Situation: Stock markets are more fragile than most people realize. For example, the S&P 500 Index has a Return on Assets or ROA of ~3% while its Weighted Average Cost of Capital or WACC is ~8%. Although the deficiency in ROA vs. WACC is unsustainable, that’s thought to be OK because the economy is still recovering from the Great Recession, i.e., the return on assets will reach parity with the cost of assets. As long as that doesn’t happen, company managers will hesitate before investing yet more capital in property, plant, equipment, and labor. Instead, they’ll be more likely to return money to investors via a buy back of stock or by raising the dividend. That has been common practice since the Great Recession, and is one reason why the stock market has a P/E ratio that is higher than its historical average.
Stock markets have only one fuel, and that is peoples’ savings, including the savings of corporations now that the US Supreme Court has decided that a corporation is essentially “a person” with the same First Amendment rights. Savings are more constrained than ever because the level of indebtedness of countries, corporations, states, cities, and small businesses has not decreased since the Great Recession. Only household debt has managed to recover somewhat. The “great unwind” has yet to occur. Deleveraging is not a priority for governments or corporations because interest rates are so low that it seems foolish not to borrow money. Until deleveraging happens, the ROA for the most important asset (educated citizens) will not be much greater than the cost of creating that asset. Why? Because the cost of servicing debt eats into savings needed for investment.
Given the above warning, you need to look for stock in companies that are responsibly managed and clearly profitable. These would be firms that have high operating margins most of the time (e.g. Nike), or moderate but stable operating margins all of the time (e.g. Wal-Mart Stores). What is an “operating margin” (see Column M in the Table)? It is an unambiguous measure of profitability, expressed as a ratio: EBIT/Total Revenue, where EBIT = Earnings Before Interest and Taxes. “Total Revenue” is the first line of an Income Statement and “Earnings Before Interest And Taxes” is usually at line 13. See this Income Statement of 3M Corporation as an example.
Mission: Screen the S&P 500 Index for companies that have the following quality markers: 1) high S&P bond ratings (A- or higher) and stock ratings (A-/M or higher); 2) are designated as a Dividend Achiever by S&P, indicating annual dividend increases for at least the past 10 yrs; 3) have a Durable Competitive Advantage or DCA (see Columns P through T in the Table), as defined by Warren Buffett (see Week 241).
Execution: Given the turbulent nature of the stock market over the past decade, there are only 9 companies that meet our requirements (see Table). All of those companies have an Operating Margin greater than the WACC (see Column N of the Table). But some of the companies have a current problem selling their goods and services that pushes their ROA lower than their WACC (compare Column O to Column N in the Table). Exxon Mobil (XOM) at Line 10 in the Table is a prime example.
Bottom Line: It is particularly difficult to save for retirement when Central Banks are busy lowering the interest rate on bonds, a move that is meant to entice people to invest in stocks, start a new business, build a factory, create an app, buy a home or get a better education. For retirement planning, you need to put ~50% of your savings into dividend-paying stocks and the remainder into US Treasuries. To get adequate diversification, your stocks need to represent all 10 S&P industries. To get adequate quality, you need to have stringent criteria like those above. Only 6 S&P industries have contributed the 9 stocks that meet our stringent criteria: Consumer Staples (WMT), HealthCare (JNJ and ABT), Utilities (NEE), Consumer Discretionary (TJX, ROST, NKE), Information Technology (MSFT) and Energy (XOM). You can check out our recent blogs on defensive industries (Week 247) and growth industries (Week 248) for help picking stocks to cover the other 4 S&P industries (Basic Materials, Communication Services, Industrials, and Financials).
Risk Rating: 5
Full Disclosure: I dollar-average into WMT, JNJ, NEE, NKE, MSFT and XOM, and also own shares of ABT, TJX and ROST.
NOTE: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. our key benchmark, VBINX at Line 16 in the Table. Total returns/Yr in Column C, and the CAGR for stock prices in Column U, are for performance over the past 20 years. That period is chosen because it covers approximately 3 market cycles, i.e., there have been 15 recessions in the past 90 years for an average of 6 years between each.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
Sunday, April 17
Week 250 - A Monthly Retirement Savings Plan With Automatic Online Additions
Situation: If you’re self-employed or work at a company that doesn’t sponsor a 401(k) or 403(b) retirement plan, you need to create your own. The “secret sauce” is payday deductions. Economists often say that the parts of your income you never see are the parts you stop thinking about. Pay stubs list those automatic withdrawals for taxes, social security, health insurance, and a tax-deferred retirement plan but you no longer care: You’re receiving “full benefits” which is why you took the job in the first place.
If you’re one of the 50% of US workers who doesn’t have a workplace retirement plan, you need to go to start an IRA funded with payday deductions. This can be done by visiting a bank, brokerage, credit union or by going online to a low-cost mutual fund site like Vanguard Group. You can also set up monthly automatic withdrawals from your checking account to invest in Dividend Re-Investment Plans (DRIPs). Your accountant will report to the IRS that those constitute your IRA. That works best if you backup those stock investments with bonds by using one of the US Treasury’s zero-cost IRA-like plans (Savings Bonds and MyRA), which have no transaction costs. At their website, you’ll see an option for automatic monthly withdrawals from your checking account.
Mission: Set up a spreadsheet that illustrates an automatic online retirement savings plan with monthly additions for each item.
Execution: If your net worth (excluding home & mortgage) is less than $1 Million, you needn’t bother with picking stocks and bonds. Just go to the Vanguard Group website and pick the Vanguard Wellesley Income Fund (VWINX at Line 25 in the Table), which is 45% stocks and 55% bonds. Make that your IRA and set up monthly withdrawals from your checking account. If you’re self-employed as an “S Corporation”, the IRS provides special tax-deferred retirement options geared to your situation.
If you choose to pick your own dividend-paying stocks and back those with Treasuries, read on:
I. Bonds
You’ll need to start by assigning 25% to 75% of your savings to US Treasury issues, with the percentage depending on your view of the economic climate. The only automatic monthly withdrawal plan offered by the US Treasury are for Savings Bonds and MyRA. Inflation-adjusted Savings Bonds (“I Bonds”) are your best choice if you might want to cash in some for emergencies. The total return on Savings Bonds is approximately the same as for 10-yr Treasury Notes that have been renewed every 10 yrs, once you consider the tax benefit from owning Savings Bonds. The biannual interest paid on Savings Bonds is accrued and cannot be taxed until after you cash the bonds, whereas, tax is due every year on the the biannual interest you receive from Treasury Notes.
II. Stocks
The remaining 25% to 75% of your retirement savings plan needs to reflect growth in the economy. There are 10 S&P industries in the economy and you’ll probably gain the most benefit if you pick a stock for each. No one can predict which industry will take the lead in a future growth spurt, and each of the 10 has taken the lead at some point in the past. To set up automatic online investments each month, you’ll need to pick stocks that pay a dividend. The two largest online DRIP vendors are Computershare and Shareowneronline.
Administration: This week’s Table is a spreadsheet for stocks I have picked (one for each S&P industry), combined with a 50% commitment to 10-yr Treasury Notes that serve as proxies for Savings Bonds. In the Table, we assume that $100/mo is invested in each stock online and $1000/mo is invested in Savings Bonds online. The total investment is $24,000/yr and the transaction costs come to $164/yr (see Column Z in the Table). The Expense Ratio (164/24000) is 0.68% for the first year. If the economy keeps growing, that $164/yr will become an increasingly smaller fraction of the asset value.
Bottom Line: Polls have shown that “planning for retirement” is the biggest financial worry Americans have after “out of control spending.” Partly this is because 50% of Americans work where there is no retirement plan. The secret to success from stashing away ~15% of your gross income in a 401(k) or 403(b) plan is that you never see the money unless you look at the paystub. If you want success from setting up a retirement plan without those 401(k) or 403(b) tools, you need to mimic them. Have the money disappear automatically from your paycheck or checking account. Sending that money to a “conservative allotment, low-cost balanced mutual fund” like The Vanguard Balanced Index Fund (VBINX in the Table) is a good way to begin solving the problem with an IRA. If you are self-employed as an S Corporation, you can set aside the entire 15% or more of your income in a tax-advantaged retirement plan. You can also pick dividend-paying stocks for your IRA, plus Inflation-protected Savings Bonds and MyRAs that are tax-advantaged like an IRA.
Risk Rating: 4
Full Disclosure: I use the plan summarized in the Table.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. The Vanguard Wellesley Income Fund or VWINX. Total Returns in Column C date to 9/1/2000, a peak in the S&P 500 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
If you’re one of the 50% of US workers who doesn’t have a workplace retirement plan, you need to go to start an IRA funded with payday deductions. This can be done by visiting a bank, brokerage, credit union or by going online to a low-cost mutual fund site like Vanguard Group. You can also set up monthly automatic withdrawals from your checking account to invest in Dividend Re-Investment Plans (DRIPs). Your accountant will report to the IRS that those constitute your IRA. That works best if you backup those stock investments with bonds by using one of the US Treasury’s zero-cost IRA-like plans (Savings Bonds and MyRA), which have no transaction costs. At their website, you’ll see an option for automatic monthly withdrawals from your checking account.
Mission: Set up a spreadsheet that illustrates an automatic online retirement savings plan with monthly additions for each item.
Execution: If your net worth (excluding home & mortgage) is less than $1 Million, you needn’t bother with picking stocks and bonds. Just go to the Vanguard Group website and pick the Vanguard Wellesley Income Fund (VWINX at Line 25 in the Table), which is 45% stocks and 55% bonds. Make that your IRA and set up monthly withdrawals from your checking account. If you’re self-employed as an “S Corporation”, the IRS provides special tax-deferred retirement options geared to your situation.
If you choose to pick your own dividend-paying stocks and back those with Treasuries, read on:
I. Bonds
You’ll need to start by assigning 25% to 75% of your savings to US Treasury issues, with the percentage depending on your view of the economic climate. The only automatic monthly withdrawal plan offered by the US Treasury are for Savings Bonds and MyRA. Inflation-adjusted Savings Bonds (“I Bonds”) are your best choice if you might want to cash in some for emergencies. The total return on Savings Bonds is approximately the same as for 10-yr Treasury Notes that have been renewed every 10 yrs, once you consider the tax benefit from owning Savings Bonds. The biannual interest paid on Savings Bonds is accrued and cannot be taxed until after you cash the bonds, whereas, tax is due every year on the the biannual interest you receive from Treasury Notes.
II. Stocks
The remaining 25% to 75% of your retirement savings plan needs to reflect growth in the economy. There are 10 S&P industries in the economy and you’ll probably gain the most benefit if you pick a stock for each. No one can predict which industry will take the lead in a future growth spurt, and each of the 10 has taken the lead at some point in the past. To set up automatic online investments each month, you’ll need to pick stocks that pay a dividend. The two largest online DRIP vendors are Computershare and Shareowneronline.
Administration: This week’s Table is a spreadsheet for stocks I have picked (one for each S&P industry), combined with a 50% commitment to 10-yr Treasury Notes that serve as proxies for Savings Bonds. In the Table, we assume that $100/mo is invested in each stock online and $1000/mo is invested in Savings Bonds online. The total investment is $24,000/yr and the transaction costs come to $164/yr (see Column Z in the Table). The Expense Ratio (164/24000) is 0.68% for the first year. If the economy keeps growing, that $164/yr will become an increasingly smaller fraction of the asset value.
Bottom Line: Polls have shown that “planning for retirement” is the biggest financial worry Americans have after “out of control spending.” Partly this is because 50% of Americans work where there is no retirement plan. The secret to success from stashing away ~15% of your gross income in a 401(k) or 403(b) plan is that you never see the money unless you look at the paystub. If you want success from setting up a retirement plan without those 401(k) or 403(b) tools, you need to mimic them. Have the money disappear automatically from your paycheck or checking account. Sending that money to a “conservative allotment, low-cost balanced mutual fund” like The Vanguard Balanced Index Fund (VBINX in the Table) is a good way to begin solving the problem with an IRA. If you are self-employed as an S Corporation, you can set aside the entire 15% or more of your income in a tax-advantaged retirement plan. You can also pick dividend-paying stocks for your IRA, plus Inflation-protected Savings Bonds and MyRAs that are tax-advantaged like an IRA.
Risk Rating: 4
Full Disclosure: I use the plan summarized in the Table.
NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. The Vanguard Wellesley Income Fund or VWINX. Total Returns in Column C date to 9/1/2000, a peak in the S&P 500 Index.
Post questions and comments in the box below or send email to: irv.mcquarrie@InvestTuneRetire.com
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