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I was going to post a response to this article by Inzkeeper (Faye) who is transitioning to a Dividend Growth Portfolio Model. But suddenly, it turned into an article.

Dear Faye:

I would start with what I think the greatest favour you could do for yourself at this point - do some research and find a very good financial advisor. I sincerely hope you do consider that option. It is my opinion that will be the best-spent money in your life - if you find a very good advisor. But that should not be challenging if you do your homework. As much as you would scrutinize any investment, you should scrutinize the financial advisors that are available.

One of the first things a financial advisor will do is assess your current situation and goals with respect to current assets and timeline and objectives. You should certainly run a retirement calculator to see how much you need to add to your portfolio each year, and the returns you need to reach those goals. And of course it starts with how much will you need in retirement. And ask (yourself if you do not use a financial advisor) all of the above questions and look at your household budget. How much can you invest on a regular basis? If the numbers don't add up, something's gotta give.

And then of course you should assess your risk tolerance. I hope you will not take offense, but from your own writings it sounds like you are very skittish and you make moves often, and you are not very patient when it comes to investing. Ask yourself how much volatility (risk) that you think you can handle. Yes that's like asking how long you think you can hold your hand in ice water (analogy from the book - The Perfect Portfolio by Dan Bartolotti). But it may be the most important question. You might or should realize that an all-equity portfolio (even one that is dividend based) is near the top of the risk ranking, just below diversified equities.

But then again, your portfolio lacks diversification so it could turn out to be a very volatile portfolio (potentially). On risk, think of your portfolio decreasing in value by 40%-50% or 60% and try to guess how you would feel, and how you would react. Would you be scared and sell, or would you see it as a purchasing opportunity? The most relevant evaluation would likely be - what was your response in 2008 and 2009? Did you hang on, or run for the hills?

You wrote that you held Ford (NYSE:F) in 2011, averaged down several times and bailed on the company (mostly). But Ford outperformed the market from 2008 to present. When the indexes did not offer up much, Ford delivered 100% gains.

If you or your advisor determines that your risk tolerance places you in a balanced or balanced growth portfolio model, then you will reduce the volatility or risk by adding bonds - likely bond ETFs. You can also reduce volatility by adding more equity diversification across sectors and by adding an international ETF or index fund. I am just guessing here (again have a financial advisor conduct your risk assessment) but it appears that your risk tolerance is very, very low. It's also possible that after conducting your risk assessment an advisor would not even be able to put you into an aggressive equity-heavy portfolio without putting themselves at risk.

As for your foray into Dividend Growth investing, I think your advisor would suggest that you buy a Dividend Growth ETF and then when you have enough funds to purchase 15-20 companies, perhaps take the top 20 from (NYSEARCA:SDY) or (NYSEARCA:VIG). Hey, then have some fun and sprinkle in a couple of selections from David Fish's dividend lists, and keep them at the weighting of your ETF skimming process. But again, if your risk profile does not match an equity-heavy portfolio you will want (or may be advised) to add a generous percentage of bonds (also known as portfolio shock absorbers) to your total portfolio.

To have a look at the shock absorber effect of bonds, visit the Vanguard site and hit the Insights tab, and then the Investor Truths tab. Then click on The Truth About Risk. It will take you here.

On that page, you can use the slider to change the asset allocation - the mix of equities, bonds and cash. Remember one should first keep 6 months or more of emergency funds in liquid assets. Stock returns are represented by the Standard & Poor's 500 Index (1926-1970), Dow Jones Wilshire 5000 Index (1971-April 22, 2005), and MSCI US Broad Market Index thereafter. Bond returns are represented by the S&P High Grade Corporate Index (1926-1968), Citigroup High Grade Index (1969-1972), Lehman Brothers U.S. Long Credit AA Index (1973-1975), and Barclays Capital U.S. Aggregate Bond Index thereafter. Cash is represented by the Citigroup 3-Month Treasury Bill Index. Returns are adjusted for inflation.

Also remember these are historical figures and do not guarantee an investor will see the same results moving forward.

Now slide the cash to zero so that we can conduct an equity and bond asset mix.

If we use the slider to select a portfolio with 35% equities and 65% bonds, we'll see that the portfolio volatility is greatly reduced.


(Click to enlarge)

In fact, from 1980 there was only once instance when this asset mix delivered an annual loss of 10% or more. In 1974, the portfolio retraced 22% and in 1960's the portfolio saw a few other declines above 10%. So, an investor might look at that asset mix and determine that if they want to dial in a portfolio that might retrace by only 10-15% on any given year (potentially and according to history), they would consider that 35-65% asset allocation. To see the returns for each year, hold your cursor over the bar - the returns will pop up. And where that conservative asset allocation would have helped the skittish investor most is in the 2000-2002 period when the portfolio experienced only one small loss of 2.9% in 2002. An all equity portfolio experienced a 13.8% decline in 2000, a 12.3% decline in 2001, and a 22.7% decline in 2002. Those three consecutive declines would have turned every $10,000 into $5830.

Now hit the Arrow Button (circled) and you can view your portfolio returns vs an all equity model.


(Click to enlarge)

Certainly, we can see that our 35-65% equity-bond portfolio underperforms an all-equity portfolio over a very long time frame. But over the last 10-15 years a balanced portfolio had outperformed the stock indexes. This equity mix is suitable for those with very low risk tolerance and those who are in a capital preservation period. Every investor has to realize that by taking on more risk they can potentially generate better long term gains. But if their risk tolerance is low, they certainly should not take on more risk than they can handle. Because we know that happens then, they abandon the investment plan and sell when the going gets rough. Individual investors historically only take about half of what the markets are offering as they (too often) buy high and sell low, or shift into different investments. Remember, for most investors a portfolio is like a bar of soap the more you handle it, the smaller it gets.

If we shift to a balanced growth model of 70% equities to 30% bonds we can see that the portfolio returns are much great than the conservative asset allocation. And with this asset mix in 2008 we also experienced a 24.4% annual decline. An all equity portfolio would have seen a 37% decline. That said, during one period within 2008-2009 an all-equity investor would have had a moment when their portfolio was down by nearly 50%. Annual numbers do not tell the whole story.


(Click to enlarge)

I'm not trying to scare anyone here. But an investor should look at the raw numbers and the true potential for volatility. Yes, history says that investors will make more money over the long-term with increased equity exposure (I must repeat the popular refrain that past performance does not guarantee future returns). But an investor must first and foremost establish their risk tolerance to the best of their ability, and then create a portfolio model that matches that risk tolerance. Never take on more risk than you can handle.

And Faye, back to your story and situation. I truly hope you will search out a financial advisor, at least for an initial evaluation. Perhaps they could set you on your course and then you could execute the trades and portfolio rebalancing.

Happy investing. But as they used to say on the popular TV drama Hill Street Blues before they sent them out on the mean streets of New York … "Be careful out there".

Source: Dividend Growth Investor - Call 911