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| Warren Buffett speaking to a group of students from the Kansas University School of Business (Photo credit: Wikipedia) |
New York, Jul.21, stock investing .- In investing, there is one rule that supersedes all others. And this rule should be the first thing you consider when building the core holdings in your portfolio.
Legendary investor Warren Buffett put it best:
"Rule No. 1: Never lose money. Rule No. 2: Don't forget rule No. 1."
There is no sure thing in investing, and every investment comes with certain risks. However, today I would like to share with you five funds that I believe are some of the safest, most stable investments on the market.
But first, let's take a look at the investment that most people consider the benchmark of safety: U.S. Treasury bonds.
Treasurys are considered the safest investments in the world because the U.S. government has never defaulted on any debt it has issued. For this reason, Treasurys serve as the benchmark when determining the amount of expected risk for other types of assets.
Today the yield on a 10-year Treasury is 2.6%. This is the benchmark we will use to compare each of the following funds.
While none of the funds we are going to look at could be considered as safe as Treasurys, I would argue that the increased risk is minimal. And the risk you take by investing in any of these funds is more than offset by what you stand to gain.
To properly analyze all five funds, this article will be divided into two parts. Today's article will focus on one "economic moat" fund and two dividend growth funds. Part 2 will focus on two additional funds that take a slightly different approach.
IShares High Dividend Equity (NYSE: HDV)
HDV tracks the Morningstar Dividend Yield Focus Index, which contains 75 U.S.-based firms screened for qualified dividends. (A qualified dividend is taxable as capital gains.) As a result, this fund does not invest in real estate investment trusts (REITs) or master limited partnerships (MLPs).
HDV tracks the Morningstar Dividend Yield Focus Index, which contains 75 U.S.-based firms screened for qualified dividends. (A qualified dividend is taxable as capital gains.) As a result, this fund does not invest in real estate investment trusts (REITs) or master limited partnerships (MLPs).
All companies in the fund must have a Morningstar Economic Moat Rating of narrow or wide. This focus on economic moats -- referring to the sustainable competitive advantages enjoyed by some companies -- helps ensure that only the safest, most stable companies make the cut.
StreetAuthority expert Elliott Gue made HDV one of his top picks in his November 2012 issue of Top 10 Stocks. Here is what he had to say:
HDV focuses on the market's biggest dividend payers... but it also only invests in dividend-paying companies with economic moats, as determined by investment research firm Morningstar.
Furthermore, the fund uses Morningstar's "Distance to Default," a further measure of a businesses' financial health. A dividend-paying company also has to rank in the top half of its peers in this measure to be included in the fund's holdings.
From there, the fund weights the portfolio based on the total amount of dividends paid each year. So AT&T -- which at $10.3 billion annually pays more in dividends than any other company in America -- isweighted the heaviest.
Because of this, HDV is weighted heavily toward its top holdings, which are larger companies that pay more in dividends. The top 10 holdings make up more than 60% of the portfolio and have a larger influence on the fund's returns than the rest of the portfolio.
Now, blue-chip stalwarts like AT&T (NYSE: T) aren't the sort of companies that are going to make you rich overnight. But that's not the point. What we are looking for here are super-safe investments that can still offer you a better rate of return than Treasurys or a simple fund that tracks an entire index like the S&P 500.
HDV invests in the types of companies that can grow your wealth over time while paying you a steadily rising stream of income. And since its inception in 2011, the fund has done exactly that:
At the time Elliot made his recommendation, shares of HDV were trading for as low as $57.70. Since then the shares have gained over 17% (not including dividends).
Today the fund offers a yield of 3.19 % with an annual expense ratio of 0.4%. At current prices it is trading about even with net asset value. Net asset value measures the value of a fund's assets minus its liabilities. So shares can be considered fairly valued at today's prices.
Vanguard Dividend Appreciation ETF (NYSE: VIG)
VIG tracks firms that have raised dividends for at least 10 years in a row. Mergent, the company that created the fund's benchmark for Vanguard, uses proprietary software to eliminate underperformingstocks that analysts believe will not be able to continue raising dividends.
VIG tracks firms that have raised dividends for at least 10 years in a row. Mergent, the company that created the fund's benchmark for Vanguard, uses proprietary software to eliminate underperformingstocks that analysts believe will not be able to continue raising dividends.
The names that make up the fund's core holdings should be familiar to every investor: Pepsico (NYSE:PEP), Proctor & Gamble (NYSE: PG), Coca Cola (NYSE: KO), Abbott Laboratories (NYSE: ABT), and Wal-Mart (NYSE: WMT) represent the top five holdings and amount to just over 20% of the fund's assets.
One of VIG's most attractive qualities is its low expense ratio. It charges an annual fee of only 0.1%, which is more than made up for by a current dividend yield of 2.2%.
Over the past three years, the fund has performed admirably, up 48% (not including dividends).
SPDR S&P Dividend (NYSE: SDY)
SDY only holds stocks in the S&P 1500 that have raised dividends every year for the past 20 years. Out of 1,500 candidates, only about 80 companies make the cut. In addition, all companies must have amarket cap of at least $2 billion.
SDY only holds stocks in the S&P 1500 that have raised dividends every year for the past 20 years. Out of 1,500 candidates, only about 80 companies make the cut. In addition, all companies must have amarket cap of at least $2 billion.
The fund uses an interesting yield-weighting strategy that allows it to focus more on mid-cap companies than might be expected. For example, while giant AT&T makes up the largest holding at 2.4%, mid-cap Pitney Bowes is right behind it at 2.39%. By allowing for more mid-cap exposure, the fund also offers more potential for growth.
SDY offers a yield of 2.7% and charges an annual expense ratio of 0.35%.
Over the past three years the fund has carved a steady uptrend, gaining 45% (not including dividends).
Risks to Consider: Because these funds focus on safe and steady companies that don't use a lot ofleverage to generate returns, they can tend to underperform during strong bull markets.
Action to Take --> These investments can be considered "Forever" funds. In other words, you can basically buy them, forget about them and hold them "forever." With funds like these as the core of your portfolio, you don't need to worry about the day-to-day drama on Wall Street, the latest news from the Federal Reserve, or which political party happens to be in the White House.
When purchasing these funds, the best time to buy is when share prices are trading at a discount to net asset value. But even if prices are relatively even with net asset value, I think the focus on dividend growth and economic moats makes all three a strong buy for any investor.
Stay tuned for Part II of this series, where we will take a look at two more "Forever" funds that should be a part of every investor's portfolio.
Regular StreetAuthority readers have probably heard us talk about "Forever Stocks" before. These are stocks of solid, blue-chip companies that pay rising dividends and hold sustainable competitive advantages. The idea is that you can essentially buy them, forget about them, and hold them forever.
In the first part of this article, we talked about three funds based on the same principle. These funds are the type of holdings that could form the core of any dividend investor's portfolio. These "Forever" funds are made up of the most solid, stable, dividend-paying stocks on the market — companies like AT&T (NYSE: T), Coca-Cola (NYSE: KO), and Wal-Mart (NYSE: WMT).
None of these funds will make you rich overnight, but that's not the point. These funds are designed for the investor who'd rather spend time golfing or playing with the grandkids instead of nervously tracking ticker symbols or trying to predict what the Federal Reserve might do next.
In today's article, we're going to take a look at two more funds that take a slightly different approach from the three mentioned in the previous article. One is a fund that focuses on dividend stocks outside the U.S. The other is a fund that tracks one of the most exciting investment opportunities to come along in years: master limited partnerships (MLPs).
PowerShares International Dividend Achievers (NYSE: PID)
PID allows investors exposure to solid dividend-paying companies overseas. The fund weights holdings by dividend yield. To qualify, companies must have raised dividends for at least the past five years.
PID allows investors exposure to solid dividend-paying companies overseas. The fund weights holdings by dividend yield. To qualify, companies must have raised dividends for at least the past five years.
The portfolio's current top five holdings are Teekay Offshore Partners (NYSE: TOO), Teekay LNG (NYSE:TGP), TELUS Corp. (NYSE: TU), Vodafone (Nasdaq: VOD), and GlaxoSmithKline (NYSE: GSK). These five make up 19% of the overall portfolio.
StreetAuthority expert Elliott Gue has had Teekay LNG in his High-Yield PRO portfolio since April 2011. So far, readers are up over 33% on the recommendation.
When you take a closer look at these holdings, it's easy to see what they all have in common: solid yields in the 4% to 6% range.
The fund has performed well over the past three years, up 23% (not including dividends).
PID is well diversified across market sectors, with energy making up 20%, telecom 16%, health care 14%, financials 12% and consumer staples 12%.
PID also serves as another form of diversification. By investing in overseas firms it offers exposure to profits in currencies other than the dollar. Earning profits in euros and British pounds can help serve as a hedge against any future weaknesses in the U.S. dollar.
One strike against PID is its relatively high expense ratio of 0.52%. While this expense is more than offset by the current 2.2% dividend yield, it still makes PID more expensive than the three funds I profiled in the first part of this series.
JPMorgan Alerian MLP Index (NYSE: AMJ)
AMJ is a closed-end fund that tracks the 50 largest MLPs on the market.
AMJ is a closed-end fund that tracks the 50 largest MLPs on the market.
Unlike a corporation, a master limited partnership is considered to be the aggregate of its partners rather than a separate entity. MLPs combine the tax advantages of a partnership with the liquidity of a publicly traded stock.
MLPs allow for pass-through income, meaning that they are not subject to corporate income taxes. Instead, owners of an MLP are personally responsible for paying taxes on their individual portions of the MLP's income, gains, losses, and deductions. This eliminates the "double taxation" generally applied to corporations (whereby the corporation pays taxes on its income and the corporation's shareholders also pay taxes on the corporation's dividends).
The fact that MLPs are not subject to income tax means that more cash is available for distributions. This generally makes MLP units worth more than similar shares of a corporation.
AMJ allows investors to earn a high yield across a wide variety of MLPs without the tax headaches that come from investing in individual MLPs. Regular MLP investors must fill out a Schedule K-1 document for every state in which the MLP operates. But AMJ distributions are reported on a single 1099 form, making things much easier come tax time each year.
The MLPs in AMJ's portfolio operate primarily in the energy industry and are involved in the exploration, production, transportation, and processing of oil and natural gas.
This sector of the economy has been covered extensively by StreetAuthority expert Nathan Slaughter in his newsletters. He recommended MLP Spectra Energy Partners (NYSE: SEP) last November, and so far his subscribers are up almost 50% on the recommendation in just eight months.
This sector of the U.S economy has been booming over the past three years, and AMJ's share price has been booming right along with it, up 49% during that time.
By law, MLPs must distribute at least 90% of income to investors. So as you might expect, AMJ currently boasts an attractive dividend yield of 4.5%. And because the MLPs in the portfolio rely more on the volume of energy moving through the system than the prices of the commodities themselves, the overall portfolio is much less volatile than the commodity market for oil and gas as a whole.
AMJ charges an annual expense ratio of 0.85%, which is high compared with the other funds we've looked at but par for the course for MLP index funds.
Because AMJ became a closed-end fund in 2012, there are a limited number of shares available. The downside to this is that now the shares are more likely to trade at a premium to net asset value.
Risks to Consider: Although PID can help investors diversify by investing in overseas companies, the fund's holdings are heavily weighted toward European holdings. Further financial troubles in the European Union could have a negative impact on PID's value.
AMJ is an exchange-traded note (ETN), which exposes investors to the credit risk of the underlying issuer. In this instance, if JPMorgan Chase were to go bankrupt, AMJ shares could drop to zero.
Action to Take –> PID and AMJ are great investments for investors looking to diversify their holdings. For both funds, it is best to wait until net asset values are close to even or (even better) selling at a discount before purchasing shares.
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