Having created the popular Team Alpha Retirement Portfolio (click here for the latest update) has given me a window into some of the thinking that income investors appear to have. For the most part, folks understand the need to own mega cap, blue chip, solid dividend winning stocks. The problem seems to come with diversification and allocation.
It is easy to understand how investors can fall into the trap of chasing high yields, and over allocating cash into those stocks, but when managing a portfolio for future financial security, or retirement, risks are increased significantly when too much of a percentage of one's portfolio is invested in any one sector or stock.
Let's just take mREITs like Annaly Capital (NYSE:NLY) and American Capital (NASDAQ:AGNC) for an example. Be honest with yourself, do you have more than 4% allocated in this business sector? I do not care if they are agency backed or non-agency backed. Nor do I care if they are a combination of hybrids within the RMBS and CMBS markets. If you have more than 4% allocated in the sector, you are risking a significant portion of your portfolio if these stocks go south.
There are investors who see those yummy yields of over 10% and read how popular they are, and in an attempt to create more income, invest too much money in them. The same can be said for any business sector. Some mega cap, blue chip stocks, overlap in their respective business sectors, but the sectors are so enormous and reliable, more allocation of funds can be invested. For example, the energy sector. The Team Alpha Portfolio holds Exxon Mobil (NYSE:XOM), as well as Chevron (NYSE:CVX). Both of these companies are prolific performers as well as dividend winning stocks. It does not mean that 30% of our investable dollars should be in just those two stocks. It raises risks.
Investors Control Diversification And Allocation, Not The Whims Of The Stock Market
Diversification and allocation will give investors balance. It does not eliminate risks, but it does reduce them. If one stock or sector gets hammered, the blow is cushioned because a smart investor will not have that many eggs on one basket. In an overall market correct, some hedging strategies can be used, like put options to protect gains in individual stocks, or inverse index ETFs for a more general approach. Most hedging costs money, and in our current environment, are very tricky to navigate for the regular individual investor.
There are some stocks that an investor can include within a diversified portfolio that could make sense, as I outlined in this article. When the stock (or stocks) also happen to pay a decent dividend, we, as individual investors can have our "cake and eat it too" so to speak.
Too much hedging and the entire portfolio can lose value in both up and down markets (as well as sideways by the way), so a balance needs to be struck, even with hedging.
The Current Team Alpha Portfolio, Diversified And Well-Allocated
I do not believe that investors can be reminded too much about the need to diversify within a well-allocated portfolio. The best way for me to show how I do it is to break down the Team Alpha Portfolio into those specific components.
The Team Alpha portfolio consists of Ford (NYSE:F) Chevron (CVX) Apple (NASDAQ:AAPL), McDonald's (NYSE:MCD), Exxon Mobil (XOM), Johnson & Johnson (NYSE:JNJ), AT&T (NYSE:T), General Electric (NYSE:GE), BlackRock Kelso Capital (NASDAQ:BKCC), KKR Financial (KFN), Procter & Gamble (NYSE:PG), CSX Corp. (NASDAQ:CSX), Realty Income (NYSE:O), Coca-Cola (NYSE:KO), Annaly Capital (NLY), Cisco (NASDAQ:CSCO), Bristol-Myers Squibb (NYSE:BMY), Newmont Mining (NYSE:NEM), and Wells Fargo (NYSE:WFC).
At first glance it looks diversified, and it is. Lets break down the sectors:
The major business sectors are well-invested, and while there is always trimming we can do, I believe this mix of sectors will withstand plenty of market uncertainty. Nothing will withstand a market collapse, but these stocks also carry a dividend yield of 4.98% currently. If we remain focused on our longer term financial needs, for a secure retirement and future, market fluctuations should actually be embraced, as I detailed in this very important article. I urge everyone to review it again, or read it for the first time.
Ok, so we are well diversified. How about our allocation?
|Stocks Held||Allocation %|
Notice that the Team Alpha Portfolio only has an allocation of 2% in the volatile mREIT sector. With NLY, the portfolio can handle a breakdown if it occurs. Our new "hedge" stock, Newmont Mining only has a 5% allocation for now, but I believe that is adequate in these topsy turvy times.
GE has the largest allocation of any one stock, 8%, but if you have been following my articles, you would have an understanding as to why I believe GE will outperform for all of us. This article will give you an overview about General Electric, as well as links to other informative articles. Take a moment to understand my opinions on the stock.
The allocations in the other stocks are very well-balanced in my opinion, and while chasing yield might be the latest stock "sport", it might come back to bite us if that is all we do.
The Bottom Line
Diversification and allocation are the basic foundations of any portfolio, especially a portfolio geared for a more secure financial future. By simply using common sense with a balanced approach, I believe individual investors can weather many different storms and stay true to their investment goals.
Disclosure: I am long AAPL, BKCC, BMY, CSCO, CSX, CVX, F, GE, JNJ, KFN, KO, MCD, NEM, NLY, O, T, WFC, XOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.