Situation: Investors should pay attention to asset classes that fluctuate in value out-of-sync with the S&P 500 Index. Such asset classes are said to have minimal or negative “correlation” with large-capitalization US stocks. Emerging markets and raw commodities are important examples. Those are a natural pair, given that most countries in the emerging markets group have an economy that is based on the production of one or more raw commodities.
The idea that you can find a safe haven for your savings, one which will allow you to ride out a crash in the US stock market, is a pleasant fiction. Articles in support of that idea are published almost daily. But unless you are a trader who can afford to rent or buy a $500,000 seat on the Chicago Mercantile Exchange, you probably aren’t deft enough to arbitrage the various risks accurately enough before they develop (and at low enough transaction costs) to avoid losing money in a crash.
If you really want to ride out most crashes, invest in a bond-heavy balanced mutual fund that is managed by real humans. The Vanguard Group offers one best, and it comes with very low transaction fees (Vanguard Wellesley Income Fund or VWINX). To refresh yourself on the competitive advantages of investing in food and agriculture companies, see our most recent blog on the subject (see Month 91). To refresh yourself on the competitive disadvantages, study this month’s Table and Bottom Line carefully.
The essential fact is that economies require money for spending and investment. That comes down to having consumers who are confident enough about their employment prospects and entrepreneurs who are confident enough about their ability to invest. Those consumers and entrepreneurs can be relied upon to transfer their successes to the larger economy by saving money, taking out loans, and paying taxes. National economies are interlinked. Because of the size and innovation of its marketplace, the US economy is the main enabler for most of the other national economies. Logic would suggest that the valuation for any asset class will roughly track the ups and downs of the S&P 500 Index, either as a first derivative or second derivative.
Mission: Use our Standard Spreadsheet to analyze US and Canadian food and agriculture companies that carry at least a BBB rating on their bonds (see Column R).
Execution: see Table.
Administration: Of the 25 companies listed in the Table, only one meets Warren Buffett’s criteria of low beta (see Column I), low volatility (Column M), high quality (Column S), strong balance sheet (Columns N-R), and TTM (Trailing Twelve Month) earnings plus mrq (most recent quarter) Book Values that yield a Graham Number which is not far from the stock’s current Price (Column Y). That company is Berkshire Hathaway. We use a Basic Quality Screen that is less stringent as his: 1) an S&P stock rating of B+/M or better (Column S), 2) an S&P bond rating of BBB+ or better (Column R), 3) 16-Yr price volatility (Column M) that is less than 3 times the rate of price appreciation (Column K), and 4) a positive dollar amount for net present value (Column W) when using a 10-Yr holding period in combination with a 10% discount rate (to reflect a 10% Required Rate of Return).
Bottom Line: Only 8 companies on the list pass our Basic Quality Screen (see Administration above): HRL, COST, PEP, KO, DE, FAST, CNI, UNP. At the opposite end of the spectrum, 9 companies have a below-market S&P bond rating of BBB. So, those stocks represent outright gambles.
Aside from Berkshire Hathaway, none of the 25 companies can be said to issue a reasonably priced “value” stock. We’re dealing with 24 “growth” stocks, only a third of which are of high quality. Three of the 9 with BBB bond ratings have high total debt levels relative to EBITDA (see Column O in the Table) that are unprotected by Tangible Book Value (Column P): SJM, MKC, GIS. The good news is that only one of the 9 appears to be overpriced, and that company (MKC) is a quasi-monopoly that has little risk of bankruptcy because it has “cornered” the US spice market.
In summary, you can do well by investing in this space as long as you understand that you’re dealing with a fragmented food industry, one that is flush with companies of dubious quality. You might like to be well-informed about these companies because food, like fuel, is an essential good, and the food industry enjoys steady growth. Why? Because the number of people in Asia & Africa who can afford to consume 50 grams of protein per day grows by tens of millions per year.
Risk Rating: ranges from 6 to 8 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion =10).
Full Disclosure: I dollar-average into TSN, KO and UNP, and also own shares of AMZN, HRL, MO, MKC, BRK-B, CAT and WMT.
"The 2 and 8 Club" (CR) 2017 Invest Tune Retire.com All rights reserved.
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Showing posts with label real estate. Show all posts
Showing posts with label real estate. Show all posts
Sunday, April 28
Sunday, August 26
Week 373 - 10 Dividend Achievers In Defensive Industries That Are Suitable For Long-term Dollar-cost Averaging
Situation: Which asset class do you favor? Stocks, bonds, real estate or commodities? On a risk-adjusted basis, none of those are likely to grow your savings faster than inflation over the near term. You might want to hold off making “risk-on” investments, unless you're a speculator, because markets are likely to fluctuate more than usual. If you think a “risk-off” approach is best, then you need to pick “defensive” stocks for monthly (or quarterly) investment of a fixed dollar amount (dollar-cost averaging). To minimize transaction costs, you’ll want to invest automatically in each stock through an online Dividend Re-Investment Plan (DRIP).
Now you will be positioned to ride-out a Bear Market, knowing that you’re accumulating an unusually large amount of shares in those companies as their stocks fall in price. And, those prices won’t fall far enough to scare you because that group of stocks has an above-market dividend yield. So, you’ll stick with the program instead of selling out in a moment of panic.
Mission: Run our Standard Spreadsheet for high-quality stocks issued by companies in defensive industries, i.e., utilities, consumer staples, healthcare, and communication services.
Execution: see Table.
Administration: Companies that don’t have at least an A- S&P rating on their bonds and at least a B+/M rating on their stock are excluded, as are those that don’t have at least a 16-yr trading record suitable for quantitative analysis by using the BMW Method. Companies that aren’t large enough to be on the Barron’s 500 List are also excluded.
Bottom Line: We find that 10 companies meet our requirements. Companies in the Consumer Staples industry dominate the list: Hormel Foods (HRL), Costco Wholesale (COST), PepsiCo (PDP), Coca-Cola (KO), Procter & Gamble (PG), Walmart (WMT), and Archer Daniels Midland (ADM). As a group, these 10 companies have above-market dividend yields and dividend growth (see Columns G & H in the Table). Risk is below-market, as expressed by 5-Yr Beta and predicted loss in a Bear Market (see Columns I & M).
Risk Rating: 4 for the group as a whole (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I dollar-average into NEE, KO, JNJ, PG and WMT, and also own shares of HRL and COST.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Now you will be positioned to ride-out a Bear Market, knowing that you’re accumulating an unusually large amount of shares in those companies as their stocks fall in price. And, those prices won’t fall far enough to scare you because that group of stocks has an above-market dividend yield. So, you’ll stick with the program instead of selling out in a moment of panic.
Mission: Run our Standard Spreadsheet for high-quality stocks issued by companies in defensive industries, i.e., utilities, consumer staples, healthcare, and communication services.
Execution: see Table.
Administration: Companies that don’t have at least an A- S&P rating on their bonds and at least a B+/M rating on their stock are excluded, as are those that don’t have at least a 16-yr trading record suitable for quantitative analysis by using the BMW Method. Companies that aren’t large enough to be on the Barron’s 500 List are also excluded.
Bottom Line: We find that 10 companies meet our requirements. Companies in the Consumer Staples industry dominate the list: Hormel Foods (HRL), Costco Wholesale (COST), PepsiCo (PDP), Coca-Cola (KO), Procter & Gamble (PG), Walmart (WMT), and Archer Daniels Midland (ADM). As a group, these 10 companies have above-market dividend yields and dividend growth (see Columns G & H in the Table). Risk is below-market, as expressed by 5-Yr Beta and predicted loss in a Bear Market (see Columns I & M).
Risk Rating: 4 for the group as a whole (where US Treasury Notes = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I dollar-average into NEE, KO, JNJ, PG and WMT, and also own shares of HRL and COST.
"The 2 and 8 Club" (CR) 2018 Invest Tune Retire.com All rights reserved.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 29
Week 330 - $150/wk For An Online Retirement Fund
Situation: You’ve heard a lot about saving for retirement, and you’ve probably heard that Social Security plus your workplace retirement plan probably won’t get you to a comfortable retirement any more. Why? Because people only reduce their spending by 15% after they retire, which means you will need a private savings plan to make up for the lost income. This savings plan can take the form of an IRA, payments into a low-cost annuity, proceeds from the sale of your home (if you move to smaller quarters), or perhaps even gold you’ve hidden away, and other choices. But when retirement is more than 5 years in the future, stocks remain your best bet.
We recommend that you minimize costs by using a stock index fund backed by a bond index fund. The Vanguard Balanced Index Fund (VBINX) provides both in one package, allocated 60% to stocks and 40% to bonds. It is rebalanced daily, so you won’t get burned if a stock market bubble bursts. (Most of those stock gains would already have been converted to bonds as part of daily rebalancing, and bonds typically increase in value when stocks crash.) Or, you can choose a low-cost managed fund that uses an excess of bonds to balance both the inherent risk of stocks and the difficulty managers have of knowing when to move away from stocks and into bonds. The Vanguard Wellesley Income Fund (VWINX) has the best record. It is bond-heavy and therefore has less volatility than VBINX but performs about as well.
The third low-cost option is to study the markets yourself and invest in stocks online through a Dividend ReInvestment Plan (DRIP) at computershare, and in bonds at treasurydirect. This third option allows you to pick only the most stable stocks and bonds.
Mission: Detail one example of a personal online retirement fund (mine). I dollar-cost average $100/mo automatically (online) into 5 stocks: NextEra Energy (NEE), Coca-Cola (KO), JP Morgan Chase (JPM), Microsoft (MSFT), and IBM (IBM), then dollar-cost average $150/mo into ISBs--inflation-protected Savings Bonds (treasurydirect).
Execution: In the Table, note that the iShares 7-10 Year Treasury Bond ETF (IEF) reflects returns from the main asset that the US Treasury uses to back its ISB accounts. Also note that we use red highlights to denote metrics that underperform our benchmark, i.e., the SPDR S&P 500 ETF (SPY). Metrics highlighted in purple indicate issues that accountants will raise with that company’s CFO.
Administration: ISBs are a tax-deferred investment much like an IRA. Contributions from your checking account can be set up for automatic monthly deposits at treasurydirect. You can have your accountant designate the money that you spend to buy stocks online through a DRIP as an IRA. Compare this week’s blog to an earlier blog with the same title (see Week 120).
Bottom Line: Dividend Reinvestment Plans (DRIPs) take time to set up, but are on “automatic pilot” the rest of the time. Savings Bonds are even easier to manage (treasurydirect). So, the key difficulty is deciding exactly which stocks you’d like to own for an extended period.
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold = 10).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
We recommend that you minimize costs by using a stock index fund backed by a bond index fund. The Vanguard Balanced Index Fund (VBINX) provides both in one package, allocated 60% to stocks and 40% to bonds. It is rebalanced daily, so you won’t get burned if a stock market bubble bursts. (Most of those stock gains would already have been converted to bonds as part of daily rebalancing, and bonds typically increase in value when stocks crash.) Or, you can choose a low-cost managed fund that uses an excess of bonds to balance both the inherent risk of stocks and the difficulty managers have of knowing when to move away from stocks and into bonds. The Vanguard Wellesley Income Fund (VWINX) has the best record. It is bond-heavy and therefore has less volatility than VBINX but performs about as well.
The third low-cost option is to study the markets yourself and invest in stocks online through a Dividend ReInvestment Plan (DRIP) at computershare, and in bonds at treasurydirect. This third option allows you to pick only the most stable stocks and bonds.
Mission: Detail one example of a personal online retirement fund (mine). I dollar-cost average $100/mo automatically (online) into 5 stocks: NextEra Energy (NEE), Coca-Cola (KO), JP Morgan Chase (JPM), Microsoft (MSFT), and IBM (IBM), then dollar-cost average $150/mo into ISBs--inflation-protected Savings Bonds (treasurydirect).
Execution: In the Table, note that the iShares 7-10 Year Treasury Bond ETF (IEF) reflects returns from the main asset that the US Treasury uses to back its ISB accounts. Also note that we use red highlights to denote metrics that underperform our benchmark, i.e., the SPDR S&P 500 ETF (SPY). Metrics highlighted in purple indicate issues that accountants will raise with that company’s CFO.
Administration: ISBs are a tax-deferred investment much like an IRA. Contributions from your checking account can be set up for automatic monthly deposits at treasurydirect. You can have your accountant designate the money that you spend to buy stocks online through a DRIP as an IRA. Compare this week’s blog to an earlier blog with the same title (see Week 120).
Bottom Line: Dividend Reinvestment Plans (DRIPs) take time to set up, but are on “automatic pilot” the rest of the time. Savings Bonds are even easier to manage (treasurydirect). So, the key difficulty is deciding exactly which stocks you’d like to own for an extended period.
Risk Rating: 6 (where 10-Yr US Treasury Notes = 1, S&P 500 Index = 5, gold = 10).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, June 11
Week 310 - The 9 Largest Equity REITs In The US
Situation: Our ITR blog encourages investors to plan for retirement by favoring stocks that have low price volatility because of being issued by high-quality companies with low debt. To measure quality, we look for Dividend Achievers having an S&P bond rating of BBB+ or better. To document “low debt”, we require that Long-term Debt be no greater than 1/3rd of Total Assets, Tangible Book Value be a positive number, and dividends be paid out of Free Cash Flow. For added safety, we focus on companies with sufficiently high revenue to be on the Barron’s 500 List, and are well enough established to have their 16-yr trading record analyzed by the BMW Method. Yes, our approach has technical details but only enough to put Warren Buffett’s principles of stock-picking into practice.
Now we’ll try to use this introduction to show that there is some value to be found by investing in the leading “alternative” asset class: equity real estate investment trusts or REITs. These capture the benefits and risks of owning real estate, but trade like stocks.
Mission: Examine the 9 largest US Equity REITs by market capitalization. Introduce the unique features of equity REITs, and carry out our standard spreadsheet analysis.
Execution: see Table.
Administration: Read no further if you’re paying down a home mortgage. Why? Because you’re already more heavily invested in Real Estate than you should be, i.e., approximately 15% of your Net Worth. Real Estate is a gamble. Most of us want to own our own home but there is less risk in owning an REIT (or an REIT index fund) than owning a home. If you’re still reading, I assume that you live in a rental and need to own shares of an REIT to diversify your portfolio. In other words, you’re looking to add an income-producing asset that tracks neither the bond market nor the stock market. In terms of investment jargon, you’re seeking alpha: “alpha is the return on an investment that is not a result of general movement in the greater market.”
A popular way to attempt this feat is to own gold but gold has storage costs and produces no income. There are other “alternative investments” but, like gold, they’re all riskier to own than either a stock index fund like the Vanguard Total Stock Market Index Fund (VTSMX at Line 23 in the Table) or an investment-grade bond market index fund like the Vanguard Bond Market Index Fund (VBMFX at Line 17), or even an REIT index fund like the Vanguard REIT Index Fund (VGSIX at Line 21), which of course lost more than VFINX during the 4.5 year Housing Crisis (see Column D in the Table).
REITs are structured to have investors pay at least 90% of the taxes, in return for receiving at least 90% of the rental payments. REITs have considerable property value and borrow heavily against that Tangible Asset. They also have different accounting conventions:
“When evaluating REITs, you will get a clearer picture by looking at funds from operations (FFO) rather than looking at net income. If you are seriously considering the investment, try to calculate adjusted funds from operations (AFFO), which deducts the likely expenditures necessary to maintain the real estate portfolio. AFFO is also a good measure of the REIT's dividend-paying capacity. Finally, the ratio price-to-AFFO and the AFFO yield (AFFO/price) are tools for analyzing an REIT: look for a reasonable multiple combined with good prospects for growth in the underlying AFFO.”
For comparison purposes, we’ll examine McDonald’s Corporation (MCD). Most of its income is derived from rents that are paid on the 82% of its properties leased to franchisees.
Bottom Line: Whenever you venture into owning an “Alternative Asset”, you’re likely to feel some symptom of stress. That’s because you’re gambling with hard-earned cash. While REITs are the safest of alternative assets, you should carefully pick one or two because simply owning an index fund of REITs does not offer enough reward to make up for the risk. In this week’s Table, we drill down on the 9 largest REITs and find that all but these two are unacceptably risky: Public Storage (PSA) and Simon Property Group (SPG), at Lines 3 and 5 in the Table. Otherwise, you’re better off investing in McDonald’s (MCD), which gains the lion’s share of its income from rents and has a risk/reward profile similar to REITs.
Risk Rating: 7 (where 10-Yr US Treasuries = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I own stock in SPG, TIREX and MCD.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 20 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 28 in the Table. The ETF for that index is MDY at Line 19. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Now we’ll try to use this introduction to show that there is some value to be found by investing in the leading “alternative” asset class: equity real estate investment trusts or REITs. These capture the benefits and risks of owning real estate, but trade like stocks.
Mission: Examine the 9 largest US Equity REITs by market capitalization. Introduce the unique features of equity REITs, and carry out our standard spreadsheet analysis.
Execution: see Table.
Administration: Read no further if you’re paying down a home mortgage. Why? Because you’re already more heavily invested in Real Estate than you should be, i.e., approximately 15% of your Net Worth. Real Estate is a gamble. Most of us want to own our own home but there is less risk in owning an REIT (or an REIT index fund) than owning a home. If you’re still reading, I assume that you live in a rental and need to own shares of an REIT to diversify your portfolio. In other words, you’re looking to add an income-producing asset that tracks neither the bond market nor the stock market. In terms of investment jargon, you’re seeking alpha: “alpha is the return on an investment that is not a result of general movement in the greater market.”
A popular way to attempt this feat is to own gold but gold has storage costs and produces no income. There are other “alternative investments” but, like gold, they’re all riskier to own than either a stock index fund like the Vanguard Total Stock Market Index Fund (VTSMX at Line 23 in the Table) or an investment-grade bond market index fund like the Vanguard Bond Market Index Fund (VBMFX at Line 17), or even an REIT index fund like the Vanguard REIT Index Fund (VGSIX at Line 21), which of course lost more than VFINX during the 4.5 year Housing Crisis (see Column D in the Table).
REITs are structured to have investors pay at least 90% of the taxes, in return for receiving at least 90% of the rental payments. REITs have considerable property value and borrow heavily against that Tangible Asset. They also have different accounting conventions:
“When evaluating REITs, you will get a clearer picture by looking at funds from operations (FFO) rather than looking at net income. If you are seriously considering the investment, try to calculate adjusted funds from operations (AFFO), which deducts the likely expenditures necessary to maintain the real estate portfolio. AFFO is also a good measure of the REIT's dividend-paying capacity. Finally, the ratio price-to-AFFO and the AFFO yield (AFFO/price) are tools for analyzing an REIT: look for a reasonable multiple combined with good prospects for growth in the underlying AFFO.”
For comparison purposes, we’ll examine McDonald’s Corporation (MCD). Most of its income is derived from rents that are paid on the 82% of its properties leased to franchisees.
Bottom Line: Whenever you venture into owning an “Alternative Asset”, you’re likely to feel some symptom of stress. That’s because you’re gambling with hard-earned cash. While REITs are the safest of alternative assets, you should carefully pick one or two because simply owning an index fund of REITs does not offer enough reward to make up for the risk. In this week’s Table, we drill down on the 9 largest REITs and find that all but these two are unacceptably risky: Public Storage (PSA) and Simon Property Group (SPG), at Lines 3 and 5 in the Table. Otherwise, you’re better off investing in McDonald’s (MCD), which gains the lion’s share of its income from rents and has a risk/reward profile similar to REITs.
Risk Rating: 7 (where 10-Yr US Treasuries = 1, S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I own stock in SPG, TIREX and MCD.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote under-performance vs. VBINX at Line 20 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 28 in the Table. The ETF for that index is MDY at Line 19. For bonds, Discount Rate = Interest Rate.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, May 21
Week 307 - Silver Is Perhaps The Most Interesting Alternative Asset
Situation: Stocks and bonds have been at or near the tops of their historic valuations for over 5 years. No corner of those markets has been overlooked; “crowded trades” are everywhere. In such circumstances, investors will reach for value by looking at alternative asset classes. Real Estate Investment Trusts (REITs) are my favorite (see Week 274). The goal is to find assets that are a) “non-correlated”, i.e, have low Beta because price-action is often out-of-sync with the market, and b) have enough economic utility to occasionally generate Alpha, which is a high “return on investment that is not a result of general movement in the greater market.”
Why is silver interesting, given that it has only gained 3.9%/yr in value over the past 30 years? For comparison, the lowest-cost S&P 500 Index fund (VFINX) has gained 9.4%/yr and the lowest-cost investment-grade bond index fund (VBMFX) has gained 6.0%/yr. Reason #1: A key use for silver is growing exponentially, which is the build-out of solar power toward a United Nations goal of generating 30% of the planet’s electricity by 2030. Copper and aluminum can be used in solar panels instead of silver, but those substitutes are less efficient and have not proven to be commercially viable, partly because the amount of silver needed per solar panel continues to decrease.
Silver has a fascinating history. For example, in 1979 the Hunt brothers attempted to “corner” the silver market and were able to borrow enough money to buy 1/3rd of the world’s supply outside government hands. This resulted in more than a 700% price increase but brought attention to the high leverage used in purchasing commodities. After the commodity exchange (COMEX) adopted “Silver Rule 7” on January 7, 1980 (to restrict the ability of speculators to purchase commodities on margin), the price of silver promptly fell 50% and the Hunt brothers were unable to meet their bank’s margin call for $100 million. They ultimately declared bankruptcy.
Could this happen again? Yes. Silver prices fluctuate more dramatically than gold prices, since silver has greater industrial demand and lower market liquidity. The rapid proliferation of solar panels will no doubt aggravate that problem; sovereign wealth fund managers will be tempted to hoard silver. Let’s do the math. World silver reserves are just under 600,000 tons. Solar panels in currently contain ~2/3rds of an ounce of silver: A ton of silver is consumed to make ~44,000 solar panels, and 4 panels are needed to make a kilowatt-hour (kWh) of electricity. So, a ton of silver generates 11,000 kWh. A billion kWh = 1 TWh (terawatt-hour). Currently, ~21,000 TW are used every hour on our planet (https://yearbook.enerdata.net/electricity-domestic-consumption-data-by-region.html). A goal of producing 30% of electricity from solar panels by 2030 implies that those panels would need to generate ~11,000 TW per hour (after allowing for population growth). A ton of silver generates 11,000 KW per hour, so a billion tons of silver is needed to generate 11,000 TW per hour. Assuming that an ~10-fold increase in efficiency will be achieved by then, only 100 million tons of silver will be required. World silver production in 2015 was ~31,000 tons. Multiply that by 13 yrs and you get ~400,000 tons. Adding that to the current reserve of 600,000 tons, you’d have one million tons available for all industrial uses on the planet through 2030. Where are the remaining 99 million tons going to come from?
Mission: Examine ways to invest in silver, using our standard spreadsheet analysis.
Execution: (see Table).
Administration: There are 4 ways to invest in silver:
1) Purchase ingots, coins, or shares in a silver ETF (SLV).
2) Purchase stock in a silver mining company, the largest and most successful being First Majestic Silver (AG).
3) Purchase stock in a financial company that loans money to silver miners in return for claims on the “stream” of the silver produced. The main silver-streaming company is Silver Wheaton (SLV) but the dominant company for financing both gold and silver mines (in return for gold royalties or a stream of silver production) is Franco-Nevada (FNV).
4) Purchase shares of a gold mining company that produces large amounts of silver as a by-product. Both companies having the largest reserves are based in Canada: Goldcorp (GG) and Barrick Gold (ABX).
Bottom Line: This is gambling, on steroids. To be successful, you’d need to have infinite patience and have enough time to update information on silver inventories every week, as well as work-in-progress for solar panels relative to demand. You can probably do well by gradually building a position in silver or the silver ETF (SLV). Professional stock pickers who focus on natural resources like to stick with the companies that a) have the largest reserves and b) develop new reserves at least as fast as they consume reserves. Barrick Gold (ABX) wins on both counts.
Risk Rating: 10 (where 10-Yr Treasuries = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I have no silver-related holdings.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Why is silver interesting, given that it has only gained 3.9%/yr in value over the past 30 years? For comparison, the lowest-cost S&P 500 Index fund (VFINX) has gained 9.4%/yr and the lowest-cost investment-grade bond index fund (VBMFX) has gained 6.0%/yr. Reason #1: A key use for silver is growing exponentially, which is the build-out of solar power toward a United Nations goal of generating 30% of the planet’s electricity by 2030. Copper and aluminum can be used in solar panels instead of silver, but those substitutes are less efficient and have not proven to be commercially viable, partly because the amount of silver needed per solar panel continues to decrease.
Silver has a fascinating history. For example, in 1979 the Hunt brothers attempted to “corner” the silver market and were able to borrow enough money to buy 1/3rd of the world’s supply outside government hands. This resulted in more than a 700% price increase but brought attention to the high leverage used in purchasing commodities. After the commodity exchange (COMEX) adopted “Silver Rule 7” on January 7, 1980 (to restrict the ability of speculators to purchase commodities on margin), the price of silver promptly fell 50% and the Hunt brothers were unable to meet their bank’s margin call for $100 million. They ultimately declared bankruptcy.
Could this happen again? Yes. Silver prices fluctuate more dramatically than gold prices, since silver has greater industrial demand and lower market liquidity. The rapid proliferation of solar panels will no doubt aggravate that problem; sovereign wealth fund managers will be tempted to hoard silver. Let’s do the math. World silver reserves are just under 600,000 tons. Solar panels in currently contain ~2/3rds of an ounce of silver: A ton of silver is consumed to make ~44,000 solar panels, and 4 panels are needed to make a kilowatt-hour (kWh) of electricity. So, a ton of silver generates 11,000 kWh. A billion kWh = 1 TWh (terawatt-hour). Currently, ~21,000 TW are used every hour on our planet (https://yearbook.enerdata.net/electricity-domestic-consumption-data-by-region.html). A goal of producing 30% of electricity from solar panels by 2030 implies that those panels would need to generate ~11,000 TW per hour (after allowing for population growth). A ton of silver generates 11,000 KW per hour, so a billion tons of silver is needed to generate 11,000 TW per hour. Assuming that an ~10-fold increase in efficiency will be achieved by then, only 100 million tons of silver will be required. World silver production in 2015 was ~31,000 tons. Multiply that by 13 yrs and you get ~400,000 tons. Adding that to the current reserve of 600,000 tons, you’d have one million tons available for all industrial uses on the planet through 2030. Where are the remaining 99 million tons going to come from?
Mission: Examine ways to invest in silver, using our standard spreadsheet analysis.
Execution: (see Table).
Administration: There are 4 ways to invest in silver:
1) Purchase ingots, coins, or shares in a silver ETF (SLV).
2) Purchase stock in a silver mining company, the largest and most successful being First Majestic Silver (AG).
3) Purchase stock in a financial company that loans money to silver miners in return for claims on the “stream” of the silver produced. The main silver-streaming company is Silver Wheaton (SLV) but the dominant company for financing both gold and silver mines (in return for gold royalties or a stream of silver production) is Franco-Nevada (FNV).
4) Purchase shares of a gold mining company that produces large amounts of silver as a by-product. Both companies having the largest reserves are based in Canada: Goldcorp (GG) and Barrick Gold (ABX).
Bottom Line: This is gambling, on steroids. To be successful, you’d need to have infinite patience and have enough time to update information on silver inventories every week, as well as work-in-progress for solar panels relative to demand. You can probably do well by gradually building a position in silver or the silver ETF (SLV). Professional stock pickers who focus on natural resources like to stick with the companies that a) have the largest reserves and b) develop new reserves at least as fast as they consume reserves. Barrick Gold (ABX) wins on both counts.
Risk Rating: 10 (where 10-Yr Treasuries = 1, S&P 500 Index = 5, and gold bullion = 10).
Full Disclosure: I have no silver-related holdings.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, January 15
Week 289 - Don't Leave Federal "Tax Expenditures" On The Table
Situation: There are 5 Federal government programs that can reduce your cost of living in retirement. You need to learn about these and take advantage of them whenever you are likely to benefit.
Program #1: The Social Security Act of 1935: You need to decide when to retire, because each year you delay results in an 8% larger Social Security check. You also need to brush up on other aspects of The Social Security Act that apply to you or your family. If you and your husband are divorced, and you’ve never remarried, you may still be eligible for some additional benefits. Check out the SSA website for answers to questions, and visit your nearest SSA office to get the help that you might need.
Program #2: Social Security Act Amendments of 1965 (Medicare): When you enroll in Medicare at age 65, you’ll have the option of taking out private “MediGap” insurance, which is supervised by your state government, or enrolling in Part C, which is a private “Medicare Advantage” plan that is a Federally-managed and “capped” supplement encompassing Parts A and B of Medicare.
Program #3: The Housing and Community Development Act of 1987 provides insurance for FHA Home Equity Conversion Mortgages (HECM), known as “reverse mortgages”. More than 3/4ths of the average retirees’ net worth is tied up in home equity, with other sources averaging ~$45,000 for Americans in the 65 to 69 year age group. By following the 4% Rule, the average American can only spend $150/mo of that “nest egg” to supplement her income from Social Security. To keep up with the myriad expenses of home ownership, she’ll have to decide whether to get a part-time job, sell her house, rent out part of it, or enter into a reverse mortgage. “Reverse mortgages are increasing in popularity with seniors who have equity in their homes and want to supplement their income. The only reverse mortgage insured by the U.S. Federal Government is called a Home Equity Conversion Mortgage or HECM, and is only available through an FHA approved lender.” But there is evidence that the average American is preparing better for retirement: As of 2015, those between the ages of 55 and 64 had saved an average of $104,000 according to the Government Accountability Office, which means $217/mo could be spent without eliminating that nest egg.
Program #4: The Cigar Excise Tax Extension Act of 1960 provides the legal framework for Real Estate Investment Trusts or REITs. This law does not create a tax expenditure (subsidy). Instead, it raises more revenue by creating an incentive for investors to move their money into real estate. That indirectly helps to reduce your cost of living at an extended care facility, when you can no longer live independently. Unless you are well off, you won’t be able to afford private long-term care insurance, and Federally subsidized long-term care insurance is only available to retired Federal employees. REITs are a partial solution, because they free real estate companies from paying Federal taxes, leaving investors with the obligation to pay that tax. REITs are similar to mutual funds except that they’re required to pay at least 90% of their income to investors, as dividends. Those dividends are attractive enough that REITs now have a large following among investors. Many “nursing homes” and extended care facilities are REITs. Retirees benefit from the capitalization structure of healthcare REITs, but investors who can tolerate a “roller-coaster ride” also come out ahead.
Program #5: The Food Stamp Act of 1964: Your next decision is whether or not to apply for food stamps. If you have no other source of income than Social Security, you are definitely eligible.
Mission: Set up a spreadsheet of ways an investor might invest in some of the public-private partnerships listed above, including health insurance companies that offer MediGap and Medicare Advantage plans. Pay particular attention to healthcare REITs.
Execution: see Table.
Bottom Line: Once you retire, your annual income will not keep up with inflation. With each passing year, you’ll become a little more watchful of spending and a little more likely to search out discounts. You’ll start to inquire about Federal programs that are particularly helpful to retirees, e.g. Food Stamps. We’ve listed 5 Federal programs that benefit retirees; you should become conversant in these before you retire. We have also listed 6 companies in the Table; 3 are healthcare REITs and 3 are large insurance companies with MediGap or Medicare Advantage plans. All 6 are high-risk high-reward businesses.
Risk Rating: 7 (where US Treasuries = 10, the S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I don’t own shares in any of the 6 companies listed in the Table, but am looking to buy shares in the only “blue chip” (Dow Jones Industrial Average company): UnitedHealth Group (UNH).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Program #1: The Social Security Act of 1935: You need to decide when to retire, because each year you delay results in an 8% larger Social Security check. You also need to brush up on other aspects of The Social Security Act that apply to you or your family. If you and your husband are divorced, and you’ve never remarried, you may still be eligible for some additional benefits. Check out the SSA website for answers to questions, and visit your nearest SSA office to get the help that you might need.
Program #2: Social Security Act Amendments of 1965 (Medicare): When you enroll in Medicare at age 65, you’ll have the option of taking out private “MediGap” insurance, which is supervised by your state government, or enrolling in Part C, which is a private “Medicare Advantage” plan that is a Federally-managed and “capped” supplement encompassing Parts A and B of Medicare.
Program #3: The Housing and Community Development Act of 1987 provides insurance for FHA Home Equity Conversion Mortgages (HECM), known as “reverse mortgages”. More than 3/4ths of the average retirees’ net worth is tied up in home equity, with other sources averaging ~$45,000 for Americans in the 65 to 69 year age group. By following the 4% Rule, the average American can only spend $150/mo of that “nest egg” to supplement her income from Social Security. To keep up with the myriad expenses of home ownership, she’ll have to decide whether to get a part-time job, sell her house, rent out part of it, or enter into a reverse mortgage. “Reverse mortgages are increasing in popularity with seniors who have equity in their homes and want to supplement their income. The only reverse mortgage insured by the U.S. Federal Government is called a Home Equity Conversion Mortgage or HECM, and is only available through an FHA approved lender.” But there is evidence that the average American is preparing better for retirement: As of 2015, those between the ages of 55 and 64 had saved an average of $104,000 according to the Government Accountability Office, which means $217/mo could be spent without eliminating that nest egg.
Program #4: The Cigar Excise Tax Extension Act of 1960 provides the legal framework for Real Estate Investment Trusts or REITs. This law does not create a tax expenditure (subsidy). Instead, it raises more revenue by creating an incentive for investors to move their money into real estate. That indirectly helps to reduce your cost of living at an extended care facility, when you can no longer live independently. Unless you are well off, you won’t be able to afford private long-term care insurance, and Federally subsidized long-term care insurance is only available to retired Federal employees. REITs are a partial solution, because they free real estate companies from paying Federal taxes, leaving investors with the obligation to pay that tax. REITs are similar to mutual funds except that they’re required to pay at least 90% of their income to investors, as dividends. Those dividends are attractive enough that REITs now have a large following among investors. Many “nursing homes” and extended care facilities are REITs. Retirees benefit from the capitalization structure of healthcare REITs, but investors who can tolerate a “roller-coaster ride” also come out ahead.
Program #5: The Food Stamp Act of 1964: Your next decision is whether or not to apply for food stamps. If you have no other source of income than Social Security, you are definitely eligible.
Mission: Set up a spreadsheet of ways an investor might invest in some of the public-private partnerships listed above, including health insurance companies that offer MediGap and Medicare Advantage plans. Pay particular attention to healthcare REITs.
Execution: see Table.
Bottom Line: Once you retire, your annual income will not keep up with inflation. With each passing year, you’ll become a little more watchful of spending and a little more likely to search out discounts. You’ll start to inquire about Federal programs that are particularly helpful to retirees, e.g. Food Stamps. We’ve listed 5 Federal programs that benefit retirees; you should become conversant in these before you retire. We have also listed 6 companies in the Table; 3 are healthcare REITs and 3 are large insurance companies with MediGap or Medicare Advantage plans. All 6 are high-risk high-reward businesses.
Risk Rating: 7 (where US Treasuries = 10, the S&P 500 Index = 5, and gold bullion = 10)
Full Disclosure: I don’t own shares in any of the 6 companies listed in the Table, but am looking to buy shares in the only “blue chip” (Dow Jones Industrial Average company): UnitedHealth Group (UNH).
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, October 2
Week 274 - Alternative Investments: American REITs
Situation: You need to hold assets other than stocks and bonds in your retirement portfolio. Stocks can become too volatile, and credit-worthy bonds can become unworthy credits. Both problems are plaguing investors these days, so we need to look at alternatives. Alternative investments usually relate to either real estate or natural resources. The idea is to combine the best feature of stocks (good dividends) with the best feature of bonds (good collateral).
Mission: Introduce readers to Real Estate Investment Trusts (REITs) based in the US, taking care to separate “the wheat from the chaff”.
Execution: REITs are mutual funds of rental properties, but with a difference. The SEC requires REITs to transfer at least 90% of income to investors as dividends. While these payouts are taxed as ordinary income instead of being taxed as capital gains, part of the payout “. . . comes from depreciation and other expenses and is considered a nontaxable return of capital.”
The largest REIT index fund is marketed by Vanguard Group as The Vanguard REIT Index Fund Investor Shares Fund (VGSIX).
Given that REITs are “real assets” in the ground, the BENCHMARK section of this week’s Table compares REITs to other investments that depend on real assets in the ground: 1) the leading oil company (XOM), 2) the leading corn processor (INGR), and 3) the NYSE ARCA Gold Bugs Index (^HUI).
Administration: We have identified 9 REITs with above-average quality (see Table), of which 5 are Dividend Achievers (10+ years of annual dividend increases). Column D in the Table shows returns that span the 4.5 year housing crisis (7/1/07-1/1/12). Specifically, the Federal Housing Finance Agency’s “seasonally-adjusted” Home Price Index (HPI) indicates that the year-over-year (YOY) median price for houses purchased with a conforming mortgage started falling in the Q3 of 2007 and began rising in Q1 of 2012. That number from Column D is added to long-term returns (i.e., since the S&P 500 Index bottomed on 10/9/02) from Column C to yield Finance Value in Column E.
You’ll notice that only two BENCHMARK investments beat their long-term returns during the 4.5 year housing crisis: 20+ year US Treasury Bonds (TLT at Line 15 in the Table) and the Gold Bugs Index (^HUI at Line 27). This is typical of recessions originating in the Finance Sector and represents the main rationale for owning long-dated sovereigns and gold.
Bottom Line: Houses and shopping centers are illiquid assets but their REITs can be bought and sold like stocks. Over the long term, returns from REITs are better than returns from Treasuries but REITs lose value in a recession whereas Treasuries gain value. In summary, REITs are moderate-risk high-reward investments. To invest in REITs, start with an Index fund (VGSIX). If you’re not distracted by the ups and downs, graduate to a low-risk REIT like Public Storage (PSA).
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, and gold = 10).
Full Disclosure: I own units of TIREX in a retirement fund.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 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 = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H in the Table. Price Growth Rate is the current 16-Yr CAGR found at Column L in the Table (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% is based on returns from a stock index of similar risk to a portfolio of individual large-cap stocks, i.e., the S&P MidCap 400 Index at Line 28 in the Table. The investment vehicle for that index is the SPDR S&P MidCap 400 ETF: MDY at Line 17.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Mission: Introduce readers to Real Estate Investment Trusts (REITs) based in the US, taking care to separate “the wheat from the chaff”.
Execution: REITs are mutual funds of rental properties, but with a difference. The SEC requires REITs to transfer at least 90% of income to investors as dividends. While these payouts are taxed as ordinary income instead of being taxed as capital gains, part of the payout “. . . comes from depreciation and other expenses and is considered a nontaxable return of capital.”
The largest REIT index fund is marketed by Vanguard Group as The Vanguard REIT Index Fund Investor Shares Fund (VGSIX).
Given that REITs are “real assets” in the ground, the BENCHMARK section of this week’s Table compares REITs to other investments that depend on real assets in the ground: 1) the leading oil company (XOM), 2) the leading corn processor (INGR), and 3) the NYSE ARCA Gold Bugs Index (^HUI).
Administration: We have identified 9 REITs with above-average quality (see Table), of which 5 are Dividend Achievers (10+ years of annual dividend increases). Column D in the Table shows returns that span the 4.5 year housing crisis (7/1/07-1/1/12). Specifically, the Federal Housing Finance Agency’s “seasonally-adjusted” Home Price Index (HPI) indicates that the year-over-year (YOY) median price for houses purchased with a conforming mortgage started falling in the Q3 of 2007 and began rising in Q1 of 2012. That number from Column D is added to long-term returns (i.e., since the S&P 500 Index bottomed on 10/9/02) from Column C to yield Finance Value in Column E.
You’ll notice that only two BENCHMARK investments beat their long-term returns during the 4.5 year housing crisis: 20+ year US Treasury Bonds (TLT at Line 15 in the Table) and the Gold Bugs Index (^HUI at Line 27). This is typical of recessions originating in the Finance Sector and represents the main rationale for owning long-dated sovereigns and gold.
Bottom Line: Houses and shopping centers are illiquid assets but their REITs can be bought and sold like stocks. Over the long term, returns from REITs are better than returns from Treasuries but REITs lose value in a recession whereas Treasuries gain value. In summary, REITs are moderate-risk high-reward investments. To invest in REITs, start with an Index fund (VGSIX). If you’re not distracted by the ups and downs, graduate to a low-risk REIT like Public Storage (PSA).
Risk Rating: 6 (where 10-Yr Treasury Notes = 1, and gold = 10).
Full Disclosure: I own units of TIREX in a retirement fund.
NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 19 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 = moving average for stock price over past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H in the Table. Price Growth Rate is the current 16-Yr CAGR found at Column L in the Table (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% is based on returns from a stock index of similar risk to a portfolio of individual large-cap stocks, i.e., the S&P MidCap 400 Index at Line 28 in the Table. The investment vehicle for that index is the SPDR S&P MidCap 400 ETF: MDY at Line 17.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 20
Week 220 - Diversification Among Core Assets
Situation: Individual stocks are not a core asset unless you’ve created your own diversified mutual fund (i.e., 40+ stocks covering all 10 S&P Industries). The reason why individual stocks are considered a liability and not a core asset is because competition (aided by unforeseen technological advancements) can doom the prospects of any one company. There are 5 Core Assets, and your investment portfolio will need representation from some of each:
1) diversified US stock mutual funds, especially index funds like VFINX and VEXMX (see the Table).
2) Bonds, mainly US Treasuries but also intermediate-term investment-grade bond index funds like VBIIX (see the Table).
3) Commodity-related investments. The relevant index fund is a “broad basket” collateralized futures ETF composed of iShares S&P GSCI Commodity Indexed Trust (GSG in the Table).
4) Real estate. Most of us already have too much invested in real estate (i.e., the equity in our homes). The relevant REIT index fund is VGSIX in the Table.
5) Cash-equivalents such as Savings Bonds, a Savings Account at an FDIC-insured bank, a short-term Treasury fund like VFISX (see the Table) or 3-6 month Treasury Bills purchased for zero cost at treasurydirect.
Mission: Set up a reasonable asset allocation, i.e., one that has worked well for me, using index funds as examples. This allocation needs to meet the standards of an acceptable personal retirement investment fund, and it does. However, opinions vary across a large spectrum. At one extreme, we have Warren Buffett who recommends that his relatives rely on a low-cost S&P 500 Index fund for 90% of their asset allocation, with the other 10% being invested in a short-term US Treasury fund. However, most investment advisors stress the importance of balancing among the 5 Core Assets listed above. In other words, hedge your bet on stocks even though the S&P 500 is well known to have outperformed all other asset classes over all rolling 20-yr periods on record. Warren Buffett takes a dim view of hedging strategies and continues to make bets that the S&P 500 Index will outperform international indexes as well as an esteemed group of hedge funds. The main reason for you to hedge your bets is that you’re not as rich as Warren Buffett’s relatives and could be financially devastated by a crash in the S&P 500 Index (if that’s where 90% of your retirement assets reside). So, hedging is a form of insurance and you’ll be glad you have it. (I never feel bad about dollar-averaging 30% of my new investment dollars into 10-yr Treasuries and Inflation-Protected Savings Bonds.)
What lies at the other end of the spectrum of advice being offered by investment advisors? Well, if you include accountants and business school professors as “advisors” you’ll find a sizeable minority who recommend that most of your retirement savings be in US Treasury Notes and Bonds having as average of ~5 yrs remaining until maturity. You can do that yourself simply by dollar-averaging into 10-yr Treasury Notes through the zero-cost Treasury website. When I was living in New York City (while going to medical school), I had a personal accountant who made that exact recommendation when I asked for his views on asset allocation. I had great respect for him as a wise and prudent man but thought his recommendation bordered on the absurd. Then, a few years ago, I went to business school and started hearing the same view again, first from an accountant in my study group and then from a professor of Banking and Finance. Finally, I read Henry Paulson’s book about his experiences as US Treasury Secretary, titled “On the Brink.” Prior to that posting, he’d been the CEO of Goldman Sachs. In the book he mentions that his personal savings are limited to bonds. In other words, the message you’re hearing at this end of the spectrum is that bonds are backed by the assets of the institution issuing them, whereas, stocks are backed by nothing other than a faith in future earnings.
Execution: We recommend that you balance stock and fixed-income investments 50:50. Real Estate Investment Trusts (REITs) are a hybrid between stocks and bonds but (when assembled into and REIT) they’re essentially a type of bond called a “growing perpetuity” and I allocate 15% there. Cash equivalents are also bonds and I allocate 5% to those. Then I allocate 15% to intermediate-term bond index funds and 15% to Treasury bonds and notes, which brings me up to 50% allocated to fixed-income. For stocks, I allocate 30% to S&P 500 stocks (which represent 75% of the US market) and 10% to smaller capitalization stock mutual funds. Commodity-related stocks represent 10% of my portfolio, though the recent underperformance of many “long cycle” investments has caused many advisors (including me) to cut back to 5%. In summary, you now have a formula for allocating 50% to stocks and 50% to bonds or bond hybrids (see Table).
Bottom Line: Core assets are vital to your financial well being. There are 5 categories, and this week’s Table gives index fund examples using an allocation that has worked well for me. By mixing 5 core assets you create your own hedge fund, the idea being to match returns of the S&P 500 Index over time while taking on less risk of a serious loss. Note: risk-adjusted returns for index funds in the commodity-linked and smaller capitalization stock categories typically underperform actively managed mutual funds.
Risk Rating: 5
Full Disclosure: I dollar-average into 10-yr Treasury Notes, and have VFINX-like and VEXMX-like investments in my 401(k).
Note: Metrics highlighted in red denote underperformance relative to VBINX. Metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
1) diversified US stock mutual funds, especially index funds like VFINX and VEXMX (see the Table).
2) Bonds, mainly US Treasuries but also intermediate-term investment-grade bond index funds like VBIIX (see the Table).
3) Commodity-related investments. The relevant index fund is a “broad basket” collateralized futures ETF composed of iShares S&P GSCI Commodity Indexed Trust (GSG in the Table).
4) Real estate. Most of us already have too much invested in real estate (i.e., the equity in our homes). The relevant REIT index fund is VGSIX in the Table.
5) Cash-equivalents such as Savings Bonds, a Savings Account at an FDIC-insured bank, a short-term Treasury fund like VFISX (see the Table) or 3-6 month Treasury Bills purchased for zero cost at treasurydirect.
Mission: Set up a reasonable asset allocation, i.e., one that has worked well for me, using index funds as examples. This allocation needs to meet the standards of an acceptable personal retirement investment fund, and it does. However, opinions vary across a large spectrum. At one extreme, we have Warren Buffett who recommends that his relatives rely on a low-cost S&P 500 Index fund for 90% of their asset allocation, with the other 10% being invested in a short-term US Treasury fund. However, most investment advisors stress the importance of balancing among the 5 Core Assets listed above. In other words, hedge your bet on stocks even though the S&P 500 is well known to have outperformed all other asset classes over all rolling 20-yr periods on record. Warren Buffett takes a dim view of hedging strategies and continues to make bets that the S&P 500 Index will outperform international indexes as well as an esteemed group of hedge funds. The main reason for you to hedge your bets is that you’re not as rich as Warren Buffett’s relatives and could be financially devastated by a crash in the S&P 500 Index (if that’s where 90% of your retirement assets reside). So, hedging is a form of insurance and you’ll be glad you have it. (I never feel bad about dollar-averaging 30% of my new investment dollars into 10-yr Treasuries and Inflation-Protected Savings Bonds.)
What lies at the other end of the spectrum of advice being offered by investment advisors? Well, if you include accountants and business school professors as “advisors” you’ll find a sizeable minority who recommend that most of your retirement savings be in US Treasury Notes and Bonds having as average of ~5 yrs remaining until maturity. You can do that yourself simply by dollar-averaging into 10-yr Treasury Notes through the zero-cost Treasury website. When I was living in New York City (while going to medical school), I had a personal accountant who made that exact recommendation when I asked for his views on asset allocation. I had great respect for him as a wise and prudent man but thought his recommendation bordered on the absurd. Then, a few years ago, I went to business school and started hearing the same view again, first from an accountant in my study group and then from a professor of Banking and Finance. Finally, I read Henry Paulson’s book about his experiences as US Treasury Secretary, titled “On the Brink.” Prior to that posting, he’d been the CEO of Goldman Sachs. In the book he mentions that his personal savings are limited to bonds. In other words, the message you’re hearing at this end of the spectrum is that bonds are backed by the assets of the institution issuing them, whereas, stocks are backed by nothing other than a faith in future earnings.
Execution: We recommend that you balance stock and fixed-income investments 50:50. Real Estate Investment Trusts (REITs) are a hybrid between stocks and bonds but (when assembled into and REIT) they’re essentially a type of bond called a “growing perpetuity” and I allocate 15% there. Cash equivalents are also bonds and I allocate 5% to those. Then I allocate 15% to intermediate-term bond index funds and 15% to Treasury bonds and notes, which brings me up to 50% allocated to fixed-income. For stocks, I allocate 30% to S&P 500 stocks (which represent 75% of the US market) and 10% to smaller capitalization stock mutual funds. Commodity-related stocks represent 10% of my portfolio, though the recent underperformance of many “long cycle” investments has caused many advisors (including me) to cut back to 5%. In summary, you now have a formula for allocating 50% to stocks and 50% to bonds or bond hybrids (see Table).
Bottom Line: Core assets are vital to your financial well being. There are 5 categories, and this week’s Table gives index fund examples using an allocation that has worked well for me. By mixing 5 core assets you create your own hedge fund, the idea being to match returns of the S&P 500 Index over time while taking on less risk of a serious loss. Note: risk-adjusted returns for index funds in the commodity-linked and smaller capitalization stock categories typically underperform actively managed mutual funds.
Risk Rating: 5
Full Disclosure: I dollar-average into 10-yr Treasury Notes, and have VFINX-like and VEXMX-like investments in my 401(k).
Note: Metrics highlighted in red denote underperformance relative to VBINX. Metrics are current for the Sunday of publication.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, September 14
Week 167 - Have Commodity-Related Stocks Hedged Against the Lack of Real Growth in the S&P 500 Index?
Situation: The S&P 500 Index made its all-time inflation-adjusted high on 9/1/00. Fourteen years is a long time for the stock market to be in the tank, even though the main hedging tool (10-yr US Treasury Notes) has been effective. After adjusting for 2.4%/yr inflation since 9/1/00, the Vanguard Intermediate-Term Treasury Fund (VFITX) has returned 3.3%/yr vs. 1.3%/yr for the Vanguard 500 Index fund (VFINX) with dividends reinvested, as of 8/16/14. Robert Shiller maintains a long-term series for both 10-yr US Treasury Notes and the S&P 500 Index. After adjusting for inflation, returns were 1.5%/yr for 10-yr Notes vs. -0.2%/yr for the S&P 500 Index (1.6%/yr with dividends reinvested). Without adjusting for inflation, 10-yr T-Notes were up 3.9%/yr and the S&P 500 Index was up 2.1%/yr (4.0%/yr with dividends reinvested).
The general explanation for this 14-yr period of low 2.4% inflation is that it results from the lack of real growth in economies around the world, and this lack of growth can be associated with two global recessions that have occurred. Most observers think that a growing reliance on borrowed funds has been a major contributor to those recessions, i.e., interest payments were shackling growth. This culminated in the credit crisis of 2007-08. The problem is slowly being corrected through deleveraging, including government action to reduce spending and raise taxes.
When central banks lower interest rates to stimulate growth during a recession, the currency is said to be weakened or debased. (The official term is financial repression, see Week 76 and Week 79.) This will correct itself when the economy recovers, i.e., central bankers will reverse their policy by withdrawing the excess reserves that they had been pushing into the banking system. During the period of currency debasement, the prices paid for “hard assets” naturally drift upward. (Think of the “bubble” that formed in US housing prices when the Federal Reserve kept interest rates too low for too long after the “dot.com” recession (March 2001 through November 2001.)
What does this information mean for readers of this blog? Do we need to protect our retirement savings during periods of “financial repression” by investing in real estate, gold, commodity-related stocks, or commodity futures? All of these have real economic utility and are therefore bound to go up in price when the value of the dollar is falling. These are also inherently volatile investments, so we need to think long and hard before making that leap. They’ll start to lose that pricing power when the Federal Reserve starts to wind down its policy of financial repression. (Look at what has happened to the price of gold. It fell 35% between the summer of 2011 and the summer of 2013.)
Let’s take a closer look at how commodity-related stocks have responded. Those stocks typically pay dividends and are easily traded, which are advantages not shared by other hard assets. On 9/10/13, we published an index of 15 commodity-related stocks (see Week 115). It showed that commodity-related stocks did indeed enjoy pricing power between 1992 and 2013, returning 14.5%/yr while the return for gold bullion was 13.7%/yr, twice the return on Vanguard’s S&P 500 Index fund (VFINX).
Now that another year has passed, let’s see how the unwinding of financial repression has impacted those results. The accompanying Table shows that both gold bullion and commodity-related stocks haven’t done as well as the S&P 500 Index fund (VFINX) over the past 5 yrs but are still ahead since 9/1/00. One of our benchmarks for this week is the T Rowe Price New Era Fund (PRNEX), a low-cost, low-risk natural resources mutual fund. Red highlights denote metrics that underperform our main benchmark, the Vanguard Balanced Index Fund (VBINX).
Bottom Line: Commodity-related stocks and gold bullion are volatile assets, but worth owning during periods of financial repression. You just need to think about switching to an S&P 500 Index fund the moment you think the Federal Reserve is starting to wind down its policy of “printing money” to “prime the pump.” Most financial professionals can’t time that trade correctly, so you’ll do better by simply owning shares in one or two of the highest quality commodity-related companies for the long term, taking care to pick companies with dividend growth that outpaces inflation (see Column H in the Table). Chevron (CVX), Exxon Mobil (XOM), Canadian National Railway (CNI), and Monsanto (MON) look like suitable candidates for long-term dollar-averaging. But there are others to consider (see Week 163), such as Archer Daniels Midland (ADM).
Risk Rating for the 15 stocks in the Table: 7
Full Disclosure: I dollar-average into a DRIP for XOM, and also own shares of CVX, CNI, POT, BBL, DD and MON.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
The general explanation for this 14-yr period of low 2.4% inflation is that it results from the lack of real growth in economies around the world, and this lack of growth can be associated with two global recessions that have occurred. Most observers think that a growing reliance on borrowed funds has been a major contributor to those recessions, i.e., interest payments were shackling growth. This culminated in the credit crisis of 2007-08. The problem is slowly being corrected through deleveraging, including government action to reduce spending and raise taxes.
When central banks lower interest rates to stimulate growth during a recession, the currency is said to be weakened or debased. (The official term is financial repression, see Week 76 and Week 79.) This will correct itself when the economy recovers, i.e., central bankers will reverse their policy by withdrawing the excess reserves that they had been pushing into the banking system. During the period of currency debasement, the prices paid for “hard assets” naturally drift upward. (Think of the “bubble” that formed in US housing prices when the Federal Reserve kept interest rates too low for too long after the “dot.com” recession (March 2001 through November 2001.)
What does this information mean for readers of this blog? Do we need to protect our retirement savings during periods of “financial repression” by investing in real estate, gold, commodity-related stocks, or commodity futures? All of these have real economic utility and are therefore bound to go up in price when the value of the dollar is falling. These are also inherently volatile investments, so we need to think long and hard before making that leap. They’ll start to lose that pricing power when the Federal Reserve starts to wind down its policy of financial repression. (Look at what has happened to the price of gold. It fell 35% between the summer of 2011 and the summer of 2013.)
Let’s take a closer look at how commodity-related stocks have responded. Those stocks typically pay dividends and are easily traded, which are advantages not shared by other hard assets. On 9/10/13, we published an index of 15 commodity-related stocks (see Week 115). It showed that commodity-related stocks did indeed enjoy pricing power between 1992 and 2013, returning 14.5%/yr while the return for gold bullion was 13.7%/yr, twice the return on Vanguard’s S&P 500 Index fund (VFINX).
Now that another year has passed, let’s see how the unwinding of financial repression has impacted those results. The accompanying Table shows that both gold bullion and commodity-related stocks haven’t done as well as the S&P 500 Index fund (VFINX) over the past 5 yrs but are still ahead since 9/1/00. One of our benchmarks for this week is the T Rowe Price New Era Fund (PRNEX), a low-cost, low-risk natural resources mutual fund. Red highlights denote metrics that underperform our main benchmark, the Vanguard Balanced Index Fund (VBINX).
Bottom Line: Commodity-related stocks and gold bullion are volatile assets, but worth owning during periods of financial repression. You just need to think about switching to an S&P 500 Index fund the moment you think the Federal Reserve is starting to wind down its policy of “printing money” to “prime the pump.” Most financial professionals can’t time that trade correctly, so you’ll do better by simply owning shares in one or two of the highest quality commodity-related companies for the long term, taking care to pick companies with dividend growth that outpaces inflation (see Column H in the Table). Chevron (CVX), Exxon Mobil (XOM), Canadian National Railway (CNI), and Monsanto (MON) look like suitable candidates for long-term dollar-averaging. But there are others to consider (see Week 163), such as Archer Daniels Midland (ADM).
Risk Rating for the 15 stocks in the Table: 7
Full Disclosure: I dollar-average into a DRIP for XOM, and also own shares of CVX, CNI, POT, BBL, DD and MON.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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