Monday, November 28, 2016

All Investments Carry Risk

What is your financial goal? If it is to accumulate wealth for a comfortable retirement, then there is no risk-free path. Throughout time every angle has been tried and failed. However, some approaches carry less risk than others. Let's consider some of the popular paths...


Cash/Money Markets/CDs

I have always considered "Cash Investments" an oxymoron. Cash is where investors park their money when they believe the investment risk is greater than the potential return - their sole focus is capital preservation. However, some people consider Cash/Money Markets/CDs et.al. as investments. This is a dangerous assumption. Their slow and predictable growth is generally always below inflation, but since it is growing the "investors" often lulled into a false sense of security and do not notice that they are actually losing ground each year until it is too late.

Land/Real Estate

The philosophy of "They aren't making anymore land" led to a false sense that you can never go wrong with real estate. Many investors have discovered the hard way that bubbles can also occur in the real estate sector. What was once seen as a safe place to put your money and forget it is now in the midst on an ugly down-turn. Home prices have fallen in many parts of the U.S over the last several years.


Gold/Precious Metals

Gold and other precious metals have a place in a well diversified portfolio as a hedge and value store. However, it should not be your core investment for retirement planning. 

If you look at a historical chart of gold prices, you will see a pattern, gold spikes to a new level during a crisis, then comes down to a level above the previous steady state (see 100-year chart here). It then trades sideways until the next crisis. It would be difficult to time your retirement to coincide with a crisis/spike.


Professionally Managed Equity Mutual Funds

Every year several professionally managed mutual funds out-perform the market. Unfortunately, it is rarely the same funds each year. It has been well documented that over time, most professionally managed funds under-perform the market.


Treasuries/Bonds

Treasuries and bonds tend to be less risky than equity investments, but have historically under-performed equities. It is important to note that there is risk associated with them. For corporate bonds, the companies could default and not pay them. For all bonds, including those issued by government, there is an interest rate risk - rising interest rates drive the price of bonds down. Bonds are an important part of many investors asset allocation. You can purchase bonds directly in the open market or bundled in funds/ETFs. Below are some low-cost Vanguard bond ETFs:

Vanguard Short-Term Bond ETF (BSV) - Yield: 1.4%
The Fund seeks to track the performance of the Barclays Capital 1-5 Year Government Index. This index includes U.S. Government, investment-grade corporate, and international dollar-denominated bonds, with maturities between 1 and 5 years.

Vanguard Intermediate-Term Bond ETF (BIV) - Yield: 2.6%
The Fund seeks to track the performance of the Barclays Capital 5-10 year Government/Credit Index. This index includes U.S. Government, investment-grade corporate, and international dollar-denominated bonds with maturities between 5 and 10 years.

Vanguard Long-Term Bond ETF (BLV) - Yield: 3.9%
The Fund seeks to match the investment performance of the Barclays Capital Mutual Fund Long Government/Corporate Index.

Vanguard Total Bond Market ETF (BND) - Yield: 2.5%
The Fund seeks to generate returns that track the performance of the Barclays Capital Aggregate Bond Index, and will maintain a dollar-weighted average maturity consistent with that of the index. The Index measures investment-grade, taxable fixed income securities in the U.S.

Also, if you live in the U.S. you can purchase Savings Bonds via TreasuryDirect.gov.

Index Funds/ETFs/CEFs

For many investors, indexed investments including mutual funds, exchange traded funds (ETFs) and closed end funds (CEFs) make up the core of their investment allocation. In effect, you are aligning your investment risk with what the index fund tracks. If you believe that over time that certain index funds, such as the S&P 500, will outperform the the various approaches listed above, you should have money invested in it. Index funds allow you to easily track any sector, market cap or index. Here are some varied funds in this category:

Vanguard 500 Index Fund Investor (VFINX) - Yield: 1.9%
The Fund seeks to track the performance of a benchmark index that measures the investment return of large-capitalization stocks. The Fund employs a "passive management" approach designed to track the performance of the Standard & Poor's 500 Index.

IShares MSCI EAFE Index Fund (EFA) - Yield: 3.0%
The Fund seeks to provide investment results that correspond generally to the price and yield performance, before fees and expenses, of the MSCI EAFE Index.

IShares Trust DJ US Basic Mat Sector (IYM) - Yield: 2.1%
The Fund seeks investment results corresponding to the price and yield performance, before fees and expenses, of the Dow Jones US Basic Materials Sector Index. Component firms are involved in the production of aluminum, chemicals, commodities, chemical specialty products, steel, and other goods and resources.

IShares Trust DJ US Real Estate Index (IYR) - Yield: 5.3%
The Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Dow Jones US Real Estate Index. Uses a representative sampling strategy. Component firms include hotel and resort firms and REIT's.

Individual Stocks

Inherently, individual stocks will carry higher risk due to the lack of diversification when evaluated on a stand-alone basis. You can mitigate this risk to a degree by selecting solid dividend paying companies with a track record of increasing their dividends each year. Over the years, some of my personal favorites in this category include:


3M Co. (MMM) provides enhanced product functionality in electronics, health care, industrial, consumer, office, telecommunications, safety & security and other markets via coatings, sealants, adhesives and other chemical additives. The company has paid a cash dividend to shareholders every year since 1916 and has increased its dividend payments for 58 consecutive years. Yield: 2.6%

Genuine Parts Co. (GPC) is a leading wholesale distributor of automotive replacement parts, industrial parts and supplies, and office products. The company has paid a cash dividend to shareholders every year since 1948 and has increased its dividend payments for 60 consecutive years. Yield: 2.7%

Johnson & Johnson (JNJ) is a leader in the pharmaceutical, medical device and consumer products industries. The company has paid a cash dividend to shareholders every year since 1944 and has increased its dividend payments for 54 consecutive years. Yield: 2.8%

PepsiCo, Inc. (PEP) is a major international producer of branded beverage and snack food products. The company has paid a cash dividend to shareholders every year since 1952 and has increased its dividend payments for 44 consecutive years. Yield: 2.9%

Abbvie Inc. (ABBV) is a global research-based pharmaceuticals business that emerged as a separate entity following its spin-off from Abbott Laboratories at the start of 2013. AbbVie's key drug is Humira for rheumatoid arthritis. The company has paid a cash dividend to shareholders every year since 1926 and has increased its dividend payments for 44 consecutive years. Yield: 4.2%

When it comes to investing your money, there is no escaping risk. A good investor will determine the desired outcome and and invest in a way to achieve their goal with minimal risk.

Full Disclosure: Long MMM, GPC, JNJ, PEP, ABBV in my Dividend Growth Stocks Portfolio. See a list of all my Dividend Growth Portfolio holdings here.

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(Photo: sean carpenter)


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