Week 93 - Which investments are "safe havens?"

Situation: The business press seems to have settled on the year 2008 as a marker for risk. What those reporters mean to say is that if your favorite investment didn't lose money in 2008, it wasn't risky. We agree with that assessment since it’s hard to argue otherwise, but would like to pair it with a longer term measure of risk. “Dead money risk” comes to mind, which means your favorite investment doesn’t make money for a number of years. For example, March 24th is the 13th anniversary of when the S&P 500 Index first rose above 1550. It fell with the dot.com blowout but recovered back to 1550+ on October 9, 2007. Then it fell again with the Lehman Panic and has just now recovered to 1550+ again.  What this means in terms of “nominal dollars” is that if you had invested money in an S&P 500 Index fund (e.g. VFINX) on March 24, 2000 that has been “dead money” for 13 yrs. What this means in terms of “real dollars” (i.e., inflation-adjusted) is that your investment has fallen 35% in value, since the Consumer Price Index (CPI) rose 35% in the interim. If you had reinvested your VFINX dividends, your total return would have kept up with the CPI for no loss, no gain. Therefore, our definition of a "safe haven” is an investment that made money since 3/24/00 AND made money in 2008 (Table).

That leaves us with only 9 S&P 500 companies that pay a dividend of at least 1.2%/yr from the list of 201 Dividend Achievers (plus GIS, which is starting its 10th consecutive year of annual dividend increases and will be accorded Dividend Achiever status in 2014). Five of these companies are in our Stockpickers Secret Fishing Hole (see Week 68), i.e., they’re part of the 65-stock Dow Jones Composite Average: MCD, WMT, XOM, CHRW and SO. Four companies are part of a category we call Lifeboat Stocks, i.e., they’re among the best “value” stocks representing “defensive” industries (see Week 23), i.e., the utilities, consumer staples and healthcare industries that are known for maintaining their revenues during a recession: WMT, GIS, CHD and SO. The remaining 5 companies are part of a category we call Core Holdings (Week 22): MCD, CHRW, ROST, FDO, SHW. Core Holdings are the best “value” stocks from “cyclical” industries, i.e., the industries that are sensitive to economic cycles. That’s where you'll make most of your money, provided that you use a strategy of adding a little money at a time (monthly or quarterly) to a dividend reinvestment plan (DRIP). We recommend that you have $2 in Core Holdings for every $1 in Lifeboat Stocks.

Bottom Line: Folks, we’re here to tell you that you can’t "play the market." Since 1900, a Bear Market has happened about every 5 yrs. That means the S&P 500 Index fell at least 20% over approximately 20 months. Then a Bull Market started and it took roughly 20 months for stocks to recover from that loss and get back to their previous high. The Bull Market then continues to reach a new high over the next ~20 months. If you weren't fully invested in stocks during the first 10 business days after the Bear Market ended, your gains from having money in the new Bull Market would have been reduced by ~20%. Lesson learned: While stocks are historically the best asset class for building a retirement nest egg, those stock holdings will represent "dead money" 2/3rds of the time. The payoff is only going to happen about a third of the time, and you have no way of telling just when that will be (except that academic studies have shown that the best time to be in stocks is when it seems insane to do so). So keep only half your retirement savings in stocks and the other half in bonds (which only become dead money during hyperinflation). If you don't want to pick your own stocks and bonds, then invest in a low-cost balanced fund (like the Vanguard Wellesley Income Fund) which does it all for you.

Risk Rating for the aggregate of 9 stocks: 3.

Full Disclosure: I own stock in MCD, WMT, CHRW and GIS.

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