It's been an amazing year for investors if you've been bullish on the U.S. markets. Through just the first four-and-a-half months of the year the broad-based S&P 500 (^GSPC +0.54%) has returned 17% -- basically double what it returned all of last year -- and has hit multiple record highs. The Dow Jones Industrial Average (^DJI +0.66%), has similarly climbed over the 15,000 level and has risen better than 130% from its lows of just four years ago.
The reasons to be optimistic are everywhere. Lending rates are at historically low levels, which has allowed businesses to expand and take on debt at exceptionally low rates, while also allowing consumers to refinance their debts (including mortgages) at historically low levels. The unemployment picture is slowly improving, with initial jobless claims and the unemployment rate hitting five-year lows earlier this month. Even housing is once again on the upswing, with low housing inventories spurring pricing power for homebuilders for the first time in years.
But if you've been an investor in the stock market for any reasonable length of time, you've heard this song before. I've come to expect that peaks and troughs are the natural occurrence of the economy, and staying diversified in the right companies over the long run is the way to best protect yourself against downside while taking advantage of economic expansion.
Getting back to basics
One way of doing this that makes a lot of sense is by investing in basic needs or necessity items like food, clothing, water, or electricity. Basic needs stocks hold advantages that you'll find in only a select few companies that you can buy today.
To begin with, basic needs stocks are generally immune to wild swings during economic downturns. Because these companies provide products that remain in demand regardless of whether the economy is booming or not, they offer investors relatively predictable profits and cash flow. Think about it this way: If you took a 20% pay cut tomorrow you may opt not to take that next vacation in order to cut expenses, but you'll still need to purchase food and basic hygiene items like toothpaste no matter what.
Source: U.S. Department of Agriculture, Commons.wikimedia.org.
Basic needs stocks' products are often price-inelastic as well. What this means is that because they're somewhat excluded from the effects of economic downturns, they face minimal downside pricing pressure. Unless basic needs companies choose to undercut their competitors on price in order to lure in new customers, their pricing power is their primary source of strength.
Basic needs stocks are also some of the top-paying dividend companies you can find. Because their cash flow remains consistent year in and year out unless they make a large acquisition or beef up their ad or R&D spending, basic needs companies have become a staple of many dividend income portfolios.
The Basic Needs portfolio
Keeping this in mind, I've decided to conduct a three-year experiment, known as the Basic Needs portfolio, that I anticipate will prove the value of basic needs companies and why they should be a staple in your portfolio or individual retirement account.
The plan here is simple: Over the next 10 weeks I'll roll out one basic needs stock a week and lay out my case for why it fits the bill as a steady long-term investment. Once all 10 companies have been unveiled, I'll open up the portfolio for a weekly comparison against the broad-based S&P 500, which I'll be using as my benchmark. There will be no trading for three years (which means I have to be confident in my selections), initial commission will count against the portfolio, and all dividends will be accrued as cash received. Unlike some of my peers, I will not necessarily be purchasing these 10 companies with my own money, but I do reserve the right, within the bounds of the Fool's disclosure policy, of course, to purchase them at a later date.
Stay tuned next week as I'll divvy out my first selection for the Basic Needs portfolio.
