Lately, I see the word "quality" being thrown around on SA dividend income related articles. I see "quality" as having 2 facets. One, we want a quality income portfolio. Two, this portfolio is made up of a group of high quality dividend payers. In the first article of this 2 article series (Part 2 is here), I'm going to explore quality at the portfolio level. At the portfolio level, we look at the bigger picture to see whether the portfolio as a whole is continuing on its track in building a growing income stream from dividends.
Building a Quality Income Portfolio
First, let's look at building a quality income portfolio. It should:
have a minimum yield
have a minimum dividend growth rate
have consistent periodic contributions
mix of different dividend growth rate companies
take compelling growth opportunities
prepare an emergency fund / buffer
1) Minimum Yield
As income investors, we care about the current yield of the portfolio. So it, as a whole, should have a minimum yield which we are happy with. I like my yield sitting at 3% or more after tax.
2) Minimum Dividend Growth Rate
As income investors, other than the current yield, we might care more about the growth rate of our dividends. This is especially true for younger investors who have many years of compounding and time for the companies we hold to grow. I like my portfolio dividend growth rate to be higher than the average inflation rate of 3%. Obviously, the higher the better. Realistically though, I'm aiming for an annual increase of 7% by the company increases alone. This means I'm counting out the income growth effect brought in by periodic contributions from my day job. Actually, I haven't quite figured out how to factor that in yet, as I contribute inconsistent amounts periodically. I would appreciate feedback on how others track this.
3) Consistent Periodic Contributions
I applaud you for building an ever-growing portfolio of quality dividend blue chips, but it's even better to consistently contribute periodically to the portfolio. This way, we are not only allowing time for the companies we hold to grow, but we're making an effort every month, quarter, or year to contribute to the growth of our net worth. Investors in their accumulation phase like to reinvest their dividends through a dividend reinvestment program or reinvesting dividends manually.
4) Mix of Different Dividend Growth Rate Companies
Having a mix of different dividend growth rate companies creates diversification in the portfolio. For example, I like Ross Stores (ROST) for its high dividend growth. However, I also have Coca-cola (KO) for moderate growth and stability.
5) Take Compelling Growth Opportunities
Instead of using a full-fledged income portfolio, after building satisfying positions in their core companies, more adventurous investors might allocate a portion of their funds in growth opportunities. Primarily, they would be for capital gains, but that doesn't mean that they aren't also paying dividends. A good opportunity in the basic materials sector is BHP Billiton (BBL). In the precious metals sector, we have Silver Wheaton (SLW). For heavy machinery, there are Caterpillar (CAT), and Deere (DE).
6) Emergency Fund / Buffer
We don't want to be in a position to be forced to sell our income-generating assets. As a result, we should keep a stash of cash which is very liquid. This cash could be stored safely in our savings account for when an unexpected expense arise.
Obviously, a quality income portfolio is composed of high quality dividend companies. So, let's take a look at the list of criteria for possible stocks to add to our portfolio.
For the portfolio as a whole, we need to keep in mind to maintain a minimum yield and minimum dividend growth rate. We must also contribute new capital consistently to the portfolio to fertilize its growth along with the dividends which are coming in. We want a mix of companies with different dividend growth rates for a nice blend. For the more adventurous investors, they might decide to take on compelling growth opportunities which have a capital gain focus, but also pay a dividend. Last but not least, ensure to have some buffer so that we do not need to sell our income-generating assets in an emergency.
Stay tuned for the next article on Building a Quality Income Portfolio at the Stock Level!