My Father's 401(k) Trusts These 5 Blue-Chip Bargains And So Can You

Summary

• Most people have made costly investing mistakes, including my father who lost 1/3 of his 401(k) to recklessly overweighting Alibaba.
• Fortunately, the world's best blue-chips can still help you recover and retire in comfort and dignity, and potentially even in safety and splendor.
• My father has now invested what's left of his 401(k) into a 65/35 Zen Ultra SWAN retirement portfolio I helped him create, that's 90% likely to let him reach his retirement goals.
• This portfolio consists of 5% cash, 30% EDV, and 13% each AMZN, ADSK, LOW, GOOG, and MA.
• Even if we're facing a lost decade for stocks, my father's new Zen Ultra SWAN portfolio is 90% statistically likely to help him retire in comfort.
• Looking for more investing ideas like this one? Get them exclusively at The Dividend Kings. Learn More »

tiero/iStock via Getty Images

In my job, I do a lot of stock picking. But there is something far more important that most people ignore, often to their sorrow.

Today I'd like to share the cautionary tale of my father's 401(k), its epic collapse, as well as its hopeful rise from the ashes, to soar like a Phoenix to new heights.

In other words, I want to share how even someone who blew up their portfolio can still recover if they get the fundamentals right. That means a focus on safety and quality first, and prudent valuation and sound risk-management always.

NEVER Forget About Sound Risk Management

It's April 2020, and the pandemic is just getting started, though the stock market is rapidly recovering from the fastest bear market in US history.

My father asks me for a recommendation for his 401(k), which he just unlocked at Delta, his former employer.

So this is what I recommended he consider.

A Prudent Investment Idea In April 2020

Company	Ticker	Allocation	Why
Amazon	(AMZN)	20%	Hyper-Growth Ultra SWAN
Alibaba	(BABA)	2.50%	Hyper-Growth Speculative Blue-Chip
3M	(MMM)	20%	High-Yield Ultra SWAN Dividend King
Prudential	(PRU)	10%	High-Yield SWAN
Nasdaq	(QQQ)	47.5%	The World's Best Wide-Moat Growth Blue-Chips
Total		100%

Click to enlarge

Why no bonds? Because 10-year yields had just bottomed at 0.3% during the pandemic and had nowhere to go but up as the economy recovered.

For a brand new economic cycle, this combination of high-quality yield and hyper-growth was a reasonable and prudent mix of growth, value, and yield that met my father's long-term goal of good income and strong returns for the 12 years until his retirement.

Had my father taken my advice, he would have done very well.

Unfortunately, he didn't, instead, this is what he did.

A Bad Investment Idea In April 2020

Company	Ticker	Allocation
Amazon	AMZN	25%
Alibaba	BABA	65.0%
3M	MMM	5%
Prudential	PRU	5%
Nasdaq	QQQ	0.00%
Total		100%

Click to enlarge

Numerous times I warned my father that not even Warren Buffett or Charlie Munger ever go 65% into their highest conviction ideas, much less a speculative company like BABA.

But for whatever reason, he kept his portfolio with this allocation, and here are the results.

Historical Returns Since January 2020 (As Close To April 2020 As I Can Get) NO Rebalancing

(Source: Portfolio Visualizer Premium)

Historical Returns Since January 2020 (As Close To April 2020 As I Can Get) Annual Rebalancing (Recommended)

(Source: Portfolio Visualizer Premium)

Had my father followed prudent risk-management guidelines he would have kept up with the S&P 500 during one of the hottest bull markets in US history and made approximately $50K in profit in about two years.

(Source: Portfolio Visualizer Premium)

And that's despite Amazon underperforming tech, 3M falling, and Alibaba going off a cliff. This is the power of diversification and prudent risk-management to overcome short-term weaknesses and even broken thesis mistakes.

Instead, he lost one-third of his money, in a retirement account that has no additional savings coming in.

So in recent weeks, I sat down with my father and spent five hours guiding him in forming a sound long-term investment plan, so he could rescue his portfolio and achieve the necessary $300K balance he needs to retire by age 70 (10 years from now).

• He actually had $100K left after losing $50K
• He needs to triple his money in 10 years
• So an aggressive growth-focused strategy

Five Ultra SWANs That My Father Trusts In His 401(k) And So Can You

DK Zen Research Terminal

• Autodesk (ADSK)
• Mastercard (MA)
• Lowe's (LOW)
• Amazon
• Alphabet (GOOG) (GOOGL)

I've linked to articles providing a comprehensive review of each company's safety and quality, growth thesis, risk profile, and valuation.

The goal for my father is simple. He either achieves approximately 12% annual returns over the next 10 years, or he doesn't retire at 70.

This is a concentrated pure Ultra SWAN hyper-growth portfolio consisting of five of the world's best growth stocks in three sectors. Fully compliant with Charlie Munger's risk-management rules of thumb for concentrated portfolios.

It's a portfolio that yields very little, just 0.4%, but my father doesn't need yield, he needs growth and lots of it.

And analysts think these five Ultra SWANs can deliver 23% annual returns over time, twice what he needs. Lots of safety buffer in case growth estimates fall later.

Let me show you what I showed my father, to showcase just how dependable and safe these companies are.

Safety And Quality My Father (And You) Can Trust In All Economic Conditions

DK Zen Research Terminal

For context, the average dividend aristocrat has:

• 87% quality
• 89% safety score
• 84% dependability
• 67% LT risk-management percentile

These Ultra SWAN growth champions have 97% average quality, 100% safety, 75th percentile risk management, and an average credit rating of A- stable. S&P estimates an average 2.78% risk of bankruptcy within the next 30 years.

In other words, these are some of the world's safest and most dependable companies.

And they also happen to be extremely attractively valued today.

Wonderful Companies At Wonderful Prices

DK Zen Research Terminal

For context, the S&P 500 is still historically 5% overvalued while these Ultra SWAN hyper-growth stocks are 23% undervalued.

They trade at a PEG of 1.04, Peter Lynch's "growth at a reasonable price".

They also have a return on capital/PEG of 179%.

• S&P 500's ROC/PEG is 7%
• dividend aristocrats is 25%

In other words, these 5 Ultra SWANs offer a potent combination of quality, growth, and valuation.

In fact, analysts estimate that these 5 Ultra SWANs will deliver 45% total returns in the next year alone.

33% total returns are fundamentally justified in the next 12 months.

Is this a better portfolio for my father's goals than his 65% BABA centric one? Without question.

But what evidence is there that these Ultra SWANs can deliver 12% long-term returns much less the 23% that analysts expect?

Historical Returns Since January 2007 (Annual Rebalancing)

"The future doesn't repeat, but it often rhymes." - Mark Twain

Past performance is no guarantee of future results, but studies show that blue-chips with relatively stable fundamentals over time offer predictable returns based on yield, growth, and valuation mean reversion.

Bank of America

So let's take a look at how these Ultra SWAN hyper-growth bargains have performed over the last 15 years when 91% of total returns were the result of fundamentals, not luck.

(Source: Portfolio Visualizer Premium)

Analysts expect 23% long-term returns (17.3% risk-adjusted expected returns) and these companies delivered 23% returns for the last 15 years.

• including through the 2nd largest stock market crash in US history

(Source: Portfolio Visualizer Premium)

These Ultra SWANs beat the Nasdaq by 8% per year, tripling its inflation-adjusted returns.

• 6X better inflation-adjusted returns than the Nasdaq

They also delivered 33% better negative volatility-adjusted total returns than the Nasdaq and 2X better than the S&P 500.

Of course, the one downside to owning a pure stock portfolio, even if it's 100% Ultra SWANs, is volatility.

The peak decline of 44% of this portfolio during the Great Recession means that it might be hard to sleep well at night during a bear market unless you can turn off your TV screen and not check the value of your portfolio.

What kind of volatility might this portfolio see in the future?

75-Year Monte Carlo Simulation: A Prudent Way To Stress Test Your Risk Management

• assume a 5% withdrawal rate
• after-tax returns (highest tax bracket)
• $100K starting portfolio
• historical inflation (bond market expectations for the future)
• 5,000 simulations

(Source: Portfolio Visualizer Premium)

There is an 80% statistical probability that these Ultra SWANs will fall between 33% and 52% at some point in the next 75 years.

• including annual withdrawals, 38% to 59% peak decline is 80% likely

So let me show you how to turn this Ultra SWAN portfolio into a Zen Ultra SWAN retirement portfolio that is optimized for both long-term returns AND minimal declines in future bear markets.

Zen Ultra SWAN: The Key To Retiring In Safety And Splendor

JPMorgan, Bank of America, and Morgan Stanley are now telling their clients that interest rates are high enough that it's safe to START buying bonds again.

JPMorgan Asset Management

Risk-free sovereign bonds are the best recession hedge historically, according to a study from Duke University.

They are negatively correlated to stocks and 92% of the time since WWII when stocks are falling, bonds are stable or going up.

So now let me show you the awesome power of a prudent allocation to long US treasury bonds.

• Vanguard Extended Duration Treasury ETF (EDV) 30% allocation
• Vanguard Short-Term Treasury ETF (VGSH) - cash equivalent 5% allocation

Historical Returns Since January 2008 (Annual Rebalancing)

(Source: Portfolio Visualizer Premium)

In exchange for 3% lower annual returns, the peak decline of the 65/35 Zen Ultra SWAN portfolio was just 22%, less than half that of the pure stock portfolio.

That was 10% lower than the peak decline of a 60/40 retirement portfolio and far less than the Nasdaq's 46% decline or S&P's 51%.

• 30% better negative volatility-adjusted returns than a pure stock portfolio
• almost 2X better than a 60/40 retirement portfolio

What about the future?

Metric	60/40	65/35 Zen Ultra SWAN (Recession-Optimized)
Yield	2.1%	1.1%
Growth Consensus	5.1%	14.8%
LT Consensus Total Return	7.2%	15.9%
Risk-Adjusted Expected Return	5.1%	11.1%
Safe Withdrawal Rate	2.6%	8.6%
Best For		Maximum Returns With Minimal Declines In Recessionary Bear Markets

Click to enlarge

You aren't getting much yield from this portfolio but that's not its goal.

The almost 16% long-term returns that analysts expect in the future means this Zen Ultra SWAN portfolio could beat a 100% Nasdaq portfolio, but with a fraction of the volatility over time.

• more than 2X the risk-adjusted expected returns of a 60/40
• 3.5X the consensus safe withdrawal rate of a 60/40

This is why my dad chose to go with his resurrection 401(k) portfolio.

How likely is my father to achieve his goal of retiring in safety and splendor at the age of 70?

10-Year Monte Carlo Stress Test (Lost Decade For Stocks)

Let's start by seeing what kind of returns are statistically likely over the next 10 years (when my father plans to retire) if the market suffers a lost decade.

• no annual withdrawals or contributions
• pre-tax returns (since it's a 401(k))
• 5,000 simulations

(Source: Portfolio Visualizer Premium)

Even the realistic worst-case scenario, a lost decade for stocks, and the 10th percentile result, still show 12% likely inflation-adjusted returns - exactly what my father needs to retire at 70.

My father needs to turn $100K into $316K inflation-adjusted wealth and that's what this portfolio offers him.

• the statistical/analyst base case is $500K

The 8.6% consensus safe withdrawal rate is likely to actually be conservative.

• 11% to 15% withdrawal rates starting at age 70 might be safe
• vs 2.6% consensus for a 60/40 retirement portfolio

Ok, so now you can see why my father has cautious optimism that he'll be able to retire one day, even with just $100K in savings and a 10-year time horizon.

What kind of retirement can he realistically expect?

Retiring In Safety And Splendor With Zen Ultra SWAN Portfolios

What happens to my father after he reaches retirement at the age of 70?

So at age 70, assuming the worst-case scenario (a lost decade for stocks and 10th percentile returns) here is what my father is likely facing.

30-Year Monte Carlo Retirement Simulation

• 8.6% withdrawal rate (the consensus safe amount)
• post-tax returns (highest tax bracket which he's not in but to be conservative)
• 30-year time horizon (stress test potential volatility and ensure he never runs out of money)

(Source: Portfolio Visualizer Premium)

Even with a very generous withdrawal rate, far higher than any 60/40 can hope to deliver, and the worst-case scenarios, my father is likely to, by age 100, turn $100K into $464K adjusted for inflation, and after extracting a fortune in retirement income from his 401(k).

The base case turns $100K into $1.2 million inflation-adjusted wealth after extracting a fortune in retirement income.

(Source: Portfolio Visualizer Premium)

In year one of retirement, my father is likely looking at least $26K per year, or more than $2K per month.

• he and my mother would be getting about $7K in Social Security as well

The base case is $31K in annual income in year one.

(Source: Portfolio Visualizer Premium)

By year 30 the most conservative case is $44K per year in inflation-adjusted income with a base case of $116K.

• base case has my father and mother enjoying $200K in annual inflation-adjusted retirement income by the end of the first 30 years of retirement
• they have never earned $200K in their lives

Scenario	Year One	Year 30	Average Income	30-Year Inflation-Adjusted Retirement Income	Inflation-Adjusted Portfolio Value	Starting Value	Capital Gains	Total Inflation-Adjusted Return
Worst-Case	$26,059	$46,697	$72,756	$2,182,680	$464,404	$315,911	$148,493	$2,331,173
Base Case	$30,969	$115,963	$146,932	$4,407,960	$1,231,380	$315,911	$915,469	$5,323,429

Click to enlarge

(Source: Portfolio Visualizer)

How can my father potentially turn $100K into $5.3 million inflation-adjusted total returns over 40 years? With a prudently constructed Zen Ultra SWAN retirement portfolio like he just built with my guidance.

Bottom Line: Even Costly Investing Mistakes Don't Mean A Rich Retirement Is Out Of Reach

It's rare to find a person who hasn't made a stupid investing mistake.

I've been investing since the age of 9 and have dabbled in every kind of speculation you can imagine.

• day trading
• commodities
• currencies
• options
• cryptocurrencies

I've made and lost several small fortunes, but fortunately, I was young and had plenty of time to recover.

My father lost 1/3 of his 401(k) by very foolishly (and against my advice) investing 65% of his savings into BABA.

That's the kind of investing mistake that can sink the average investor's rich retirement dreams.

But that's where the power of hyper-growth Ultra SWANs comes in.

Today Amazon, Mastercard, Lowe's, Autodesk, and Alphabet offer a lifeline to people like my father who have very limited capital to work with and zero additional savings.

Don't get me wrong, there is a limit to what Ultra SWAN investing can do.

If you have less than five years to retirement and need to triple your money to sustain your lifestyle? Then you probably are going to have to spend less in retirement.

But as long as you have 5+ years and follow the core principles of disciplined financial science, then hope is not lost.

• prudent risk management
• safety and quality
• sound to attractive valuation
• safe yield
• strong and sustainable growth prospects

According to a study from Fidelity, these are the only fundamentals that determine 97% of long-term investing success.

Or to put it another way, as long as you entrust your savings to the world's best companies, and don't bet the farm on any single one, then you too can likely retire in safety and splendor.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of AMZN, ADSK, GOOG, LOW, MA either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Dividend Kings owns AMZN, ADSK, GOOG, LOW, and MA in our portfolios.