Week 142 - A “Starter” Hedge Fund

Situation: Every retirement website has to offer a generic plan, one that’s scalable and highlights its best ideas. Here at ITR, we stress the importance of gradually accumulating stock in companies that increase their dividend annually. Why? Because dividend-paying stocks historically grow wealth, whereas, investments in other asset classes result only in “forced savings” for the most part. In other words, after accounting for inflation, transaction costs, and taxes, you’re not earning much! Over the past 35 yrs, the S&P 500 Index has grown an average of 6.6%/yr but with dividends reinvested it has grown 9.9%/yr. Companies in the Index that increase their dividend annually do even better. We also stress the importance of owning some US Treasury Notes or Savings Bonds because those go up in value when stocks go down. Remember: You’ll probably need extra money when the economy’s in recession, and you certainly don’t want to sell your stocks then. Finally, we stress the basic concept behind a hedge fund, which is that you are most likely to prosper in the long run if you don’t lose money in the short run. In other words, maintain what you’ve obtained. That means paying close attention to the Finance Value of each asset you buy. Know its history of losses and deduct those from its history of gains. 

This week’s Table lays out the least complex package we can devise to illustrate our ideas. It has fewer than 10 items so you can use it as a “starter” retirement plan. Red highlights denote underperformance relative to our benchmark, the Vanguard Balanced Index Fund (VBINX), which is a hedged version of the S&P 500 Index. We have stressed ownership of bond-like stocks, so Johnson & Johnson (JNJ), Procter & Gamble (PG), McDonald’s (MCD), and NextEra Energy (NEE) are good examples. But there are also growth stocks that sometimes offer investors good finance value while paying little or no dividend. Examples are The TJX Company (TJX), Nike (NKE), and Berkshire Hathaway (BRK-B). International Business Machines (IBM) has characteristics of both. While all of the companies have high Finance Value (Column E in the Table), two have a 5-yr Beta (Column I) that denotes  more volatility than we like. So we offset the risk attached to each of those two (IBM and NKE) with an equal investment in Inflation-protected Savings Bonds (ISBs). 

All but two of the stocks (TJX and BRK-B) can be purchased through dividend reinvestment plans (DRIPs) at computershare. To keep your investment costs low, you’ll need to purchase those just once a year by using an online stockbroker. That can be done for as little as $6.95/trade at TD-Ameritrade, Merrill Lynch Edge, or Capital One. Savings Bonds are zero-cost investments that can be purchased online at treasurydirect and carry the same tax advantages as an IRA. Column M in the Table lays out the transaction costs for each trade, and Column N shows the annual charges for investing $100/mo (or $1200/yr) in each item. If you invest $12,000/yr, your transaction costs will be $79.90, or an expense ratio of 0.67%.   

Bottom Line: The idea is to invest small amounts regularly in fewer than 10 different assets where the risks are offset internally. That allows you to have an aggregate investment that is very attractive in terms of both recent and long term gains, as well as risk. Reinvest dividends while you’re still working. After you’ve retired, cash the dividend checks and add that money to your income. 

Risk Rating: 3 

Full Disclosure of current activity: I make monthly additions to DRIPs in NEE, IBM, JNJ, NKE, and PG.

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