Situation: Market turmoil is turning stock and bond index funds into a “crowded trade.” Both are momentum investments, and both remain overvalued. Neither offsets the risk of the other. This is a good time to take some chips off the table and bulk-up your Rainy Day Fund. More importantly, it is a time to revisit the fundamentals of sound investing. For example, stop making “one-off” stock investments. Those are usually speculative. But follow Warren Buffett’s lead and continue to invest in strong companies by dollar-cost averaging. Those are “forever” investments that will likely prove worthwhile, through bear markets as well as bull markets, as long as you stay the course.
But how do we find “strong” companies? Experienced traders mainly offer 5 qualifiers: Look for 1) large and 2) well-established companies that have 3) strong Balance Sheets, and pay a 4) good and 5) growing dividend. We have converted those into numbers on a spreadsheet, and call it “The 2 and 8 Club.” We start by looking at the companies in the S&P 100 Index because those are required to have a robust market in Put and Call options (which facilitate Price Discovery). Approximately 20 of the 100 earn membership in our Club. Approximately 10 more companies on the Barron’s 500 List meet our requirements, allowing us to create an ~30 stock list (the Extended Version).
Mission: Produce a spreadsheet of the ~30 companies in the Extended Version of “The 2 and 8 Club.”
Execution: see Table.
Administration: What are our criteria for meeting each of the 5 qualitative objectives?
Large companies
Those are the 500 on the Barron’s 500 List published each May (see Columns N & O in our Tables).
Well-established companies
Those are the companies on the Barron’s 500 List that are also on the 16-Yr list of companies that are quantitatively evaluated each week by using the BMW Method. See Columns K-M in our Tables.
Strong Balance Sheet
Companies must have an S&P Bond Rating of BBB+ or higher (Column T in our Tables). For more granularity on this topic, we provide key metrics: Long-Term Debt as a percent of Total Assets (Column P), Operating Cash Flow as a percent of Current Liabilities (Column Q), Tangible Book Value per Share as a percent of Share Price (Column R), Dividend Payout as a percent of Free Cash Flow (Column S), Weighted Average Cost of Capital vs. Return on Invested Capital (Columns Z and AA). Values in those 6 columns that we think of as sub-par are highlighted in purple.
Good Dividend
Companies must be listed in the FTSE High Dividend Yield Index (US version). Those are the ~400 companies in the Russell 1000 Index that are judged by The Financial Times editors to have a dividend yield that is reliably above the market yield of approximately 2% (see Column G). The most convenient investment vehicle for that is the Vanguard High Dividend Yield ETF (VYM). The list is updated monthly, and you can access holdings here.
Growing Dividend
We require companies to have increased their dividend payout at least 8%/yr over the past 5 years (see Column H), as determined by calculating the Compound Annual Growth Rate (CAGR) for the most recent 4 quarters of regular dividend payouts vs. the same 4 quarters 5 years ago.
As a sanity check, we require that companies have historic returns relative to risk that is within reason for the retail investor, i.e., an S&P Stock Rating of at least B+/M (see Column U).
Finally, there are two important caveats that you need to keep in mind: 1) No one invests solely on the basis of numbers. The story behind a company’s stock has to be examined by using multiple online sources, and revisited at least monthly. 2) Every investor needs a Watch List to help her get started with each month’s research. “The 2 and 8 Club” is our Watch List.
Bottom Line: If you’re a downhill ski racer, your goal is to get to the Bottom Line safely and quickly. “Safely” is accomplished by setting up a few gates with line judges, and allowing you to “shadow” the course the night before. “Quickly” is assessed by using a stopwatch, combined with a video camera trained on the finish line. In other words, the activity is standardized to allow comparison with other racers and place limits on sanity. Stock picking isn’t much different. You need a starting place, a process governed by sanity checks, and a way to judge your performance. “The 2 and 8 Club” satisfies those basic needs. It will help give you a chance to outperform an S&P 500 Index enough to pay for the additional transaction costs and capital gains taxes that you’ll incur.
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10).
Full Disclosure: I dollar-average into MSFT, NEE, PEP, JPM, CAT and IBM, and also own shares of TRV, MMM, CSCO and CMI.
"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
Showing posts with label rainy day fund. Show all posts
Showing posts with label rainy day fund. Show all posts
Sunday, May 27
Sunday, May 20
Week 359 - Gold Can Be Useful To Own When Markets Are In Turmoil
Situation: On April 2, 2018, a new downtrend began for the US stock market according to Dow Theory. This officially ends the Bull Market that began on March 9, 2009. Gold now becomes one of the go-to destinations for traders, along with other “safe haven” investments like Japanese Yen, Swiss Francs, US dollars, and US Treasury Bonds. When traders stop moving new money into stocks and instead resort to a safe haven, they often move some into SPDR Gold Shares (GLD at Line 15 in the Table).
Why has the US stock market embarked on a primary downtrend? Because the risk of a Trade War has increased. But it’s a perfect storm because the Federal Open Market Committee (FOMC) of the US Treasury has also put the US stock and bond markets at risk by steadily increasing short-term interest rates. Normally when the economy falters, bonds are a good alternative to stocks. The exception happens when the FOMC raises short-term interest rates to ward off inflation: Long-term rates also rise, giving their new investors an asset that is falling in value.
An option to buying gold bullion (GLD) is to buy stock in mining companies. Gold miners are emerging from difficult times, given that the 2014-2016 commodities crash caught them competing on the basis of growth in production, which they had funded with ever-increasing debt. Now they are paying down that debt and instead competing on the basis of free cash flow, in order to reward investors (i.e., buy back stock and increase dividends).
Mission: Run our Standard Spreadsheet to analyze gold-linked investments, as well as short-term bonds. Include manufacturers of mining equipment, and other enablers like railroads and banks.
Execution: see Table.
Administration: Some advisors suggest that gold should represent 3-5% of your retirement savings. However, gold has marked price volatility but remains at approximately the same price it had 30 years ago. If you plan to hold it long-term, you’d best think of it as one of your Rainy Day Fund holdings (see Week 291).
What actions are reasonable to take when Dow Theory declares that stocks are entering a new downtrend? Gold is one of the 5 places to consider routing new money instead of stocks, the others being US dollars, Japanese Yen, Swiss Francs, and US Treasury Bonds. We’ve shown that US Treasury Bonds are not a suitable choice in a rising interest rate environment. For US investors, that leaves gold and US dollars as safe haven investments. The most inflation-resistant way to invest in US dollars is to dollar-average into 2-Yr US Treasury Notes or Inflation-protected US Savings Bonds at no cost through the government website. But for traders who are willing to pay transaction costs, the 1-3 Year Treasury Note ETF (SHY at Line 15 in the Table) is more convenient.
How best to invest in gold? Let’s start with the old lesson about how to profit from gold mining, learned during the California gold rush of 1949: Gold miners don’t make much money but their enablers do. Those are the bankers who loan them money, and the owners of companies that provide them with equipment, consumables and transportation. Go to any open-pit gold mine and the first thing you’ll notice is the massive yellow-painted trucks carrying ore. Those are made by Caterpillar (CAT at Line 6 in the Table).
Now look at the top of the Table. The second company listed is Union Pacific (UNP). This highlights the fact that ores recovered at any mine have to be transported to smelters. The fourth company, Royal Gold (RGLD), is a Financial Services company. This highlights the fact that bankers can profit greatly from loaning money to gold miners, provided they do it in an unusual way, which is issuing loans that don’t have to be repaid in dollars but instead can be repaid by the grant of either a royalty or a specified fraction (“stream”) of gold produced over the lifetime of the mine. Royal Gold (GLD) prefers royalty contracts. The other two Financial Services companies that service gold miners prefer streaming contracts: Franco-Nevada (FNV) and Wheaton Precious Metals (WPM).
Bottom Line: SPDR Gold Shares (GLD) will be in demand until Dow Theory declares that the downtrend in US stocks has been reversed. 2-Yr US Treasury Notes (SHY) will be in demand until the FOMC stops raising short-term interest rates.
Risk Rating: 10 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into CAT, UNP and 2-Yr US Treasury Notes, and also own shares of WPM.
"The 2 and 8 Club" (CR) 20187 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Why has the US stock market embarked on a primary downtrend? Because the risk of a Trade War has increased. But it’s a perfect storm because the Federal Open Market Committee (FOMC) of the US Treasury has also put the US stock and bond markets at risk by steadily increasing short-term interest rates. Normally when the economy falters, bonds are a good alternative to stocks. The exception happens when the FOMC raises short-term interest rates to ward off inflation: Long-term rates also rise, giving their new investors an asset that is falling in value.
An option to buying gold bullion (GLD) is to buy stock in mining companies. Gold miners are emerging from difficult times, given that the 2014-2016 commodities crash caught them competing on the basis of growth in production, which they had funded with ever-increasing debt. Now they are paying down that debt and instead competing on the basis of free cash flow, in order to reward investors (i.e., buy back stock and increase dividends).
Mission: Run our Standard Spreadsheet to analyze gold-linked investments, as well as short-term bonds. Include manufacturers of mining equipment, and other enablers like railroads and banks.
Execution: see Table.
Administration: Some advisors suggest that gold should represent 3-5% of your retirement savings. However, gold has marked price volatility but remains at approximately the same price it had 30 years ago. If you plan to hold it long-term, you’d best think of it as one of your Rainy Day Fund holdings (see Week 291).
What actions are reasonable to take when Dow Theory declares that stocks are entering a new downtrend? Gold is one of the 5 places to consider routing new money instead of stocks, the others being US dollars, Japanese Yen, Swiss Francs, and US Treasury Bonds. We’ve shown that US Treasury Bonds are not a suitable choice in a rising interest rate environment. For US investors, that leaves gold and US dollars as safe haven investments. The most inflation-resistant way to invest in US dollars is to dollar-average into 2-Yr US Treasury Notes or Inflation-protected US Savings Bonds at no cost through the government website. But for traders who are willing to pay transaction costs, the 1-3 Year Treasury Note ETF (SHY at Line 15 in the Table) is more convenient.
How best to invest in gold? Let’s start with the old lesson about how to profit from gold mining, learned during the California gold rush of 1949: Gold miners don’t make much money but their enablers do. Those are the bankers who loan them money, and the owners of companies that provide them with equipment, consumables and transportation. Go to any open-pit gold mine and the first thing you’ll notice is the massive yellow-painted trucks carrying ore. Those are made by Caterpillar (CAT at Line 6 in the Table).
Now look at the top of the Table. The second company listed is Union Pacific (UNP). This highlights the fact that ores recovered at any mine have to be transported to smelters. The fourth company, Royal Gold (RGLD), is a Financial Services company. This highlights the fact that bankers can profit greatly from loaning money to gold miners, provided they do it in an unusual way, which is issuing loans that don’t have to be repaid in dollars but instead can be repaid by the grant of either a royalty or a specified fraction (“stream”) of gold produced over the lifetime of the mine. Royal Gold (GLD) prefers royalty contracts. The other two Financial Services companies that service gold miners prefer streaming contracts: Franco-Nevada (FNV) and Wheaton Precious Metals (WPM).
Bottom Line: SPDR Gold Shares (GLD) will be in demand until Dow Theory declares that the downtrend in US stocks has been reversed. 2-Yr US Treasury Notes (SHY) will be in demand until the FOMC stops raising short-term interest rates.
Risk Rating: 10 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold bullion = 10)
Full Disclosure: I dollar-average into CAT, UNP and 2-Yr US Treasury Notes, and also own shares of WPM.
"The 2 and 8 Club" (CR) 20187 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 28
Week 343 - Raise Cash For The Crash
Situation: By now, you know that many are predicting that we are in the late stages of a bull market. Euphoria is the last stage, and in the present climate, one would expect that euphoria will begin happening as the new tax bill takes effect. Two or 3 years later, the stock market will over-correct to the downside and recession will likely soon follow. Now would be a good time for small investors to begin to protect themselves. One way to do that would be to “bulk up” on cash equivalents and Treasuries. The money you still have in equities will need to move in the direction of high-yielding Dividend Achiever type stocks.
Why should we start making these changes now? Because the yield curve is flattening (see Appendix below), which is the best indicator that Financial Services professionals have to predict a market crash.
Mission: Draw up a portfolio of stocks and bonds that will carry you through a market crash relatively unscathed.
Execution: see Table.
Administration: There are 4 ways to raise cash for a crash.
1) Have a Rainy Day Fund that covers 6 months of expenses and is inflation-protected. All of us resist maintaining this “Dead Money Account.” Why? Because it keeps taking money away from spending as our income increases. The trick is to make it painless by a) eliminating transaction costs, tax payments, and inflation risk, and b) paying into the Account automatically. Sounds great, but how? By going to the US Treasury website and directing that a transfer of $25+/mo be made from your checking account into an Inflation-Protected Savings Bond (ISB). Follow a First In/First Out (FIFO) policy when cashing-out your Rainy Day Fund, since you’ll lose an interest payment if you cash-out sooner than 5 years. Taxes are only due after you’ve drawn down the Account.
2) Increase your Cash-Equivalents Allocation: dollar-average into 2-Yr Treasury Notes. Normally, this allocation is whatever cash cushion you like to maintain in your Savings, Checking, and Brokerage Accounts. But now isn’t a normal time. You need to plus-up those cash holdings and build a “backstop.” Why? Because there’s a material risk that your household will soon be living on less income (that is, a reduction upwards of 5%/yr). The easiest way to build a temporary backstop is to go back into www.treasurydirect.com and invest $1000 every 2 months in a 2-Yr Treasury Note. After 2 years, you’re done. You’ve allocated $12,000 that will start paying $1000 into your Checking Account every 2 months. Meantime, you can track the value of this investment through the ticker SHY (iShares 1-3 Year Treasury Bond ETF -- see Line 20 in the Table),
3) Reduce your Equity Allocation but retain Dividend Achievers with above-market yields. This week’s Table has suggestions that may assist you. Those stocks were chosen largely on the basis of a) high ratings from S&P, b) above-market yields, c) the likelihood of payouts continuing to increase in a recession, d) P/E ratios at or below market, and e) predicted losses in a bear market (see Column M in the Table) that are less than or equal to those predicted for the S&P 500 Index (at Line 20). When the crash hits, you will be tempted to sell these (your most crash-resistant stocks) because you’re afraid they’ll fall further. Don’t. Instead of reinvesting dividends, just have the dividend checks sent to your mailbox. If you aren’t a stock picker, simply invest in VYM (Vanguard High Dividend Yield ETF at Line 17 in Table) and XLU (SPDR Utilities Select Sector ETF at Line 14).
4) Increase your Fixed-Income Allocation: dollar-average into 20+ Yr Treasury Bonds. In a Bear Market, you may need to raise cash by selling assets. You might want to sell assets that have temporarily spiked upward in value because stocks are crashing. Only one asset that will predictably do that for you: 20+ Year Treasury Bonds, which are already being bought up and flattening the yield curve (see Appendix below). These are the Treasuries you’ll be buying, and later turning around to sell. So, you’ll need to have a brokerage account that is fee-based (that is, you’re charged ~1% of Net Asset Value/yr in return for transaction costs being waived). Then dollar-average into TLT (iShares 20+ Year Treasury Bond ETF at Line 15 in the Table). Sell those when you think the stock market has bottomed, and spend the proceeds on stocks in that Fire Sale.
Bottom Line: To avoid sleepless nights and migraine headaches, pull in your horns now. Stop gambling (but restart after the market collapses). Build up your Rainy Day Fund, and invest in cash equivalents, high-yielding high-quality stocks, and long-term Treasuries. When the crash hits, people will tell you to stop buying stocks altogether. Why do they say that? Because nobody can say for sure how long the market will keep going down. But Walmart (WMT) and McDonald’s (MCD) will be booming, even while layoffs in the Industrial Sector continue to make headlines. The End of the World isn’t happening. Get over it. Read the Wall Street Journal. When the Bear looks to be getting tired, call your stock broker and buy.
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into NEE and TGT, and also own shares of PEP, PFE, HRL, and MO. I am executing on the 4 suggestions above for raising cash.
APPENDIX: The yield curve is Flattening. What does that jargon term mean? Savvy investors are moving money out of growth stocks and into Long-Term Treasuries, even while the Federal Reserve is raising Short-Term interest rates. It doesn’t make sense. Long-Term rates would typically move up in tandem with Short-Term rates, provided the economy is truly gaining strength.
You can follow that increase in Long-Term Treasury Bond prices (which move in the opposite direction of interest rates) by going to Yahoo Finance and entering TLT (for iShares 20+ Yr Treasury Bond ETF). Click on “chart” and select the 2 Year chart. Then on “indicator” and choose a 200-day moving average. That will show the steady upward movement in the price of those bonds—because buyers outnumber sellers. That results in a steady downward movement in the rate of interest being earned by new buyers, which flattens the yield curve.
There are several explanations why Long-Term interest rates might fall even as Short-Term rates are rising: “the likeliest...is the simplest: markets are losing confidence in the Fed’s ability to raise [Short-Term] rates without inflation sagging.” You might want to learn more about the falling yield curve, so read on.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Why should we start making these changes now? Because the yield curve is flattening (see Appendix below), which is the best indicator that Financial Services professionals have to predict a market crash.
Mission: Draw up a portfolio of stocks and bonds that will carry you through a market crash relatively unscathed.
Execution: see Table.
Administration: There are 4 ways to raise cash for a crash.
1) Have a Rainy Day Fund that covers 6 months of expenses and is inflation-protected. All of us resist maintaining this “Dead Money Account.” Why? Because it keeps taking money away from spending as our income increases. The trick is to make it painless by a) eliminating transaction costs, tax payments, and inflation risk, and b) paying into the Account automatically. Sounds great, but how? By going to the US Treasury website and directing that a transfer of $25+/mo be made from your checking account into an Inflation-Protected Savings Bond (ISB). Follow a First In/First Out (FIFO) policy when cashing-out your Rainy Day Fund, since you’ll lose an interest payment if you cash-out sooner than 5 years. Taxes are only due after you’ve drawn down the Account.
2) Increase your Cash-Equivalents Allocation: dollar-average into 2-Yr Treasury Notes. Normally, this allocation is whatever cash cushion you like to maintain in your Savings, Checking, and Brokerage Accounts. But now isn’t a normal time. You need to plus-up those cash holdings and build a “backstop.” Why? Because there’s a material risk that your household will soon be living on less income (that is, a reduction upwards of 5%/yr). The easiest way to build a temporary backstop is to go back into www.treasurydirect.com and invest $1000 every 2 months in a 2-Yr Treasury Note. After 2 years, you’re done. You’ve allocated $12,000 that will start paying $1000 into your Checking Account every 2 months. Meantime, you can track the value of this investment through the ticker SHY (iShares 1-3 Year Treasury Bond ETF -- see Line 20 in the Table),
3) Reduce your Equity Allocation but retain Dividend Achievers with above-market yields. This week’s Table has suggestions that may assist you. Those stocks were chosen largely on the basis of a) high ratings from S&P, b) above-market yields, c) the likelihood of payouts continuing to increase in a recession, d) P/E ratios at or below market, and e) predicted losses in a bear market (see Column M in the Table) that are less than or equal to those predicted for the S&P 500 Index (at Line 20). When the crash hits, you will be tempted to sell these (your most crash-resistant stocks) because you’re afraid they’ll fall further. Don’t. Instead of reinvesting dividends, just have the dividend checks sent to your mailbox. If you aren’t a stock picker, simply invest in VYM (Vanguard High Dividend Yield ETF at Line 17 in Table) and XLU (SPDR Utilities Select Sector ETF at Line 14).
4) Increase your Fixed-Income Allocation: dollar-average into 20+ Yr Treasury Bonds. In a Bear Market, you may need to raise cash by selling assets. You might want to sell assets that have temporarily spiked upward in value because stocks are crashing. Only one asset that will predictably do that for you: 20+ Year Treasury Bonds, which are already being bought up and flattening the yield curve (see Appendix below). These are the Treasuries you’ll be buying, and later turning around to sell. So, you’ll need to have a brokerage account that is fee-based (that is, you’re charged ~1% of Net Asset Value/yr in return for transaction costs being waived). Then dollar-average into TLT (iShares 20+ Year Treasury Bond ETF at Line 15 in the Table). Sell those when you think the stock market has bottomed, and spend the proceeds on stocks in that Fire Sale.
Bottom Line: To avoid sleepless nights and migraine headaches, pull in your horns now. Stop gambling (but restart after the market collapses). Build up your Rainy Day Fund, and invest in cash equivalents, high-yielding high-quality stocks, and long-term Treasuries. When the crash hits, people will tell you to stop buying stocks altogether. Why do they say that? Because nobody can say for sure how long the market will keep going down. But Walmart (WMT) and McDonald’s (MCD) will be booming, even while layoffs in the Industrial Sector continue to make headlines. The End of the World isn’t happening. Get over it. Read the Wall Street Journal. When the Bear looks to be getting tired, call your stock broker and buy.
Risk Rating: 4 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-cost average into NEE and TGT, and also own shares of PEP, PFE, HRL, and MO. I am executing on the 4 suggestions above for raising cash.
APPENDIX: The yield curve is Flattening. What does that jargon term mean? Savvy investors are moving money out of growth stocks and into Long-Term Treasuries, even while the Federal Reserve is raising Short-Term interest rates. It doesn’t make sense. Long-Term rates would typically move up in tandem with Short-Term rates, provided the economy is truly gaining strength.
You can follow that increase in Long-Term Treasury Bond prices (which move in the opposite direction of interest rates) by going to Yahoo Finance and entering TLT (for iShares 20+ Yr Treasury Bond ETF). Click on “chart” and select the 2 Year chart. Then on “indicator” and choose a 200-day moving average. That will show the steady upward movement in the price of those bonds—because buyers outnumber sellers. That results in a steady downward movement in the rate of interest being earned by new buyers, which flattens the yield curve.
There are several explanations why Long-Term interest rates might fall even as Short-Term rates are rising: “the likeliest...is the simplest: markets are losing confidence in the Fed’s ability to raise [Short-Term] rates without inflation sagging.” You might want to learn more about the falling yield curve, so read on.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, June 18
Week 311 - A-rated S&P 100 “Defensive” Companies With Tangible Book Value
Situation: We know for certain that this is a period of great anxiety in credit markets. Trillions of dollars in loans have been made by banks in Southern Europe and East Asia that are now worth less than a third of their face value. Many of these loans were made by private banks, but governments are ultimately “on the hook” for the debt. With non-performing debts on their books, banks have less ability to make worthwhile loans to support economic growth, education and upgrades of infrastructure. A credit crunch is going to happen, unless these bad debts are boxed up, tied with a ribbon, and sold to the highest bidder. Remember: the credit crunch of 2008-09 quickly cut worldwide GDP growth per capita in half, from 2%/yr to 1%/yr. And it didn’t start to recover until this year.
What’s the best way for you to drill down on this subject? I suggest that you read Peter Coy’s article, which appeared in Bloomberg Business Week last October. His analysis responds to the International Monetary Fund’s 2016 Global Financial Stability Report that was hot off the press. Here are bullet points from that report: “medium-term risks continue to build”, meaning 1) growing political instability; 2) persistent weakness of financial institutions in China and Southern Europe; 3) excessive corporate debt in emerging markets. In China, combined public and private debt almost doubled over the past 10 years, and is now 210% of GDP (worldwide it’s 225% of GDP).
Mission: What’s the best way to tailor your retirement portfolio in response to these global risks? Become defensive. That doesn’t just mean having a Rainy Day Fund that is well-stocked with interest-earning cash-equivalents (Savings Bonds, Treasury Bills, and 2-Yr Treasury Notes). It means overweighting high quality “defensive stocks” in your equity portfolio. What is the Gold Standard? Companies in the S&P 100 Index that are in the 4 S&P Defensive Industries:
Consumer Staples;
Healthcare;
Utilities; and
Communication Services.
Large companies have multiple product lines, and membership in the S&P 100 Index requires a healthy options market for the company’s stock, to facilitate price discovery. You have to drill deeper in your analysis, to be sure the company’s S&P credit rating is A- or better, and its stock rating is A-/M or better. Statistical information has to be available from the 16-Yr series of the BMW Method and the 2017 Barron’s 500 List. Check financial statements for signs of high debt: long-term bonds that represent more than a third of total assets, operating cash flow that covers less than 40% of current liabilities, or an inability to meet dividend payments out of free cash flow (FCF). Exclude companies with negative Tangible Book Value.
Execution: By using the above criteria, we uncover 7 companies out of the 32 “defensive” companies in the S&P 100 Index (see Table).
Bottom Line: Defensive companies are less interesting than growth companies or companies involved in the production of raw commodities. But high-quality defensive companies, such as Johnson & Johnson (JNJ) and NextEra Energy (NEE), consistently grow earnings faster than GDP and are quick to correct any earnings shortfall. All an investor need do is learn to read financial statements, and regularly examine websites for data on companies of interest.
Risk Rating: 4 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold bullion).
Full Disclosure: I dollar-average into Coca-Cola (KO), NextEra Energy (NEE), and Johnson & Johnson (JNJ). I also own shares in Costco Wholesale (COST) and Wal-Mart Stores (WMT).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 15 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 4-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K. 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 20 in the Table. The ETF for that index is MDY at Line 14. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
What’s the best way for you to drill down on this subject? I suggest that you read Peter Coy’s article, which appeared in Bloomberg Business Week last October. His analysis responds to the International Monetary Fund’s 2016 Global Financial Stability Report that was hot off the press. Here are bullet points from that report: “medium-term risks continue to build”, meaning 1) growing political instability; 2) persistent weakness of financial institutions in China and Southern Europe; 3) excessive corporate debt in emerging markets. In China, combined public and private debt almost doubled over the past 10 years, and is now 210% of GDP (worldwide it’s 225% of GDP).
Mission: What’s the best way to tailor your retirement portfolio in response to these global risks? Become defensive. That doesn’t just mean having a Rainy Day Fund that is well-stocked with interest-earning cash-equivalents (Savings Bonds, Treasury Bills, and 2-Yr Treasury Notes). It means overweighting high quality “defensive stocks” in your equity portfolio. What is the Gold Standard? Companies in the S&P 100 Index that are in the 4 S&P Defensive Industries:
Consumer Staples;
Healthcare;
Utilities; and
Communication Services.
Large companies have multiple product lines, and membership in the S&P 100 Index requires a healthy options market for the company’s stock, to facilitate price discovery. You have to drill deeper in your analysis, to be sure the company’s S&P credit rating is A- or better, and its stock rating is A-/M or better. Statistical information has to be available from the 16-Yr series of the BMW Method and the 2017 Barron’s 500 List. Check financial statements for signs of high debt: long-term bonds that represent more than a third of total assets, operating cash flow that covers less than 40% of current liabilities, or an inability to meet dividend payments out of free cash flow (FCF). Exclude companies with negative Tangible Book Value.
Execution: By using the above criteria, we uncover 7 companies out of the 32 “defensive” companies in the S&P 100 Index (see Table).
Bottom Line: Defensive companies are less interesting than growth companies or companies involved in the production of raw commodities. But high-quality defensive companies, such as Johnson & Johnson (JNJ) and NextEra Energy (NEE), consistently grow earnings faster than GDP and are quick to correct any earnings shortfall. All an investor need do is learn to read financial statements, and regularly examine websites for data on companies of interest.
Risk Rating: 4 (where 1 = 10-Yr Treasury Notes, 5 = S&P 500 Index, 10 = gold bullion).
Full Disclosure: I dollar-average into Coca-Cola (KO), NextEra Energy (NEE), and Johnson & Johnson (JNJ). I also own shares in Costco Wholesale (COST) and Wal-Mart Stores (WMT).
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 15 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 4-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K. 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 20 in the Table. The ETF for that index is MDY at Line 14. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 22
Week 291 - Back-up Your Rainy Day Fund With A-rated Defensive Stocks That Are Dividend Achievers With Clean Balance Sheets
Situation: After retirement, you’ll have a stream of fixed income, ideally from several sources, namely annuities, a pension or Reverse Mortgage, Social Security, an IRA, a 401(k) or 403(b), and RMDs (Required Minimum Distributions) on any of those you haven’t converted to annuities. For 30-40% of you, Social Security and perhaps a Reverse Mortgage will be the extent of your retirement income. You’ll budget that income, perhaps with the help of Food Stamps. But also need to have an FDIC-insured Savings Account for emergencies. That Rainy Day Fund will be eroded by inflation, travel, and non-recurring capital expenditures, mainly co-payments and deductibles on your health insurance. To keep ahead of inflation, we recommend that you stuff your Rainy Day Fund with Inflation-Protected Savings Bonds (ISBs), which currently yield 2.76%. You can cash those bonds in after 5 yrs without incurring a penalty, but would lose only one interest payment if you were to cash in earlier.
The money you take out of your Rainy Day Fund has to be replaced, so as to have at least a one-year year buffer, i.e., in order to keep it from disappearing. Those replacement dollars will have to come from a part-time job, renting out a room in your house, or severe budgeting. But there is a better way, which is to arrange (before you retire) to have a growing income. To help achieve this, back up your Rainy Day Fund by investing in “defensive” stocks, using the cheapest way possible, which is to purchase shares online and use “dollar-cost averaging” via automatic withdrawals from your checking account--into stocks of one or two companies among S&P’s defensive industries. These are: Health Care, Utilities, Consumer Staples, and Telecommunication Services.
Mission: Set up a spreadsheet of A-rated Dividend Achievers in the 4 S&P defensive industries.
Administration: This week’s Table has 8 such Dividend Achievers, and the shares of all but Procter & Gamble (PG) and McCormick (MKC) can be purchased from Computershare; PG and MKC shares are offered by Wells & Fargo. The annual cost of investing $100/mo online in each is shown in Column AB of the Table. The average cost for investing $1200/yr in monthly installments is $8.00, giving an Expense Ratio of 0.67% (8/1200). There are also exchange-traded funds (ETFs) available for each S&P Industry but those would need to be purchased through a broker. The average dividend yield for all 8 is a little less than 3% (see Column G in the Table), and the average long-term price appreciation of the stocks is ~9.5% (see Column K in the Table). All 8 have less risk of loss in the next Bear Market than the S&P 500 Index (see Column M in the Table).
Bottom Line: After you retire, your only sources of income growth are Social Security and dividend-paying stocks. The best way to safely capture dividend growth is to invest in a low-cost managed mutual fund like Vanguard Wellesley Income Fund (VWINX), where the managers mainly use safe bonds but thread in dividend-paying stocks to represent 30-40% of assets. The next best way is to have a computer hold stocks at 60% and bonds at 40%, e.g. the Vanguard Balanced Index Fund (VBINX). Finally, if you have the time and interest, pick relatively safe “defensive” stocks on the basis of dividend growth (see Column H in the Table) and historically low volatility (see Column M in the Table). Today’s blog focuses on that option.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG, JNJ and NEE, and also own shares of KO, WMT, ABT and MKC.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 17.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The money you take out of your Rainy Day Fund has to be replaced, so as to have at least a one-year year buffer, i.e., in order to keep it from disappearing. Those replacement dollars will have to come from a part-time job, renting out a room in your house, or severe budgeting. But there is a better way, which is to arrange (before you retire) to have a growing income. To help achieve this, back up your Rainy Day Fund by investing in “defensive” stocks, using the cheapest way possible, which is to purchase shares online and use “dollar-cost averaging” via automatic withdrawals from your checking account--into stocks of one or two companies among S&P’s defensive industries. These are: Health Care, Utilities, Consumer Staples, and Telecommunication Services.
Mission: Set up a spreadsheet of A-rated Dividend Achievers in the 4 S&P defensive industries.
Administration: This week’s Table has 8 such Dividend Achievers, and the shares of all but Procter & Gamble (PG) and McCormick (MKC) can be purchased from Computershare; PG and MKC shares are offered by Wells & Fargo. The annual cost of investing $100/mo online in each is shown in Column AB of the Table. The average cost for investing $1200/yr in monthly installments is $8.00, giving an Expense Ratio of 0.67% (8/1200). There are also exchange-traded funds (ETFs) available for each S&P Industry but those would need to be purchased through a broker. The average dividend yield for all 8 is a little less than 3% (see Column G in the Table), and the average long-term price appreciation of the stocks is ~9.5% (see Column K in the Table). All 8 have less risk of loss in the next Bear Market than the S&P 500 Index (see Column M in the Table).
Bottom Line: After you retire, your only sources of income growth are Social Security and dividend-paying stocks. The best way to safely capture dividend growth is to invest in a low-cost managed mutual fund like Vanguard Wellesley Income Fund (VWINX), where the managers mainly use safe bonds but thread in dividend-paying stocks to represent 30-40% of assets. The next best way is to have a computer hold stocks at 60% and bonds at 40%, e.g. the Vanguard Balanced Index Fund (VBINX). Finally, if you have the time and interest, pick relatively safe “defensive” stocks on the basis of dividend growth (see Column H in the Table) and historically low volatility (see Column M in the Table). Today’s blog focuses on that option.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG, JNJ and NEE, and also own shares of KO, WMT, ABT and MKC.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 17 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256: Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = average stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 3-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% approximates Total Returns/yr from a stock index of similar risk to owning shares in a small number of large-cap stocks, where risk due to “selection bias” is paramount. That stock index is the S&P MidCap 400 Index at Line 31 in the Table. The ETF for that index is MDY at Line 17.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, December 25
Week 286 - Should You Take Out A Reverse Mortgage?
Situation: Young couples are often advised to make payments each month on 1) a home mortgage, and 2) a “whole life” insurance policy. Homes are not good investments, and neither are “whole life” policies. They’re a form of compelled savings. If we later find ourselves unprepared for retirement, we may be guided to recoup those savings by “taking out” a reverse mortgage or “borrowing against” a whole life policy. The government joins the party by compelling us to save during our working years (under the Federal Insurance Contributions Act of 1935), and then guides us to recoup our “Social Security” savings in retirement.
Mission: Look at the costs and benefits of reverse mortgages. NOTE: To obtain more detailed information, I suggest reading this article that appeared in USA Today on October 28.
Execution: “On the plus side, reverse mortgages are considered loan advances to you, not income you earned. Thus, the payments you receive are not taxable. Moreover, they usually don't affect your Social Security or Medicare benefits.” Emotional benefits play a role, given that 1) you get to keep living in your home without paying rent, and 2) your children get to inherit a house that retains considerable equity. And, reverse mortgages make a great Rainy Day Fund.
On the negative side, there is “opportunity cost”: You are giving up the opportunity to invest a large sum of your own money, if you sell the house and rent a place more suited to your needs. Transaction costs on the sale are the same as those for taking out a reverse mortgage (6%), which leaves 94% for you to invest. We provide an example (see Table) of how you might set up an online investment in bonds and stocks that pays out at least 2%/yr (after transaction costs) and grows those payments at least 2%/yr.
Administration: The investment example has an asset allocation of 50% bonds/50% stocks. The bonds are “zero risk/zero cost” 10-Yr Treasury Notes accessed through the government website; that site also offers inflation-protected Treasury Notes. You can invest in KO, JNJ and WMT online but have to use a different website to invest in PG. Each pays a good and growing dividend, and had Total Returns/yr during the Housing Crisis that were better than those for our key benchmark, the Vanguard Balanced Index Fund (VBINX; see Column D in the Table).
It is best to make these investments over time, starting with 40% of your proceeds then adding $100/mo to each of the 4 stocks and $1200/qtr to T-Notes. So, 60% of the proceeds from selling your house would initially go to an FDIC-insured savings account paying little interest. Part of that 60% will never be invested because it serves as your Rainy Day Fund. Nonetheless, you’ll be in a position to withdraw $9600/yr for electronic transfers to bond and stock accounts. Annual transaction costs come to ~$72/yr (see Column N in the Table).
Bottom Line: Reverse mortgages can be a good idea, if you’ve paid off your home mortgage and have almost no source of retirement income outside of Social Security. But inflation will always be with us, so it might be better to sell your house and move to a place that is not designed for raising children. Then, you can invest the proceeds from selling your house in a manner that costs you little and provides an opportunity to protect yourself from inflation.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG and JNJ, as well as inflation-protected Savings Bonds (which are an IRA-like version of 10-Yr Treasury Notes). I also own shares of KO and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Look at the costs and benefits of reverse mortgages. NOTE: To obtain more detailed information, I suggest reading this article that appeared in USA Today on October 28.
Execution: “On the plus side, reverse mortgages are considered loan advances to you, not income you earned. Thus, the payments you receive are not taxable. Moreover, they usually don't affect your Social Security or Medicare benefits.” Emotional benefits play a role, given that 1) you get to keep living in your home without paying rent, and 2) your children get to inherit a house that retains considerable equity. And, reverse mortgages make a great Rainy Day Fund.
On the negative side, there is “opportunity cost”: You are giving up the opportunity to invest a large sum of your own money, if you sell the house and rent a place more suited to your needs. Transaction costs on the sale are the same as those for taking out a reverse mortgage (6%), which leaves 94% for you to invest. We provide an example (see Table) of how you might set up an online investment in bonds and stocks that pays out at least 2%/yr (after transaction costs) and grows those payments at least 2%/yr.
Administration: The investment example has an asset allocation of 50% bonds/50% stocks. The bonds are “zero risk/zero cost” 10-Yr Treasury Notes accessed through the government website; that site also offers inflation-protected Treasury Notes. You can invest in KO, JNJ and WMT online but have to use a different website to invest in PG. Each pays a good and growing dividend, and had Total Returns/yr during the Housing Crisis that were better than those for our key benchmark, the Vanguard Balanced Index Fund (VBINX; see Column D in the Table).
It is best to make these investments over time, starting with 40% of your proceeds then adding $100/mo to each of the 4 stocks and $1200/qtr to T-Notes. So, 60% of the proceeds from selling your house would initially go to an FDIC-insured savings account paying little interest. Part of that 60% will never be invested because it serves as your Rainy Day Fund. Nonetheless, you’ll be in a position to withdraw $9600/yr for electronic transfers to bond and stock accounts. Annual transaction costs come to ~$72/yr (see Column N in the Table).
Bottom Line: Reverse mortgages can be a good idea, if you’ve paid off your home mortgage and have almost no source of retirement income outside of Social Security. But inflation will always be with us, so it might be better to sell your house and move to a place that is not designed for raising children. Then, you can invest the proceeds from selling your house in a manner that costs you little and provides an opportunity to protect yourself from inflation.
Risk Rating: 4 (where 10-Yr Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I dollar-average into PG and JNJ, as well as inflation-protected Savings Bonds (which are an IRA-like version of 10-Yr Treasury Notes). I also own shares of KO and WMT.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, February 7
Week 240 - Does Your Retirement Fund Need to Look Like a Rainy Day Fund?
Situation: Warren Buffett suggests that investors follow certain guidelines, such as “Rule No.1: Never lose money. Rule No.2: Never forget rule No.1.” If you read this blog regularly, I’m guessing you’re partly a gambler like the rest of us. Warren is just asking us to engage that superego (which we all possess) and be prudent while building a nest egg. Some money is for gambling, the rest has to look a lot like a Rainy Day Fund (see Week 203) and be suitable for weathering an unforeseen financial calamity. Retirement or unanticipated medical expenses could prove to be such a calamity. To prevent that, you’ll need to construct a retirement portfolio that is weighted with stocks that behave in a bond-like manner, and Treasury Notes. (Growth stocks, with their greater risk of loss, could do long-term damage to your retirement portfolio if the market were to crash soon after you retire.) Think about it. When we were young, financial advisors stressed the importance of owning growth stocks because we’d have time to recover from a crash and still come out ahead compared to owning Treasury Notes and bond-like stocks. But retirement planning uses the opposite logic. You don’t have time on your side, particularly if you’ve reached age 55 and your retirement savings amount to less than 4 times your income.
The problem: Almost half of the US’s soon-to-be-retired population has no access to a workplace retirement plan, and retirement savings for that age group only average $1000. If you, or someone you know, is in that cohort, then the least risky and lowest cost way to start digging out of that hole is to set up a “MyRA” online. That will help you save up to $15,000 in US Treasury issues by investing as little as $2.00 a time. “Interest earned is at the same rate as investments in the Government Securities Fund, which earned 2.31% in 2014 and an average annual return of 3.19% over the ten-year period ending December 2014.” During that 10-yr period, inflation averaged 2.04% you would have cleared a 1.15%/yr profit if MyRA accounts had been available then. Before MyRA accounts became available, only Federal employees had access to the Government Securities Fund. It pays the aggregate interest rate for all outstanding government securities that have more than 4 yrs remaining to maturity. There is no better way to reliably clear a profit net of inflation, net of transaction costs (zero in this case), and net of taxes (zero if you convert to a Roth IRA after investing the initial $15,000). Free money no strings attached.
Mission: Come up with a safe mix of assets for a Rainy Day Fund, i.e., a mix that has little chance of losing money in a financial crisis yet has a high chance of making a profit in each market cycle after allowing for expenses (inflation, taxes, and transaction costs). This is difficult to accomplish, as you might have noticed from reading our previous blogs on the subject (see Week 28, Week 33, Week 44, Week 112, Week 119, Week 151, Week 162, Week 188, Week 203). Our benchmark for Rainy Day Funds is the Vanguard Wellesley Income Fund (VWINX) at Line 15 in the Table, which is 60% bonds and 40% stocks. Its annual return has exceeded expenses (inflation, taxes and transaction costs) in 21 of the past 25 yrs while averaging 8.8%/yr, which beats inflation by 6.5%/yr.
Execution: No single investment (other than a MyRA) will protect you from losing money after inflation, taxes and transaction costs, but US Treasury Notes come close. Over the past 5 yrs, 10-yr Treasury Notes have paid 4.0%/yr if interest payments are reinvested in new 10-yr Notes (you can buy those cost-free in amounts of as little as $100 at treasurydirect.gov). Inflation took 1.2% and taxes took another 1.4%, leaving you with a 1.4%/yr profit. Why invest for the sake of a 1.4% return? Well, you need a safe place for some of your money. You don’t know when you’ll need it but you know that day will come. Wouldn’t a bond mutual fund be better? Those fluctuate a lot in value when interest rates change, going down when rates go up (and going up when rates go down), whereas, all of your principal investment is certain to be returned when a Treasury Note matures. Why not buy corporate bonds? Those carry high transaction costs and can’t beat comparably dated Treasury issues on a risk-adjusted basis. Why is that? Because all fixed-income investments are priced off Treasuries. A corporate bond is marketed to pay the investor a high enough interest rate to compensate for its risk of default. The risk-adjusted return of a 10-yr corporate bond is the same as the risk-adjusted return of a 10-yr Treasury Note issued the same month of the same year. You might as well point-and-click at treasurydirect.gov to get all your bonds, since transaction costs are zero, taxes are less, and inflation-protected options are available. The simplest way to invest in 10-yr Treasury Notes is to schedule monthly purchases of Inflation-Protected Savings Bonds (ISBs) online. You can point-and-click to sell those anytime. Proceeds go into your checking account the following business day, at which point you become liable for Federal Income Tax on the accrued interest. (You have no liability for state or local taxes.) If you cash an ISB before holding it for 5 yrs, you’ll miss out on one interest payment.
What about owning “safe” stocks? There isn’t such a thing but you can justify owning stock in selected “utilities” and “communication services” companies for even a minimal-risk Rainy Day Fund. The utilities industry has 3 different types of companies: fossil-fuel based providers of electricity, natural-gas based providers of space heating, and renewable energy based electricity providers that use nuclear, solar, or wind energy. I invest in NextEra Energy (NEE) as the renewable-energy electricity provider because it is the leader in using renewable and non-polluting sources of intermittent and unreliable power (wind and solar). But to continuously and reliably provide power from a renewable and non-polluting source, there is only one option: nuclear power. The severity and momentum of global warming is such that nuclear will have to become a much bigger power source than it is at present. There is only one electric utility in the US that both specializes in delivering nuclear power and has a large fleet of such units: Exelon (EXC). Picking a natural gas utility is tricky though. There are no large utilities dedicated to providing natural gas for space heating, partly because the price of natural gas varies so much. Second best is to choose a company that diversifies equally into natural gas and electricity markets. I like Dominion Resources (D), which has an extensive pipeline network for natural gas and “operates the largest North American interstate gas storage system.” Finally, you need to choose a “communications services” company. I like AT&T (T).
Bottom Line: If you’re “late to the game,” your Retirement Fund needs to look like a minimal-risk Rainy Day Fund. The emphasis here is to avoid loss, not to get rich. We’re really looking at a version of “The Tortoise and Hare” story whenever we design a Rainy Day Fund. Given enough time (2-3 market cycles), the slow and steady growth of a Rainy Day Fund composed 40% of low-risk stocks and 60% of 10-yr Treasuries will benefit from the near-absence of losses during stock market crashes. Eventually, its “price return” will eclipse the S&P 500 Index (compare Lines 12 and 20 at Column K in the Table), and do so at less risk (compare Lines 12 and 20 at Column M in the Table). But take good care of your health during those sunset years because 2-3 market cycles is a long time.
Risk Rating: 3
Full Disclosure: I dollar-average into 10-yr T-Notes, NEE, D, T, and EXC at the ratios indicated in the Table.
Note: Metrics in the Table are current as of the Sunday of publication; metrics highlighted in red denote underperformance relative to the Vanguard Balanced Index Fund (VBINX), our key benchmark. Returns in Column C of the Table date to September 28, 1992, because that is when VBINX was first traded.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The problem: Almost half of the US’s soon-to-be-retired population has no access to a workplace retirement plan, and retirement savings for that age group only average $1000. If you, or someone you know, is in that cohort, then the least risky and lowest cost way to start digging out of that hole is to set up a “MyRA” online. That will help you save up to $15,000 in US Treasury issues by investing as little as $2.00 a time. “Interest earned is at the same rate as investments in the Government Securities Fund, which earned 2.31% in 2014 and an average annual return of 3.19% over the ten-year period ending December 2014.” During that 10-yr period, inflation averaged 2.04% you would have cleared a 1.15%/yr profit if MyRA accounts had been available then. Before MyRA accounts became available, only Federal employees had access to the Government Securities Fund. It pays the aggregate interest rate for all outstanding government securities that have more than 4 yrs remaining to maturity. There is no better way to reliably clear a profit net of inflation, net of transaction costs (zero in this case), and net of taxes (zero if you convert to a Roth IRA after investing the initial $15,000). Free money no strings attached.
Mission: Come up with a safe mix of assets for a Rainy Day Fund, i.e., a mix that has little chance of losing money in a financial crisis yet has a high chance of making a profit in each market cycle after allowing for expenses (inflation, taxes, and transaction costs). This is difficult to accomplish, as you might have noticed from reading our previous blogs on the subject (see Week 28, Week 33, Week 44, Week 112, Week 119, Week 151, Week 162, Week 188, Week 203). Our benchmark for Rainy Day Funds is the Vanguard Wellesley Income Fund (VWINX) at Line 15 in the Table, which is 60% bonds and 40% stocks. Its annual return has exceeded expenses (inflation, taxes and transaction costs) in 21 of the past 25 yrs while averaging 8.8%/yr, which beats inflation by 6.5%/yr.
Execution: No single investment (other than a MyRA) will protect you from losing money after inflation, taxes and transaction costs, but US Treasury Notes come close. Over the past 5 yrs, 10-yr Treasury Notes have paid 4.0%/yr if interest payments are reinvested in new 10-yr Notes (you can buy those cost-free in amounts of as little as $100 at treasurydirect.gov). Inflation took 1.2% and taxes took another 1.4%, leaving you with a 1.4%/yr profit. Why invest for the sake of a 1.4% return? Well, you need a safe place for some of your money. You don’t know when you’ll need it but you know that day will come. Wouldn’t a bond mutual fund be better? Those fluctuate a lot in value when interest rates change, going down when rates go up (and going up when rates go down), whereas, all of your principal investment is certain to be returned when a Treasury Note matures. Why not buy corporate bonds? Those carry high transaction costs and can’t beat comparably dated Treasury issues on a risk-adjusted basis. Why is that? Because all fixed-income investments are priced off Treasuries. A corporate bond is marketed to pay the investor a high enough interest rate to compensate for its risk of default. The risk-adjusted return of a 10-yr corporate bond is the same as the risk-adjusted return of a 10-yr Treasury Note issued the same month of the same year. You might as well point-and-click at treasurydirect.gov to get all your bonds, since transaction costs are zero, taxes are less, and inflation-protected options are available. The simplest way to invest in 10-yr Treasury Notes is to schedule monthly purchases of Inflation-Protected Savings Bonds (ISBs) online. You can point-and-click to sell those anytime. Proceeds go into your checking account the following business day, at which point you become liable for Federal Income Tax on the accrued interest. (You have no liability for state or local taxes.) If you cash an ISB before holding it for 5 yrs, you’ll miss out on one interest payment.
What about owning “safe” stocks? There isn’t such a thing but you can justify owning stock in selected “utilities” and “communication services” companies for even a minimal-risk Rainy Day Fund. The utilities industry has 3 different types of companies: fossil-fuel based providers of electricity, natural-gas based providers of space heating, and renewable energy based electricity providers that use nuclear, solar, or wind energy. I invest in NextEra Energy (NEE) as the renewable-energy electricity provider because it is the leader in using renewable and non-polluting sources of intermittent and unreliable power (wind and solar). But to continuously and reliably provide power from a renewable and non-polluting source, there is only one option: nuclear power. The severity and momentum of global warming is such that nuclear will have to become a much bigger power source than it is at present. There is only one electric utility in the US that both specializes in delivering nuclear power and has a large fleet of such units: Exelon (EXC). Picking a natural gas utility is tricky though. There are no large utilities dedicated to providing natural gas for space heating, partly because the price of natural gas varies so much. Second best is to choose a company that diversifies equally into natural gas and electricity markets. I like Dominion Resources (D), which has an extensive pipeline network for natural gas and “operates the largest North American interstate gas storage system.” Finally, you need to choose a “communications services” company. I like AT&T (T).
Bottom Line: If you’re “late to the game,” your Retirement Fund needs to look like a minimal-risk Rainy Day Fund. The emphasis here is to avoid loss, not to get rich. We’re really looking at a version of “The Tortoise and Hare” story whenever we design a Rainy Day Fund. Given enough time (2-3 market cycles), the slow and steady growth of a Rainy Day Fund composed 40% of low-risk stocks and 60% of 10-yr Treasuries will benefit from the near-absence of losses during stock market crashes. Eventually, its “price return” will eclipse the S&P 500 Index (compare Lines 12 and 20 at Column K in the Table), and do so at less risk (compare Lines 12 and 20 at Column M in the Table). But take good care of your health during those sunset years because 2-3 market cycles is a long time.
Risk Rating: 3
Full Disclosure: I dollar-average into 10-yr T-Notes, NEE, D, T, and EXC at the ratios indicated in the Table.
Note: Metrics in the Table are current as of the Sunday of publication; metrics highlighted in red denote underperformance relative to the Vanguard Balanced Index Fund (VBINX), our key benchmark. Returns in Column C of the Table date to September 28, 1992, because that is when VBINX was first traded.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 24
Week 203 - Rainy Day Fund Updated
Situation: Since the Lehman Panic, leading nations have tightened and coordinated regulatory oversight of the financial sector. The largest banks are now fewer in number yet control more assets. Paradoxically, the US Federal Reserve has less freedom to manage a credit crisis, thanks to the Dodd-Frank Wall Street Reform and Consumer Protection Act. While money-center banks are required to have more equity behind every loan, Congress has used the Lehman Panic to set rules that may make future credit crises harder to tamp down. (With global debt per capita still growing, the next one can’t be far off.)
When those happen, there’s a 50:50 chance that the ranks of the unemployed will double, your children will have difficulty finding work to match their education, and you will want to stay employed past retirement age. Here at ITR, we encourage you to have a Rainy Day Fund big enough to cover your basic needs for 18 months. Interest rates may remain low for awhile, so we recommend you choose more bond-like investments than previously recommended in setting up a Rainy Day Fund (see Week 162). Here are your choices (see Table):
Inflation-protected US Savings Bonds (www.treasurydirect.gov);
3-month US Treasury Bills (www.treasurydirect.com);
FDIC-insured Savings Accounts and Certificates of Deposit;
Vanguard Money-Market Reserve Fund (VMMXX);
10-yr US Treasury Notes (www.treasurydirect.gov);
iShares 1-3 yr Treasury Bond Fund (SHY);
iShares 3-7 yr Treasury Bond Fund (IEI);
iShares 7-10 yr Treasury Bond Fund (IEF);
Gold bullion;
Vanguard Short-Term Treasury Bond Fund (VFISX);
Vanguard Interm-Term Bond Index Fund (VBIIX);
Shares of Wal-Mart Stores (WMT), the only S&P 100 company whose stock grew more than 5% in value during the Lehman Panic;
Shares of Johnson & Johnson (JNJ), the only AAA-rated company whose stock fell less than 20% during the Lehman Panic.
Among these 13 choices, 10-yr T-Notes are my favorite. Why? Because the bank where you have the checking account that accepts the electronic interest payments from the T-Notes you bought through TreasuryDirect will be happy to loan you money at a very low interest rate, if your FICO credit score is over 800. In other words, you'll have the best collateral and the lowest repayment risk. You’ll likely be granted an immediate loan in the same amount as the T-Notes in your TreasuryDirect account. You’ll only need to sign over future principal and interest payments until you’ve paid off the loan. The next best choice is to build up an FDIC-insured Savings Account at that same bank (or hold a lot of 3-month Treasury Bills in your TreasuryDirect account).
You can invest in WMT and JNJ online at computershare, where it costs $1.00/mo to dollar-average your investment in each of those stocks. Columns J-L in the Table include the relevant BMW Method metrics (see Week 199 and Week 201) for both of those stocks, VBIIX, gold and the S&P 500 Index (^GSPC).
We recommend that you pick six of the 13 options listed above, assigning each to cover 3 months worth of your household expenses. Four of those options are insured against loss of principal: Treasury Bills, Treasury Notes, inflation-protected US Savings Bonds (ISBs), and Savings Accounts at an FDIC-insured bank. Use all 4 of those if you’re risk-averse. Inflation-protected US Savings Bonds are the most prudent and convenient choice for a Rainy Day Fund because those protect you against the ravages of inflation, and cost nothing (treasurydirect): Whenever you need money, just return to that website and pick the bonds you wish to redeem. The money will show up in your checking account the next business day. As with an IRA, interest payments that you’ve accrued over the years will be taxed as income. If you cash an ISB before 5 yrs have passed, you’ll forfeit one interest payment.
Bottom Line: Learn to pay your credit cards off every month, and set up automatic monthly purchases of inflation-protected Savings Bonds.
Risk Rating: 2
Full Disclosure: I dollar-average into WMT, JNJ, ISBs, and 10-yr Treasury Notes.
NOTE: In the Table, metrics that underperform our key benchmark (VBINX) are highlighted in red; metrics are brought current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
When those happen, there’s a 50:50 chance that the ranks of the unemployed will double, your children will have difficulty finding work to match their education, and you will want to stay employed past retirement age. Here at ITR, we encourage you to have a Rainy Day Fund big enough to cover your basic needs for 18 months. Interest rates may remain low for awhile, so we recommend you choose more bond-like investments than previously recommended in setting up a Rainy Day Fund (see Week 162). Here are your choices (see Table):
Inflation-protected US Savings Bonds (www.treasurydirect.gov);
3-month US Treasury Bills (www.treasurydirect.com);
FDIC-insured Savings Accounts and Certificates of Deposit;
Vanguard Money-Market Reserve Fund (VMMXX);
10-yr US Treasury Notes (www.treasurydirect.gov);
iShares 1-3 yr Treasury Bond Fund (SHY);
iShares 3-7 yr Treasury Bond Fund (IEI);
iShares 7-10 yr Treasury Bond Fund (IEF);
Gold bullion;
Vanguard Short-Term Treasury Bond Fund (VFISX);
Vanguard Interm-Term Bond Index Fund (VBIIX);
Shares of Wal-Mart Stores (WMT), the only S&P 100 company whose stock grew more than 5% in value during the Lehman Panic;
Shares of Johnson & Johnson (JNJ), the only AAA-rated company whose stock fell less than 20% during the Lehman Panic.
Among these 13 choices, 10-yr T-Notes are my favorite. Why? Because the bank where you have the checking account that accepts the electronic interest payments from the T-Notes you bought through TreasuryDirect will be happy to loan you money at a very low interest rate, if your FICO credit score is over 800. In other words, you'll have the best collateral and the lowest repayment risk. You’ll likely be granted an immediate loan in the same amount as the T-Notes in your TreasuryDirect account. You’ll only need to sign over future principal and interest payments until you’ve paid off the loan. The next best choice is to build up an FDIC-insured Savings Account at that same bank (or hold a lot of 3-month Treasury Bills in your TreasuryDirect account).
You can invest in WMT and JNJ online at computershare, where it costs $1.00/mo to dollar-average your investment in each of those stocks. Columns J-L in the Table include the relevant BMW Method metrics (see Week 199 and Week 201) for both of those stocks, VBIIX, gold and the S&P 500 Index (^GSPC).
We recommend that you pick six of the 13 options listed above, assigning each to cover 3 months worth of your household expenses. Four of those options are insured against loss of principal: Treasury Bills, Treasury Notes, inflation-protected US Savings Bonds (ISBs), and Savings Accounts at an FDIC-insured bank. Use all 4 of those if you’re risk-averse. Inflation-protected US Savings Bonds are the most prudent and convenient choice for a Rainy Day Fund because those protect you against the ravages of inflation, and cost nothing (treasurydirect): Whenever you need money, just return to that website and pick the bonds you wish to redeem. The money will show up in your checking account the next business day. As with an IRA, interest payments that you’ve accrued over the years will be taxed as income. If you cash an ISB before 5 yrs have passed, you’ll forfeit one interest payment.
Bottom Line: Learn to pay your credit cards off every month, and set up automatic monthly purchases of inflation-protected Savings Bonds.
Risk Rating: 2
Full Disclosure: I dollar-average into WMT, JNJ, ISBs, and 10-yr Treasury Notes.
NOTE: In the Table, metrics that underperform our key benchmark (VBINX) are highlighted in red; metrics are brought current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 3
Week 200 - Agronomy Companies on the Barron’s 500 List
Situation: I know, you’re already bored. But we really have to talk about commodity-related stocks occasionally because those are the high-risk, high-reward, high-cost stocks that anchor the world economy. Their prices usually reflect a megacycle that lasts for decades, starting with supply shortages (relative to demand) and ending with overproduction that persistently exceeds demand for a time (e.g. today’s oil & gas markets). The pricing of such stocks correlates with global demand, not with the typical 5-7 yr economic cycle of individual countries or regions. Some commodities are so adept at reflecting the global economic cycle as to earn special respect, like “Doctor Copper”. You’ll want to own two or three of these “non-correlated” stocks that dampen the ups and downs of the economic cycle. In particular, consider production agriculture companies because those have special advantages: 1) Their profits are driven more by the weather cycle than the economic cycle; 2) ten million people per year enter the middle class in Asia and Africa who can finally afford to consume the 60 grams/day of protein that is required for good health and a long life.
Livestock has been the best-performing commodity sector over the past year. Let’s think about what goes into livestock production: grain, hay, and soybeans are the most important inputs. (Four pounds of feed is needed to make one pound of Grade A meat.) Production of those crops requires certain inputs: tractors and combines (see Week 197), irrigation equipment (see Week 129), and this week’s topic about the tools of an agronomist (seeds, fertilizer, insecticides, herbicides, and fungicides). Agronomists work “on call” for individual farmers (or a farmer's cooperative) to address issues of plant genetics & physiology, soil science, and meteorology. Think of them as general practitioners overseeing the crop. Increasingly, this role is played by “seed analysts” from one of the major seed production companies (Monsanto, Syngenta, Bayer or Dupont). Seed analysts also look for farmers who will allow part of their fields to be used for plant research.
This week’s Table has all of the large, publicly-held agronomy companies in the United States and Canada. Stocks in these companies are not suitable for inclusion in a retirement portfolio. But several are suitable for a portfolio of non-correlated assets, i.e., those where prices don’t follow the economic cycle. The pricing of agronomy companies is mainly driven by weather cycles, and the worldwide growth rate for workers who are paid enough to provide their families with an adequate protein intake.
Bottom Line: You need to have a few investments that don’t track the S&P 500 Index, so-called "non-correlated assets." Inflation-protected Savings Bonds epitomize this concept, and you should have a Rainy-Day Fund that is mainly invested in those or Treasury Bills (see Week 162). But there are other, more rewarding non-correlated investments. Most are commodity-related and come with a lot more risk. We like large companies that focus on the needs of farmers and ranchers. This week's Table has 8 of those.
Risk Rating: 7
Full Disclosure: I own stock in MON, CF, and DD.
NOTE: Data are current as of the Sunday of publication; red highlights denote underperformance vs. our key benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Livestock has been the best-performing commodity sector over the past year. Let’s think about what goes into livestock production: grain, hay, and soybeans are the most important inputs. (Four pounds of feed is needed to make one pound of Grade A meat.) Production of those crops requires certain inputs: tractors and combines (see Week 197), irrigation equipment (see Week 129), and this week’s topic about the tools of an agronomist (seeds, fertilizer, insecticides, herbicides, and fungicides). Agronomists work “on call” for individual farmers (or a farmer's cooperative) to address issues of plant genetics & physiology, soil science, and meteorology. Think of them as general practitioners overseeing the crop. Increasingly, this role is played by “seed analysts” from one of the major seed production companies (Monsanto, Syngenta, Bayer or Dupont). Seed analysts also look for farmers who will allow part of their fields to be used for plant research.
This week’s Table has all of the large, publicly-held agronomy companies in the United States and Canada. Stocks in these companies are not suitable for inclusion in a retirement portfolio. But several are suitable for a portfolio of non-correlated assets, i.e., those where prices don’t follow the economic cycle. The pricing of agronomy companies is mainly driven by weather cycles, and the worldwide growth rate for workers who are paid enough to provide their families with an adequate protein intake.
Bottom Line: You need to have a few investments that don’t track the S&P 500 Index, so-called "non-correlated assets." Inflation-protected Savings Bonds epitomize this concept, and you should have a Rainy-Day Fund that is mainly invested in those or Treasury Bills (see Week 162). But there are other, more rewarding non-correlated investments. Most are commodity-related and come with a lot more risk. We like large companies that focus on the needs of farmers and ranchers. This week's Table has 8 of those.
Risk Rating: 7
Full Disclosure: I own stock in MON, CF, and DD.
NOTE: Data are current as of the Sunday of publication; red highlights denote underperformance vs. our key benchmark (VBINX).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 25
Week 151 - “Lifeboat Stocks” for your Rainy Day Fund
Situation: Over time, you will spend a lot of the money that is stashed in your Rainy Day fund (see Week 33 and Week 119). Life has unique ways of generating unbudgeted capital expenses, which frequently require that you choose between two means of payment. Either use credit or use equity (i.e., your Rainy Day Fund). How can you cover those “pop-up” expenses and still avoid destroying your Rainy Day Fund? Remember, a key ingredient in a Rainy Day Fund is Inflation-protected US Savings Bonds (ISBs - see Week 33). Those actually grow 20-80% faster than inflation and offer several tax advantages. However, a quarter’s worth of interest is lost if you cash out an ISB before 5 years have passed. But, let’s face it: ISBs won’t allow you to spend much without depleting your Rainy Day Fund.
A remedy is to add what we like to call “Lifeboat Stocks” (see Week 8, Week 23, Week 50 and Week 106) to your Rainy Day Fund. Those stocks are issued by companies in “defensive” industries--utilities, healthcare, and consumer staples. The reason we make that recommendation is to get a higher total return while giving up only a little safety. That allows the effects of price appreciation and dividend reinvestment to replenish the Fund and keep it growing. The trick is deciding which companies to select for investment. There aren’t many companies that grow steadily and issue a stock that holds up well during downturns (bear markets and recessions) without becoming overpriced during upturns (like the current one). We can find only 12 companies that fit the bill, and 5 of those are electric utilities (see Table). Given that the stock issued by electric utility companies has many bond-like features, you might as well allocate the non-Savings Bond part of your Rainy Day Fund to a “balanced” mutual fund that has a lot of high-quality corporate and government bonds. We recommend the Vanguard Wellesley Income Fund (VWINX, Line 20 in the Table), which is 45% stocks and 55% bonds. Its annual expense ratio is only 0.25%/yr. But you’ll need to make an initial investment of $3,000 to get into the fund; then you can add as little as $100 at a time. So, a combination of 50% ISBs and 50% VWINX is a cheap and convenient way to have a continuously useful Rainy Day Fund.
But many of you want to invest in stocks because they’re interesting and offer a way to beat inflation and taxes, as long as you keep your transaction costs low and reinvest dividends. So, you’ll want to know how we picked the 12 stocks in the Table. Firstly, they had to have very good S&P credit ratings and be Dividend Achievers (S&P’s name for companies that have raised their dividends annually for 10 or more yrs). More importantly, they had to perform better than our benchmark (The Vanguard Balanced Index Fund, VBINX) over both the long term (10+ yrs) and short term (5 yrs) without losing as much as VBINX did during the 18-month Lehman Panic, which was 28%. But we bend those rules a little if there is outperformance in another area, like volatility (5-yr Beta) or valuation (P/E). Red highlights are used in the Table to denote underperformance relative to VBINX.
Bottom Line: A Rainy Day Fund won’t be of much use to you unless it includes stocks.
Risk Rating: 2.
Full Disclosure: For my Rainy Day Fund, I dollar-average into ISBs, WMT, JNJ, and NEE. It also contains shares of PEP and GIS, as well as standard US Savings Bonds--EESBs, which the US Treasury guarantee to at least double your money if you hold them for 20 yrs (total return = 3.5%/yr).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
A remedy is to add what we like to call “Lifeboat Stocks” (see Week 8, Week 23, Week 50 and Week 106) to your Rainy Day Fund. Those stocks are issued by companies in “defensive” industries--utilities, healthcare, and consumer staples. The reason we make that recommendation is to get a higher total return while giving up only a little safety. That allows the effects of price appreciation and dividend reinvestment to replenish the Fund and keep it growing. The trick is deciding which companies to select for investment. There aren’t many companies that grow steadily and issue a stock that holds up well during downturns (bear markets and recessions) without becoming overpriced during upturns (like the current one). We can find only 12 companies that fit the bill, and 5 of those are electric utilities (see Table). Given that the stock issued by electric utility companies has many bond-like features, you might as well allocate the non-Savings Bond part of your Rainy Day Fund to a “balanced” mutual fund that has a lot of high-quality corporate and government bonds. We recommend the Vanguard Wellesley Income Fund (VWINX, Line 20 in the Table), which is 45% stocks and 55% bonds. Its annual expense ratio is only 0.25%/yr. But you’ll need to make an initial investment of $3,000 to get into the fund; then you can add as little as $100 at a time. So, a combination of 50% ISBs and 50% VWINX is a cheap and convenient way to have a continuously useful Rainy Day Fund.
But many of you want to invest in stocks because they’re interesting and offer a way to beat inflation and taxes, as long as you keep your transaction costs low and reinvest dividends. So, you’ll want to know how we picked the 12 stocks in the Table. Firstly, they had to have very good S&P credit ratings and be Dividend Achievers (S&P’s name for companies that have raised their dividends annually for 10 or more yrs). More importantly, they had to perform better than our benchmark (The Vanguard Balanced Index Fund, VBINX) over both the long term (10+ yrs) and short term (5 yrs) without losing as much as VBINX did during the 18-month Lehman Panic, which was 28%. But we bend those rules a little if there is outperformance in another area, like volatility (5-yr Beta) or valuation (P/E). Red highlights are used in the Table to denote underperformance relative to VBINX.
Bottom Line: A Rainy Day Fund won’t be of much use to you unless it includes stocks.
Risk Rating: 2.
Full Disclosure: For my Rainy Day Fund, I dollar-average into ISBs, WMT, JNJ, and NEE. It also contains shares of PEP and GIS, as well as standard US Savings Bonds--EESBs, which the US Treasury guarantee to at least double your money if you hold them for 20 yrs (total return = 3.5%/yr).
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
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