Published July 13th, 2016
I designed Sure Dividend to be an all-in-one dividend growth portfolio solution. That’s what I thought would provide the most value to people.
But… I was wrong.
Based on a recent survey a full 76% of Sure Dividend readers read other dividend investing newsletters.
Should I be mad that people are using ideas from the Sure Dividend newsletter in combination with other dividend newsletters?
I don’t think so.
The reality is, I don’t have a monopoly on good dividend investment ideas. The systematic 8 Rules of Dividend Investing strategy has worked well as evidenced by model portfolio returns (shown below)
- 20 Stock Model Portfolio annualized return: 16.0%
- S&P 500 annualized return: 5.2%
There are (of course) valuable dividend investment ideas in other dividend newsletters. There’s even high quality analysis floating around for free – if you are willing to sift through a lot of less than stellar research.
This article takes a look at how to combine dividend investment ideas from different sources into one coherent portfolio.
Overview of Strategy
Dividend investors should have a plan of action before taking action. Don’t buy and sell stocks until you have a concise and well-thought-out investing plan.
Your plan should match with your investing goals.
Are you investing for a short-term goal (like saving up for a house? Are you investing for a long-term goal (like retirement)? Are you investing for current income and income growth (like being in retirement)?
What your goals are will dictate your investment strategy.
Potential investors who will need funds in 5 years or less (at a very minimum) should not be investing in stocks at all… The market can lose half – or more than half – of its value at any time. If you are saving for a shorter term goal, do just that; save. Do not invest in businesses and subject yourself to the vicissitudes of the market.
Investing for a long-term goal lends itself to investing in great businesses with strong competitive advantages and shareholder friendly (preferably dividend paying) managements.
These types of businesses have historically generated excellent returns on both an absolute and risk-adjusted basis.
Case-in-point: The Dividend Aristocrats. The Dividend Aristocrats are a group of 50 businesses with 25+ years of consecutive dividend increases. You can see their performance below.
Source: S&P Fact Sheet
Investing in retirement also lends itself to investing in great businesses with strong competitive advantages for safety. The difference is that income and income growth take on a greater importance than when an investor is preparing for retirement (or other goals).
In summary, know your goals before investing. Align your investments with your goals.
- If you are trying to make a ‘quick buck’ in the market, don’t.
- Invest in great businesses with strong competitive advantages for the long-run
- Retired investors should factor in higher yielding stocks
Portfolio Allocation & Position Sizing
Before investing, take the time to determine how many different individual stocks you will hold in your dividend portfolio.
There is no one right ‘one size fits all’ answer. There is a distinct trade-off between diversification and focus.
The more stocks you hold, the better when it comes to diversification. That’s because you have less money invested in each stock. If you hold 100 stocks with 1% of your portfolio invested in each, the worst loss you can experience from any 1 stock is only 1% of your portfolio.
On the other hand, your portfolio is not concentrated in your best ideas. Great investors like Warren Buffett and Seth Klarman invest the bulk of their portfolio in only a few high conviction investments. Buffett’s top 3 stock holdings are shown below:
- Wells Fargo (WFC) is 20% of Buffett’s portfolio
- Kraft-Heinz (KHC) is 18% of Buffett’s portfolio
- Coca-Cola (KO) is 13% of Buffett’s portfolio
3 stocks make up 51% of Buffett’s portfolio. That is not ‘well diversified’. At one point, Buffett put 40% of his portfolio in American Express (AXP) stock.
The downside is that you and I are not Buffett. We shouldn’t go thinking we can invest with the same skill. Therefore, more diversification is required.
I believe the healthy medium in number of stocks to hold is around 20 to 30. This is enough to benefit if one of your stocks performs very well. It is also enough positions to benefit from reductions in portfolio standard deviation through diversification.
On top of this, investors should invest using equal weights when making their initial investments. Don’t allocate 90% of your portfolio to one stock, and then hold 30 stocks with a total of 10% of your portfolio. That is most certainly not adequate diversification.
Equally weighting a portfolio of between 20 and 30 stocks strikes a compelling balance between focusing on your best ideas and diversifying to prevent over exposure to any one business.
On top of diversification between individual stocks, investors should also look for some level of diversification between sectors and industries. Holding 30 upstream oil businesses is not being well diversified, for example.
There are 10 (soon to be 11 with the addition of Real Estate) sectors in the GICS.
Source: GICS Website
These sectors are:
- Consumer Discretionary
- Consumer Staples
- Health Care
- Information Technology
- Telecommunication Services
It is not necessary for investors to allocate exactly equal amounts of funds to each of the 10 sectors. Some entire sectors may not be suitable for certain investors (for example, utilities for growth oriented investors).
What is important is to not lump all of your portfolio into one or two sectors. You want reasonable diversification between sectors and industries. Use common sense here more than exact rules. Investing in great businesses trading at fair or better prices is more important than investing perfectly equally in all sectors.
Before entering into a prospective investment be sure to outline when and why you will sell that investment. More specifically, think about your desired holding period.
The Warren Buffett quote below shows his take on the optimal holding period:
“When we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.”
Forever is the ideal case. But forever can be a very long time.
Define your reasons for selling a dividend stock before investing. The Sure Dividend system sells for 3 reasons:
- If a stock reduces or eliminates its dividend
Reasoning: Businesses that cut or eliminate dividend are likely in decline
- If a stock becomes absurdly overvalued (measured by P/E ratio > 40)
Reasoning: Stocks with absurd P/E ratios are unlikely to provide favorable returns going forward
- In unique situations like acquisitions
Value investors may sell a stock when it hits a preordained price-to-earnings multiple or ‘fair value’ price. Other investors may sell if a business is not hitting a specific growth target. Still other investments may be sold based on the price of a commodity. For example, ‘sell XYZ Gold Miner when the price of gold hits $1,700’.
Finally, investors may hold a stock until a better idea is available. This approach can be dangerous. The grass always looks greener. Transaction costs and tax consequences are very real. High portfolio turnover can cause a significant drain on portfolio performance.
Defining your holding period beforehand helps to prevent ‘changing your mind’ too quickly with an investment. Think of each investment as its own little battle. You have to see it through to the end.
Putting It All Together: The Framework
The ~1,200 words above give general guidelines on how to plan to invest over many different dividend newsletters.
The following is a concise framework to implement various investment ideas into your portfolio.
Before even thinking about buying individual stocks, outline your investment goals.
- What is your required return?
- How often will you save?
- When do you plan on withdrawing funds?
After that, plan out your portfolio:
- How many stocks will you hold?
- What percentage of funds will you allocate to each holding?
- What is your minimum required yield (if any)?
- Remember sector and industry diversification
Once your portfolio a concise framework is below:
- Determine amount of funds (if any) available for investment
- Write out your most promising investment ideas
- Weed out investments that don’t match your specific criteria (high yield, growth, etc.)
- Estimate risk-adjusted total returns for all investments
- Invest in the highest risk-adjusted total return idea you have available
Other Dividend Newsletters
A brief list of dividend investing newsletters is below. I do not specifically endorse these newsletters (other than my own, which I obviously do endorse).
But that doesn’t mean they don’t have good investment ideas. Many Sure Dividend readers also read some of the following:
- Sure Dividend Newsletter
- Morningstar Dividend Investor
- Dividend.com’s Dividend Advisor
- AAII Dividend Investing
- Investment Quality Trends
The Seeking Alpha authors and bloggers below regularly put out high quality dividend investing work:
These sources should provide far more ideas than any one investor needs.