Week 113 - A Diversified Online Investment Plan with Zero Ongoing Costs

Situation: Many investors were shocked at how much their savings plan was damaged in 2008 (blown-up is the jargon term). This has built a wall of mistrust between investors and the professional financial advisors who are supposed to be assisting them. How do we move forward? I suggest that the financial services industry start by recommending “starter investment plans” that cost the investor little to set up and nothing going forward. Such a plan is likely to satisfy the investor even if there’s a market downturn. That’s how to build trust.

Along the way, the investor will naturally discover that she needs help with research. For example, by using Merrill Edge for a little online trading (at $6.95/trade) she’ll have full access to Standard and Poor’s research as well as Morningstar’s, AND phone access to a broker. Or, by using a low-cost nationwide brokerage, Edward Jones for example, she’ll have an in-person relationship with a local broker and receive up-to-date reports on a hundred or more companies each month.

Mission: To provide 3 investment plans that can be managed online at little cost, including one with zero costs. Include information about long-term and recent returns, losses or gains during the Lehman Panic, and both of the main sources of risk (debt and volatility).

Execution:
Option #1 is to use an online balanced fund like the Vanguard Wellesley Income Fund (60% bonds) or the Vanguard Balanced Index Fund (40% bonds) as the anchor for the plan. Those funds require an initial investment of $3000 and a minimum $100 for each subsequent investment (such as automatic monthly payments from your checking account). Costs are very low, e.g. 10-yr costs for the initial $3000 investment total less than $100. Total Returns were 7% for each fund over the past 11 yrs thru 8/15/13 (see Table). Over the past 5 yrs, VWINX returned 8.6% and VBINX returned 7.2%. Neither fund leveraged (has debt). VBINX has a higher 5-yr Beta (0.94) than VWINX (0.58). Since 2001, the most that VWINX lost in a single year was 9.9% vs. 19.9% for VBINX (Column K in Table). During the 18-month Lehman Panic, VWINX lost 16% and VBINX lost 28% (Column D in the Table).
Option #2 is generic: half bond index and half stock index. Almost every 401(k) Plan has those choices. The goal here is to maintain 50% of your assets in a short to intermediate term global investment-grade bond index fund, like the Vanguard Intermediate-term Bond Index Fund (VBIIX), and 50% in a low-cost S&P 500 Index fund, like the Vanguard 500 Index Fund (VFINX). This combination had a total return of 6.5% over the past 11 yrs (Column C in Table), improving to 6.9% over the past 5 yrs (Column F in Table). Neither fund is leveraged but companies in the S&P 500 Index are ~40% financed by long-term loans. 5-yr Beta is 0.5; you can expect single-year losses up to 15.6%, based on experience since 2001 (Column K in Table). 
Option #3: Maintain one third of assets in Inflation-protected Savings Bonds (ISBs) obtained through treasurydirect at no cost for setup or ongoing purchases; maintain one third of assets in DRIPs for what we call hedge stocks (see Week 95) that also have no costs for setup or ongoing purchases (see Note below): NextEra Energy (NEE) and Johnson & Johnson (JNJ). The final third is for DRIPs in riskier stocks that again have no costs for setup and ongoing purchases: Exxon Mobil (XOM) and Procter & Gamble (PG). This stock/bond combination has returned 8.6% since 7/1/02 (Column C in Table) and 7.2% over the past 5 yrs (Column F). Long-term debt is 15.2% of total capital (Column N) but most of that is held by a regulated utility (NEE) backed by the State of Florida. The 5-yr Beta for Option #3 is 0.31, which is much lower than the other two options. Average single-year losses since 2001 were 6% (Column K), which is considerably less than the 14.5% and 15.6% losses that can be expected for Option #1 and Option #2, respectively. In summary, Option #3 appears to be the most rewarding and least risky.

Notes for Option #3: a) The JNJ DRIP charges $1.00 for automatic withdrawals from your checking account but there is no charge for one-time requests made as often as you like. b) Savings Bonds are not taxed until cashed out; that tax advantage, over time, adds a little over 1%/yr to total returns. c) For our presentation of Option #3 in the Table, we have substituted a reasonable proxy for ISBs, namely VBIIX, and entered it twice to denote its one third weighting relative to the two thirds weighting for the 4 stocks. d) For NEE to have zero ongoing costs for automatic monthly DRIP investments, a minimum of $100 has to be invested. e) If you choose ISBs for your bond investment, you’ll need to make that request each time using your registered computer and checking account. If you choose instead to use the similar Vanguard mutual fund (VBIIX), you’ll be able to set up automatic monthly investments but your initial investment has to be $3000 (as for the other Vanguard mutual funds listed in the Table) and the service is not free: it has a 0.2% expense ratio. f) There are no charges for setting up DRIPs at computershare on NEE, XOM, JNJ and PG, nor are there charges for dividend reinvestment. To summarize: If you have a $600 monthly investment plan ($200 for ISB, $100 each for NEE, XOM, JNJ and PG) there are zero costs both initially and going forward; all dividends and interest payments are reinvested automatically. If you choose to make automatic monthly investments for JNJ, instead of one-off investments, that will incur a $1.00/mo charge.

Bottom Line: In preparing for retirement, you need to make peace with the financial services industry. Yes, I know, they charged 2-4% of your net asset value each year to guide you to an asset allocation that collapsed in 2008, along with your dreams of a secure retirement. To make matters worse, your retirement plan will never recover from those losses even though those losses have been reversed by the amazing recovery of the stock market (assuming you didn’t sell any of your stock holdings during the Lehman Panic). Why? Because now you are 6 yrs closer to retirement and those recovered losses don’t buy as much now as in 2007. You could still be feeling like you’d been thrown off a horse. The best way to get back on that horse is to learn to take better care of yourself by owning the problem and using the internet more. Why is that an advantage over using a financial planner? For example, I think inflation-protected Savings Bonds are the best foundation for a savings plan but very few financial services professionals will even mention those. Neither will they guide you to the bond mutual fund that mimics Savings Bonds (VBIIX in the Table), even though its about the only short to intermediate-term bond fund that hasn’t lost money in any year since 1999. Why do they shy away from recommending that you put some of your money in a very safe place where returns still beat inflation handily (bottom of Column C in Table)? Because there’s no way for them or their friends to profit from that advice. Somehow, the idea of minimizing your out-of-pocket expenses (as a way to build trust) has never dawned on them. Almost any auto dealer, furniture salesman, or casino manager knows better these days. 

So, get started by having fun making a little money on your own. Then expand on that experience by using the financial services industry for institutional stock analyses.

Risk Rating: 4

Full Disclosure: I have been using Option #3 for a long time, as well as Option #2 for my 401(k).

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