than large companies, often taking on too much debt. But even without troublesome debt and cash flow problems their stocks are often volatile. This is because investors hop on the bandwagon expecting that growth to get even more exciting but it inevitably slows. These “momentum investors” then sell at a loss, even though growth remains impressive. Apple stock (AAPL) is a current example of how the bandwagon works, and shows that even the largest companies can fall prey.
Companies that offer a good and growing dividend can usually avoid large price swings, so we have consulted the buyupside list of 199 Dividend Achievers (companies that have raised dividends annually for 10+ yrs), excluding those in the S&P 500 Index. We also require that stocks on our list meet our definition of a hedge stock (see Week 82):
a) a 15-yr annualized total return that beats the S&P 500 Index (VFINX);
b) a Lehman Panic (10/07-4/09) total return that is less than 65% as bad as the 45.6% loss in the S&P 500 Index;
c) a 5-yr Beta of less than 0.65.
Our survey has turned up 28 companies (see attached Table) but only 7 are free of red flags in metrics for efficiency (ROIC), debt (LT debt/total capitalization), and cash flow (FCF/div). Those 7 companies include two food producers (LANC & SAFM), two property & casualty insurers (HCC & WRB), one company that sells cleaning products (CHD), one that builds pipelines and collects tolls for oil & gas transportation (PAA), and one that provides conventional electricity (MGEE). Close study of the table will show that all 28 companies have remarkably strong and steady profitability.
Bottom Line: These days economic growth is constrained, so investors need to carefully take on more risk to adequately prepare for retirement. The “new normal” is a term you’ve seen by now, used to describe globally weak economic growth (due to vast amounts of debt that have to be serviced or repaid). The “new normal” clearly sums up present reality. What is less clear is that the financiers who came up with the term also think it sums up future reality. Why? Because the underlying reasons are long-term: a) governments, companies and families have borrowed too much in the expectation that the heady growth of the 1990s will come back and pay off those loans. b) But GDP growth at those 90s rates is unlikely to return because commodity prices (for oil, iron, copper, corn, soybeans, etc.) are likely to grow faster than “core inflation” when over a hundred million people/yr are emerging from poverty and wanting a better life.
Let’s take oil as an example. Think about the expense and risk of a) drilling in deep water, b) hydro-fracking for oil and gas that is locked in deeply buried shale deposits, c) bulldozing and boiling tar sands into bitumen, and d) drilling under the Arctic Ocean. Then remember that oil is the main up-front cost for running a modern economy. When energy is cheap, GDP growth is readily achieved: the growth rates for both GDP and the price of oil have been the same since 1960 at 3.1%/yr (adjusted for inflation). But oil was cheap for only the first half of that 52-yr stretch (its been tripling in price every 10 yrs for the last half). You can see the problem, and its not going to go away until cheaper and cleaner energy substitutes are developed. The only near-term solution is conservation (driven by heavy taxation of electricity, vehicles, and fuels), such as Denmark has been doing for decades.
Risk Rating: 6.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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