People are always asking me: What's your stock pick of the month? I'm reluctant to give advice about individual stocks/companies as most people aren't active traders, investors, or sophisticated financiers who know the difference between a stock and a bond, or when to get in and out of a position. Come to think of it, most sophisticated financiers with their Ivy League degrees don't know either, as 80% of managed funds can't beat their benchmark index. As John Bogle, the founder of The Vanguard Group, has consistently preached, index investing will continually beat the market. Well, that's partially right, and to be partially right in investing is a huge achievement. Let's take this index investing a step further and start building the ultimate lazy investor portfolio.
Guggenheim S&P 500 Equal Weight ETF (RSP)
The Guggenheim S&P 500 Equal Weight ETF is essentially what its name implies: taking the 500 stocks in the S&P 500 and allocating the same amount of capital to each company. What's the difference between the RSP and the SPDR S&P 500 Trust ETF (SPY)? The difference is the SPY allocates invested capital based on the 500 stocks' market capitalization, creating an unequal distribution between large and small companies. Common sense would lead you believe this makes sense as small companies are riskier than larger companies, but a couple of components to this argument are missing: 1) What about the companies in between the largest and smallest?, 2) large companies with a market capitalization greater than $10B are unlikely to double, and 3) investing in the SPY is not pure index investing as the majority of your money is asymmetrically skewed toward larger market capitalization companies.
These points are not talking points as numbers don't lie. Over a period of 10 years, RSP has outperformed SPY by over 40%. The flaw in SPY is that it's a weighing machine that gets more skewed as the year progresses. Far from in between, RSP places capital equally between all stocks in the S&P 500, which provides your capital to have an equal chance to generate returns in excess of the market average in an increasing and decreasing market. If the benchmark for professional investors was an equally weighted S&P 500 index, more than 95% or greater of professional money managers wouldn't be able to beat the market.
Dogs of the Dow
Dogs of the Dow gained its notoriety from Michael B. O'Higgins in 1991, in which an investor takes the 10 highest yielding stocks in the Dow Industry Average index and invests equally among them, and then reinvests distributed dividends every quarter and rebalances portfolio every year. Dogs of the Dow assumes the investor is reinvesting their dividends back into the positions they're holding to obtain a compounding effect. Currently for 2013, the Dogs of the Dow are AT&T (T), Verizon Wireless (VZ), Intel (INTC), Merck (MRK), Pfizer (PFE), Dupont (DD), Hewlett-Packard (HPQ), General Electric (GE), McDonald's (MCD), and Johnson & Johnson (JNJ). They have estimated returns of .54%, 14.55%, 13.38%, .71%, 18.14%, .86%, 59.79%, 21.27%, 5.17%, and 30%, respectively.
Over a short period of time, the Dogs of the Dow may not outperform the S&P 500 index as described above using SPY. But over a period of 20 years, the Dogs of the Dow portfolio strategy has outperformed the market by 1.2%, averaging 10.8%. Definitely not a sexy strategy, but if you're beating the market by only having to 1) rebalance your portfolio annually, and 2) reinvest dividends quarterly, then who cares if it's not sexy.
Warren Buffett is arguably one of the top five investors who has ever lived, and he is the chairman and CEO of Berkshire Hathaway. Berkshire is a conglomerate of companies that report up into Berkshire Hathaway. All the companies underneath Berkshire run and manage their companies to the best of their abilities, and any excess capital that isn't necessary to run the business is sent to parent company Berkshire Hathaway. There, the Oracle of Omaha works his magic and allocates the excess capital. I plan to write an article about Berkshire Hathaway eventually, but in looking at Berkshire's stock performance over the past 48 years since its inception, it has beaten the market (S&P 500).
Buffett is a little arrogant with respect to the fact that if he doesn't think he can get better returns than the market, he feels he should be giving the money back to shareholders. Regardless if you feel as an investor he should be paying dividends, repurchasing shares, or reallocating the money into additional investments, his track record speaks for itself. You can view it in any annual report. I'm sure someone could find flaws in Buffett's investment analysis at some point, but overall he has built an empire in a lifetime any businessman would be proud of.
The Ultimate Lazy Investor Portfolio
Let's take the three pieces of this article and merge them together and see what type of portfolio we get: the RSP, an equally balanced S&P 500 index; Dogs of the Dow, the 10 highest yielding stocks of the Dow Industrial Average; and Berkshire Hathaway. What would a portfolio made up of these three pieces look like?
- 33.33% RSP
- 33.33% Dogs of the Dow
- 33.33% Berkshire Hathaway
I don't have any graphs to make this pretty, but you get the picture. It's a low-maintenance, globally diversified, and outperforming market portfolio.
Low Maintenance: Just as most people need to get a checkup at their local dentist a couple of times a year, we'll need to rebalance our portfolio at least once a year and reinvest our distribution payments back into the positions that paid them out quarterly (Dogs of the Dow).
Globally Diversified: Investors don't need to invest in foreign exchanges around the world to get international exposure for their portfolio. I prefer to invest in U.S. companies that have international operations and have sales in different countries. Why hassle with other countries' regulatory environments and have another level of complexity with regard to foreign exchange, when everything can be priced in U.S. dollars? As the saying goes, "Keep it simple stupid."
Outperform the Market: All three of these stock or portfolio strategies outperform the market on an individual basis. Most investors, including myself, like a concentrated portfolio with diversification. These three positions on a standalone basis would work to achieve above-market results, but together they create synergy in which the sum is greater than the parts.