The month of June caused countless retired or soon to be retired investors to question their current investment strategy. Growth stocks were down, same with Blue Chips. Bonds went down as well. Gold too was down. How about reits and mlps? You guessed it … down. What does all this turbulence mean for investors who are already retired and are now relying on their portfolios for monthly retirement income? Is now the time to explore new income investment strategies? These were some the questions poised in Part One of this series available here.
When you retire at some point you become dependent on your portfolio for income. As inflation increases your income needs grow in proportion. Most investment strategies require that you depend on the capital gains performance of your equities for income. It's easy to sell low when following this approach. It's also easier to sell out of fear since loss in value directly affects loss in income.
In Part One I introduced many of you to a strategy that has permitted me to maintain a portfolio yielding more than double that of the S&P 500 index. I heard from folks who had already made the decision to follow this strategy. I also heard from those who were interested in converting their mutual funds or etfs but didn't know how or where to begin. In the comment section that followed, we discussed a strategy producing income in excess of what I would have been permitted to withdraw from my account each month under the 4% withdraw rule. Most importantly, we discussed a strategy which handles concern about inflation through a focus on stocks with growing dividends surpassing the rate of inflation. The investment strategy I'm suggesting you consider is built around a structured portfolio business plan with goals and guidelines for buying and selling positions that you develop personally. Mine is available here.
There is a select group of stocks available to those seeking to initiate this strategy and build the kind of portfolio upon which it is based. The stocks I refer to are collectively known as the Dividend Champions, Challengers and Contenders or CCCs. These lists are maintained by Seeking Alpha contributor David Fish, updated the first of each month and available through this link .
For those of us favoring a dividend growth investment strategy or anyone looking to explore this strategy further, the information provided is priceless. Here anyone can quickly compare dividend growth stocks by important metrics like yield, payout ratio, beta, 1,3,5 year rates of dividend growth and estimated 5yr earnings growth.
All stocks on these lists are not equal. Some have low dividend yields, some have greater volatility, some lack dividend growth keeping pace with inflation. Just as most of you wouldn't purchase each stock on the DOW or the S&P 500, every stock on these lists is not for you. Using these list with due diligence you can create a portfolio I believe will safely support any reasonable retirement income objective.
My portfolio business plan requires a portfolio that collectively yields 4.5%. To maintain that requires that I pass on purchasing stocks with yields of less than 3%. Since stocks do drop, a stock yielding 2.5% today could yield 3% tomorrow.
The latest Excel list of Dividend Champions, Challengers and Contenders was posted on June 30th. In an hour of work that Sunday I had reduced the list from over 400 to just over 200, all yielding 2.5% or more.
Let's say you're considering converting a mutual fund or etf based portfolio into a Dividend Growth. Let's get started. You downloaded the latest excel spreadsheet of Dividend Champions, Challengers and Contenders. You reduce the list as I suggested based on preferred yield. Next you might look at column BX.
Column BX tracks a special formula known as the Chowder Rule. This formula suggests we avoid stocks where the combination of dividend yield and dividend growth rate in less than 8%. If we apply the Chowder Rule, an additional 36 stocks are eliminated from consideration. You now have a more manageable list with which to fashion your portfolio.
The next question you need to ask is how many stocks should make up my portfolio?
That's a question I'm afraid we each have to answer personally. I would consider the risk of owning a Dividend Growth portfolio smaller than 25 stocks each of equal weight. I'm of the mind that a portfolio of 50 or more stocks is ideal because any stock can cut or worst yet eliminate its dividend. Should that happen it would mean a loss of income. Since I own more than 50 equal weight positions, each represents 2% or less of my portfolio. I like the idea of a portfolio that limits the impact of such a cut.
Of the 180 stocks remaining on the lists, some are currently over valued, some fairly valued and others even under valued. If I were to assemble a new Dividend Growth portfolio today I would likely pass on any stock shown to be currently over valued. I would patiently wait for a better opportunity before buying. One of the easiest tools to determine value is Fast Graphs available at a monthly cost of under $10. Morningstar value rankings are also available on many stocks at no cost. Make no mistake, you will enhance your success with the investment strategy I am describing if you don't over pay for your holdings.
The next thing to consider in building or enhancing your portfolio is stability and safety. Back at the end of 2011 when I began self directed investing and was unsure about my portfolio I did a year by year back test of the period 2002 - 2011. I was looking to build a portfolio from stocks yielding 2% or more that showed the strongest performance during that turbulent 10 year period and had maintained and even grew their dividends during the same time frame. From my study emerged more than 60 stocks I call My Dividend Safety Superstars. To assess that list up-dated at the end of 2012 click here. These stocks would ultimately make up the core of my portfolio. Some were over priced and initially passed over when I was assembling my portfolio but became fairly priced when I was building my wife's, one year later. To succeed long term as investors we must learn patience.
The next thing any Dividend Growth investor needs to consider is quality. Standards & Poor's maintains quality rankings you should certainly consider before purchase.
Your next decision is how to handle sector distribution. You may discover that your not comfortable owning 5 stocks in each of the ten sectors. Dividend cuts in technology and big banks during the bear markets of 2002 and 2008 have made me uncomfortable about owning them. You may disagree with my decision. No problem, the market does as well since the highest weight in the S&P 500 index is the Technology and Financial Sectors with a total of 35.6%. I'm also light Consumer Discretionary and Industrials each weighting in at over 10% each in this index. With 58% plus invested in stocks I don't favor you can see why investing in the S&P 500 Index is not part of my investment strategy.
Next I believe a prudent Dividend Growth Investor needs to consider growth. I believe that growing company are more likely to continue and grow their dividends. The 132 stocks on my Dividend Growth watch list have an estimated 5 year Avenue annual growth average of 7.6%. Consider again the chart below that I first presented in Part One. Recognize its potential to provide safe and growing income.
Est. 5 Year
5 yr BETA
Finally consider a broker that provides accounts with free trades or better yet free month trades. This year my total portfolio management costs are $10 per month for Fast Graphs and $40 for David Van Knapp's E-Book. Talk about low cost.
Those are my thoughts on setting up a new Dividend Growth Income Portfolio. Now is the time for your suggestions and as always your questions. (Check out Part 3 of this series here.)