Readers here at Seeking Alpha are the beneficiaries of many great writers on dividend growth investing. I have learned a significant amount from them and look forward to getting their insights every day. One aspect of dividend growth investing that gets less attention is where your dividend growth stocks should fit within your total portfolio.
Should you be 100% DGI?
I have read a couple of articles on this website suggesting that an investor should only hold dividend growth stocks. I doubt that many readers take that advice seriously, nor do I expect that it was intended to be taken seriously. For those that do, they should familiarize themselves with the great debate among academics and wall street professionals regarding the modern portfolio theory and the capital asset pricing model, and their usefulness in investing. For two opposing articles, see the [PDF] links here and here.
My education and research have steered me towards believing that exposure to multiple countries and asset classes will be beneficial in the long run. If you are 100% dividend growth stocks, you can obtain a significant amount of diversification in terms of country exposure and in terms of exposure to different asset classes such as master limited partnerships and real estate investment trusts. The problem is that you are missing any exposure to the bond market (and preferred stocks to a lesser extent).
Your response to my suggestion that bonds need to be in your portfolio may something like this: "Bonds are a terrible investment right now! Junk bonds are in a bubble. U.S. government bonds are in a bubble!" I am not going to disagree. Consider, however, the below chart of the 6-month correlations between various asset classes, as indicated by a corresponding ETF:
Using this Correlation Tracker, which will go to a three-year time frame, SPY had a 0.44, 0.67, 0.72 and 0.61 correlation to TLT, TIP, LQD and PICB respectively. Compare this to the three-year correlation between SPY and VEU, VSS and VWO of 0.33, 0.28 and 0.08 respectively. This is not the outcome that I expected, but both sets of data illustrate the diversification offered by bonds and exposure to international and emerging markets.
Perhaps if you have a long enough time frame, a high enough risk tolerance, and will follow through with the DGI mantra of reinvesting your dividends in good times and in bad, then you could be 100% in dividend growth stocks, provided that you maintain diversification (and rebalance) across the available asset classes and economies. When bonds become more attractive, or else when your time frame or risk tolerance changes, then hopefully you would purchase bonds.
A More Balanced Approach
For the rest of us though, myself included, it is advisable to fit a group of dividend growth stocks within a portfolio that is customized to your risk-tolerance and goals. We are often forced by our limited options in our 401(k) and 529 plans to build our individual selections around what we are stuck with for those holdings. For example, if you decide that you want 50% of your portfolio to be allocated to U.S. stocks, but you are stuck with the Spartan S&P 500 mutual fund (MUTF:FUSEX) as the only decent low-cost choice in your 401(k), then hold that fund and adjust your available funds for U.S. dividend growth stocks accordingly.
I strongly prefer using low-cost index-based ETFs and mutual funds to gain exposure to asset classes or regions in which either 1) dividend growth stocks are not available (i.e., bonds, preferred stocks) 2) there is not enough capital available for that asset class to spread out between multiple dividend growth stocks; or 3) exposure to the asset class is needed, but adequately priced individual dividend growth stocks have not been discovered by the investor. I like DEM, DES, SDY and PID as place holders until time, funds and/or opportunities become available for investment, although there are many other low-cost ETFs and mutual funds that focus on dividends and dividend growth. Note that just with dividend growth stocks you should reinvest the dividends paid by these funds as you bide your time to make individual purchases.
Diversification across asset classes and world economies is believed to be beneficial to providing better risk-adjusted returns over longer time frames, although there is plenty of sentiment to the contrary. It is advisable for most people to not invest 100% in dividend growth stocks, but rather maintain some bond exposure in addition to exposure to REITs, MLPs, foreign and emerging stocks. If you need exposure to an asset class but do not have the time, money or opportunities to pick individual dividend growth stocks, then I suggested some ETFs that are more dividend focused for you to research.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.