Building an effective investment portfolio for your golden years can be a daunting task, but you don't have to do it alone, and you don't have to reinvent the proverbial wheel. One way to make the job easier is to take some cues from established money management geniuses like Warren Buffett, the charismatic investing legend at the head of Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B).
We asked three of The Motley Fool's top contributors for their thoughts on which of Buffett's holdings would best benefit an American heading into retirement. Read on to see why they selected Johnson & Johnson (NYSE:JNJ), American Express (NYSE:AXP), and Wells Fargo (NYSE:WFC).
Hop on the stagecoach
Jordan Wathen (Wells Fargo): Though Wells Fargo's fee machine may have lost some of its luster following the revelation of its fraudulent accounts fraud, its fee-based business model is really only part of what makes it an attractive bank. The other part of its advantage is its low-cost deposits -- Wells Fargo paid just 0.23% on its average deposit in the first quarter of 2017. Many other banks pay substantially more, often two to three times as much.
A low funding cost is an inherent advantage, as it allows a bank to generate superior returns with below-average risks. A regional bank that pays 0.5% on its deposits would have to price loans higher, or select worse credit risks, to generate the same returns as Wells Fargo, all other things being equal.
There is every reason to believe that this low funding cost advantage is sustainable. Going back to 2007, when the federal funds rate was as high as 5%, Wells Fargo paid just 3.4% on its average interest-bearing deposit.
In our post-financial-crisis world, its status as a "Too Big to Fail" institution likely gives it additional pricing power, as large depositors prefer low-yielding accounts at banks with the implicit backstop of the U.S. Treasury to higher-yielding accounts at smaller institutions. It's trading at about 1.9 times tangible book value, so the market isn't giving as much credit to Wells Fargo as it is other to very profitable institutions, making it a good pick among large cap banks.
American Express: Don't leave home without it
Anders Bylund (American Express): Buffett is a big fan of credit card service companies. Berkshire holds $600 million of Mastercard shares and a cool $1 billion worth of Visa. But head and shoulders above the rest, Buffett has invested nearly $12 billion in American Express, building a 17% stake in the company over the years.
American Express has earned Warren Buffett's appreciation in many ways. He opened his first stake in the company more than 50 years ago, taking advantage of a scandal-tinted sell-off on a fundamentally high-quality business. Its portfolio of credit card operations and other financial services has survived many economic meltdowns and changes in consumers' preferences.
Above all else, American Express churns out prodigious amounts of free cash flow year after year. That cash is funneled into shareholder-friendly share buybacks and steady dividend growth. Payouts have doubled over the last decade, including a 60% increase over the last five years alone.
American Express is as safe as houses, with a decent and sustainable dividend yield to boot. It's exactly the kind of investment you need when priority one is protecting your wealth and the next order of business is earning a steady dividend income. On top of that, the stock is selling at just 12 times forecast earnings today, about half the forward P/E ratio of Mastercard or Visa. If Buffett's long-lasting stamp of approval doesn't sway you, American Express can stand on its own merits, thanks to its solid financial foundation and a very reasonable valuation.
A healthy dividend payer
Keith Noonan (Johnson & Johnson): This healthcare giant makes up a relatively small component of Berkshire Hathaway's holdings: Buffett's company owned just 321,000 shares valued at roughly $42.1 million as of its last 13-F filing. However, Johnson & Johnson stands out as one of the best investment options for retirees, based on its reliable income generation, sturdy business, and reasonable valuation.
The company's dividend yield sits at roughly 2.6%, which is comfortably above the S&P 500's average yield of 1.9, and few dividend-paying stocks have a better track record of returning income to shareholders than J&J. It has raised its annual payout for 55 years running, and is a cash-generating machine with roughly $16.7 billion in free cash flow over the trailing-twelve-month period. That puts the cost of distributing its dividend at roughly 55% of trailing FCF and indicates that the company has room to continue building on its impressive history of annual payout increases.
J&J's business is diversified across medical devices, pharmaceuticals, and consumer products, and the company is backed by considerable brand strength across its segments, bolstering its profile as a relatively low-risk stock that's well-suited for retirement portfolios. Trading at roughly 18 times forward earnings estimates, Johnson & Johnson also has a non-prohibitive valuation that presents a reasonable entry point for retirees looking for solid income generation.