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I Own SCHF And Plan To Buy More; Here Is My Reasoning

Summary My international allocation is currently underweight, but I expect stronger performance in international markets moving forward. The Federal Reserve is pursuing a policy of raising short term rates even though the United States has higher 10 year treasury rates than many developed countries. The top holdings in SCHF have materially lower interest rates than the United States. I expect the expansionary policies to result in stronger growth of GDP and earnings which should lead to higher valuations. The Schwab International Equity ETF (NYSEARCA: SCHF ) is one of my top choices for international diversification. The fund provides exposure to developed international markets with great diversification in the holdings. There are 1226 individual holdings in the fund and yet the expense ratio is only .08%. My criteria for picking top international funds are fairly. The top allocations are Japan and the United Kingdom which combine to be about 40% of the holdings. While I like to see some additional diversification, I can handle that by simply adding a couple other international ETFs to fill out the position. I’m already long on SCHF, but the position is only a very small part of my portfolio. I intend to change that over the winter as I want to shift my portfolio to have a larger allocation towards international equity at the cost of domestic equity. My preferred strategy for making these allocations is generally to leave active limit orders to buy more shares. If the market turns down in a hard way, that means I’ll find myself in before it gets very low. I counter that problem by allocating more cash away from my checking account and into my brokerage account whenever I’m seeing new 1 year lows. Why I want International Since I’m currently underweight on international, it would be reasonable to assume that I simply want to reach a more balanced allocation. However, my desire to raise the international allocation is based off a belief that international equity should be in position for some solid performance. As an mREIT analyst, watching the yield curves is a major part of my research. I’m also keeping an eye on actions by the Federal Reserve and some of the economic indicators. It is my opinion that the Federal Reserve is intent on raising short term rates even if raising the rates runs contrary to their dual mandate. They wish to remain relevant, but their constant talk of raising rates has only created uncertainty. Central Banks Around the World If investors look at central bank policies abroad, they are doing the exact opposite of the Federal Reserve. They are pushing to lower interest rates as far as possible. Some countries are already using NIRP, which is “Negative Interest Rate Policy”. For decades there has been a simple economic understanding that it is impossible to get investors to lock in negative nominal interest rates. It was also believed that investors would not accept negative real interest rates, but the yield on TIPS (treasury inflation protected securities) has clearly proven that negative real interest rates were readily accepted. In negative interest rate policy we see that negative rates can occur as well. The theory that rates could not turn negative was based off the idea that the owners of cash could simply stuff it in their mattress rather than accepting a negative rate. The banks have learned that stuffing billions into the mattress is not viable. There is a cost to protect cash. Because there is a cost, it is possible for the negative interest rates to be the cheapest option available. Resulting Yields Because central banks have taken very different policies in both their talk and their actions, the interest rates around the world are materially different. To demonstrate, I’d like to present charts showing the 10 year treasury yields in several countries. (click to enlarge) The rate on a 10 year treasury bond for the United States is 2.27%. The top two allocations in SCHF were Japan has a 10 year yield of .30% and the United Kingdom which has a yield of 2.01%. To make it simpler to see the relevant rates for the countries that are represented in SCHF’s portfolio, I built the following chart. The heaviest allocations are on the left and the smaller allocations are on the right. This list is not exhaustive, but it provides the top several countries: (click to enlarge) To put that in perspective, Australia is the only foreign country in the top 10 allocations for SCHF that has a materially higher 10 year rate than the United States. South Korea’s 10 year rate was very slightly higher, but the difference was small enough that it could easily flip back and forth in a day. Interpretation The Federal Reserve is intent on raising short term rates and their desire to raise short term rates combined with a positive employment report about a week ago resulted in domestic treasury rates moving significantly higher. The Federal Reserve has not even acted yet, but already our yields are materially higher than most developed markets. To be fair, there are many emerging markets with higher treasury yields. How many investors do you know that consider the United States to be an emerging market rather than a developed one? In my opinion, these other developed countries represent the best comparison of peers. Because I believe the central banks in international markets are doing a better job of handling economic policy, I believe those economies have an advantage for establishing stronger performance moving forward. I believe the expansionary policies will result in a faster growth rate of GDP and higher sales for companies in those locations should translate to stronger earnings and higher valuations. Conclusion SCHF is a diversified low fee index fund for gaining exposure to developed international markets. The top allocations in the fund are to countries that are showing materially lower treasury yields than the United States. The expansionary policies in those countries provide a tailwind to growth that should drive up their GDP. When those economies are expanding, I expect the strength in sales to lead to stronger earnings and higher valuations. Therefore, I will aim to increase my international allocations over the next few months. I may place some limit orders over the weekend to begin the process of acquiring more shares.

Dividend Aristocrats Part 24 Of 52: Consolidated Edison

Summary See why Consolidated Edison is the ultimate ‘tortoise stock’. The company has paid increasing dividends for 41 consecutive years. Are you the type of investor that will benefit from Consolidated Edison stock? Aesop was born into slavery in Greece around 620 BC . His tremendous intelligence did more than earn him his freedom. He rose to become a respected advisor to kings and city-states. One of Aesop’s most famous fables is the tortoise and the hare. An arrogant, speedy hare brags to a plodding turtle about how fast he is. The plodding turtle challenges Aesop to a race. The hare took a commanding lead and looks back, feeling confident that he will win the race. The hare decides to take a ‘power nap’. The slow and steady turtle passes the hare and wins the race. The moral of Aesop’s fable: slow and steady wins the race . Aesop’s story of the tortoise and the hare reminds me of Consolidated Edison (NYSE: ED ). (click to enlarge) Consolidated Edison’s History Consolidated Edison can trace its history back to 1823 – nearly 200 years ago. Back then, the company was known as New York Gas Light Company. In 1884, representatives of several gas light utilities throughout New York came together and consolidated their respective companies into a new business – the Consolidated Gas Company of New York. The company continued to grow and acquire gas, electric, and steam companies serving New York City and Westchester County. In 1936, the company changed its name to Consolidated Edison. Consolidated Edison has paid increasing dividends for 41 consecutive years . The company is the only utility in the S&P 500 with 30+ years of increasing dividends. Consolidated Edison’s dividend growth over the last 41 years is shown below: (click to enlarge) Source: Data from Yahoo! Finance Consolidated Edison Business Overview Consolidated Edison is primarily a regulated utilities business. The company has generated 89% of its revenue from its regulated utilities business segments through the first 9 months of fiscal 2015 . (click to enlarge) Source: 2015 EEI Conference Presentation , slide 25 The company operates in 3 segments: CECONY O&R Competitive Energy Business CECONY stands for C onsolidated E dison C ompany O f N ew Y ork. O&R stands for O range & R ockland. Together, these two segments make up Consolidated Edison’s regulated utilities business. The company’s Competitive Energy Business segment which participates in infrastructure projects, provides energy related products to wholesale and retail customers, and sells electricity purchased on wholesale markets to retail customers. Low Stock Price Standard Deviation & High Yield Investing in ‘turtles’ is not right for everyone. If you are looking for a high dividend yield, safety, and inflation matching (or beating) growth, then Consolidated Edison is a suitable investment. The company’s stock is currently offering investors a high dividend yield of 4.2%. For comparison, the 20 year U.S. Treasury Bond ETF (NYSEARCA: TLT ) is offering investors a yield of just 2.6%. Unlike a bond, Consolidated Edison’s dividend payments are growing (albeit slowly). The company has managed dividend growth of 1.4% a year over the last decade. This is about in line with inflation over the same period. The company should grow its dividend payments faster over the next decade (more on that in the future growth section of this article). Consolidated Edison has a 10 year stock price standard deviation of just 16.7%; the second lowest of any large cap dividend stock with 25+ years of dividend payments [for reference, Johnson & Johnson (NYSE: JNJ ) has the lowest]. You may be wondering… Why does stock price standard deviation matter? There are two answers. First, lower stock price standard deviation means a less ‘bouncy’ ride on your way to total returns. Lower dips make Consolidated Edison stock easier to hold as compared to more volatile stocks. Second, stocks with low stock price standard deviations have historically outperformed the market . That’s why low stock price standard deviation is one of the ranking metrics used in The 8 Rules of Dividend Investing . The image below shows the relative outperformance of the S&P Low Volatility Index over the last decade. The S&P 500 Low Volatility Index is comprised of the 100 lowest volatility stocks in the S&P 500 index. (click to enlarge) Source: S&P 500 Low Volatility Index Factsheet Consolidated Edison’s Future Growth Potential & Total Returns Consolidated Edison grew its earnings-per-share at 3.4% a year over the last decade. Earnings grew around 5%, but the company partially financed itself through share issuances, which dilutes earnings-per-share. In total, the company’s share count has grown at around 1.4% a year over the last decade. Going forward, I Consolidated Edison is expected to grow its earnings-per-share at around 3.5% a year. This number is very close to its 3.4% 10 year historical compound earnings-per-share growth rate. Consolidated Edison’s management is targeting a 60% to 70% dividend payout ratio. The company currently has a 68.8% dividend payout ratio; on the high end of management’s range. As a result, I believe that the company’s dividend payments will increase at either the same rate as earnings-per-share growth for the company, or slightly slower. Investors in Consolidated Edison should expect total returns of around 7.5% a year from the company’s stock. Returns will come from earnings-per-share growth of around 3.5% a year and dividends of ~4% a year. Consolidated Edison stock has a payback period of 16 years using an assumed growth rate of 3.5% and the company’s current share price and dividend. More Safety: Invest In What You Understand Consolidated Edison is an easy to understand stock . The company makes the vast majority of its profits selling electric and gas utility services to both business and residential customers on the East Coast. Other investors have taken notice of Consolidated Edison’s durable geography based competitive advantage. Here’s what Lanny at Dividend Diplomats had to say about the Consolidated Edison : “I understand utilities, I know how they physically work and I know what benefit and value it provides: Providing energy to fuel the day-to-day of operations. Let’s think big businesses, industries, etc., all the way to our entertainment platforms and this stems into our very own households. The need is and for now – will always be there, therefore, this is a very used product that will always be used.” It is very, very likely that Consolidated Edison will be around for a long time in the future. The company operates in a highly regulated industry that creates natural local monopolies. Moreover, the company operates a business that we all use every day (though not necessarily from Consolidated Edison, depending on where you live) – electricity and gas utility services. Peter Lynch is one of the most successful institutional investors of all time. Here’s what he has to say about investing in what you know: (click to enlarge) Final Thoughts: Who Should Buy Consolidated Edison Consolidated Edison stock is not for everyone . The company has a passable-but-not-great expected total return of 7.5%. As a utility, Consolidated Edison does not have rapid, or even average, growth potential. The company’s high dividend yield and high levels of safety (both qualitatively and quantitatively) make it an ideal choice for risk-averse investors looking for high yielding investments that will pay inflation adjusted (or better) dividend payments. Consolidated Edison is the prototypical tortoise investment . Slow and steady dividend growth wins the race.

What To Do When Your Stocks And Bonds Portfolio Reaches Minimum Volatility

Summary Investors typically increase exposure to bonds as they near retirement, hoping to reduce volatility and drawdown risk. It is very possible to reach a point where further increasing exposure to bonds will increase rather than decrease volatility. This phenomenon is more likely to occur with longer duration bond funds. Once you reach minimum volatility for a two-fund stocks and bonds portfolio, you can further reduce risk by (1) buying treasuries or (2) switching to a shorter term bond fund. There is no general result for which strategy is preferred, but (2) tends to give better returns and may be easier to implement. Expected Returns and Volatility as you Increase Bond Exposure Suppose you are implementing a basic stocks and bonds portfolio comprised of two Vanguard mutual funds: Vanguard 500 Index Fund Investor Shares (MUTF: VFINX ) and Vanguard Long-Term Bond Index Fund (MUTF: VBLTX ). Using historical data going back to Feb. 28, 1994, here is how expected returns and volatility of the VFINX/VBLTX portfolio vary with asset allocation. (click to enlarge) Here the top-right point represents 100% VFINX/0% VBLTX; the next data point is 90% VFINX/10% VBLTX; and so on until the bottom-most point, which is 0% VFINX/100% VBLTX. As you near retirement, you may increase your VBLTX allocation to reduce risk. If you go from 90% VFINX/10% VBLTX to 60% VFINX/40% VBLTX, for example, you reduce your expected returns a little (0.041% to 0.037%), while reducing volatility considerably (1.06% to 0.70%). Further increasing the VBLTX allocation reduces volatility, but only to a point. At 25.8% VFINX/74.2% VBLTX, you reach the leftmost point on the curve, and further increasing VBLTX allocation actually increases volatility while reducing expected returns. Of course, there is never a good reason to increase volatility and decrease expected returns. So looking back at the past 21.5 years, you would never have wanted to allocate more than 74.2% to VBLTX in a VFINX/VBLTX portfolio. Longer Duration Bond Funds Have Lower Critical Points The expected returns vs. volatility curve doesn’t always have a clear critical point like we saw for VFINX/VBLTX. In general, longer duration bond funds are more likely to exhibit this phenomenon. You can see this when you compare the curve for VFINX paired with VBLTX to VFINX paired with Vanguard’s short-term and intermediate-term bond funds, VBISX and VBIIX . (click to enlarge) Looking at the blue curve, VFINX/VBISX does have a minimum volatility point, but it’s at a very high VBISX allocation (4.3% VFINX/95.7% VBISX). Note however that if you’re using VFINX and VBISX you probably wouldn’t want to go higher than 90% VBISX, as doing so sacrifices considerable expected returns while reducing volatility very little (if at all). The green curve is in between the first two, with minimum volatility at 12.7% VFINX/87.3% VBIIX. I would not recommend going any higher than 80% VBIIX, though, from an expected returns/volatility standpoint. Reducing Volatility Beyond the Critical Point What do you do if you want to further reduce volatility after reaching your portfolio’s critical point? I see two reasonable options: Allocate some of your portfolio to treasuries (e.g. 10-year US treasury bonds). Swap for a shorter duration bond fund. Let’s go back to the first two-fund portfolio, VFINX/VBLTX. Suppose we’re at 25.8% VFINX/74.2% VBLTX and we recognize that we’ve reached minimum volatility. We would like to reduce volatility to one-fourth that of VFINX (the leftmost dotted line in the previous figures, at 0.298). We can’t do it with all of our assets allocated to VFINX or VBLTX. Let’s consider option (1). Allocating some of your portfolio to cash would pull the red curve down and to the left. But if you’re going to have cash, you may as well get some interest on it. So instead of cash let’s say we generate risk-free returns on whatever percentage we pull out of our VFINX/VBLTX portfolio, from investing those assets in US treasuries for example. The next figure shows the expected returns vs. volatility curves for various allocations to a risk-free investment that returns 1.5% annually. (click to enlarge) To clarify, the highest curve the same as we saw before; the next highest is 10% receiving risk-free 1.5% annual returns, and the remaining 90% split to VFINX/VBLTX in 10% increments; and so on until the lowest curve (which you can barely see), which is 90% risk-free 1.5% annual returns, and the remaining 10% split to VFINX/VBLTX in 10% increments. The first curve to extend to a volatility of 0.298 is the one with 40% allocated to the risk-free investment. For this portfolio, we would have to allocate the remaining 60% of our assets to 30% VFINX/70% VBLTX, to achieve an expected return of 0.0226% with volatility of 0.298%. Now let’s consider option (2). The next figure is the same as the last one, but with the curves for VFINX/VBIIX and VFINX/VBISX included. (click to enlarge) Interestingly, swapping VBLTX for VBISX lets us reach a volatility of 0.298 with a mean daily return slightly higher than that reached with VFINX/VBLTX and 40% risk-free. A 24.7% VFINX/75.3% VBISX portfolio has means returns of 0.0232%. A natural question is how the risk-free rate affects whether strategy (1) or (2) is better. For the Vanguard funds examined here, strategy (1) would always outperform strategy (2) if the risk-free rate was 4% or higher (i.e. rarely or never). Strategy (2) would always outperform strategy (1) if the risk-free rate was 0% (i.e. you held cash rather than treasuries). For risk-free rates between 0% and 4%, it really depends on the particular level of volatility you’re trying to achieve. Conclusions I think a lot of investors operate under the assumption that increasing exposure to bonds reduces volatility. But in fact there is often a point where further increasing exposure to bonds increases volatility and reduces expected returns. You don’t want to go past that point. To reduce volatility further than your two-fund portfolio allows, you can either allocate some of your assets to a risk-free investment, say US treasuries, or you can switch to a shorter duration bond fund. I favor the second strategy, as it tends to allow for greater expected returns and seems logistically easier to implement. More generally, I think it is very important to know where your portfolio is at in terms of the expected returns vs. volatility curve. You should have a good idea of how any potential change in asset allocation or choice of funds affects your portfolio’s characteristics.