As I've learned more about Dividend Growth Investing (DGI), adopted it as my investing method, and began to realize how good the returns could be, I found myself wanting to share it with those around me. I have begun discussing DGI with people at work and have shown them how they can use it to not only improve their investing results, but also to take control of their own portfolios. Eventually I turned to my parents to see if I could use DGI to help them with their retirement account. I approached them and asked if they were happy with the performance of their retirement account, and if I could review their portfolio. Their portfolio was in a Fidelity account, and was run by the Fidelity Portfolio Advisory Services (PAS). They really didn't know how well it had been doing because it's not something they paid attention to. So they gave me permission to look at the portfolio and tell them what I thought.
As I examined their portfolio I was shocked. Fidelity had put my parent's money in 24 different mutual funds. 24! I mean, I'm all for diversification, but 24 different mutual funds??? And I looked at the top holdings of some of these mutual funds, and some of them held other mutual funds! I calculated the yield for the portfolio, and determined that it was about 1.5%. Way to low for a retirement account, in my opinion. And with all the mutual fund fees I was sure that holding all these mutual funds was costing them money.
Here is a list of the mutual funds they held, the expense ratio, and the yield.
Arden Alternative Strategies (ARDNX)
Blackstone Alternative Multi Manager (BXMMX)
Strategic Advisors Short Duration (FAUDX)
Strat. Advis. Core (FCSAX)
Fidelity GNMA Fund (FGMNX)
Fidelity Municipal Income (FHIGX)
Strat. Advis. International (FILFX)
Strat. Advis. Core Income (FPCIX)
Strat. Advis. Income Opportunity (FPIOX)
Strat. Advis. Emerging Markets (FSAMX)
Strat. Advis. Small Mid Cap (FSCFX)
Strat. Advis. Growth (FSGFX)
Fidelity Short Term Bond (FSHBX)
Fidelity Advisor Limited Term Muni In (FSTFX)
Fidelity Total Bond (FTBFX)
Strat. Advis. US Opportunity (FUSOX)
Strat. Advis. Value (FVSAX)
T. Rowe Price Tax-free Income Adv. (PATAX)
PIMCO Short Term Admin (PSFAX)
PIMCO Total Return Admin (PTRAX)
Templeton Global Bond (TPINX)
Wells Fargo Advantage Muni (WUSMX)
DWS Strategic High Yield Tax Free (SHYTX)
The Merger Fund is a fund that tries to profit off of arbitrage opportunities from mergers and acquisitions. Why would a portfolio manager put money from a retirement account into that kind of mutual fund?!?! Crazy, if you ask me.
Now, of course, if the returns achieved through this "diversification" had been good I would have said "well, ok. I guess it's working. They must know what they're doing so I'll leave it alone". But the returns were horrible! For example, this year, the S&P is up over 15%, but the portfolio was up only 7%. Now the portfolio was supposedly managed conservatively, as per my parent's wishes, and this could justify the underperformance this year. But if it underperforms during bull markets due to a conservative focus, it should conversely out perform during bear markets. But when I looked back to 2007-2009 to see how the portfolio had performed during the great recession I found that their portfolio was down just as much as the market. In fact, the Fidelity website itself reports that the performance of their portfolio, as a whole, significantly lagged the market over the past ten years. Did they make up for this under performance by producing excellent income? No. As I mentioned, the yield was only about 1.5%. So they gave my parents poor income and poor total returns. And for this horrible performance they charged my parents over $3700 dollars in fees this year alone! Fidelity should not be charging that kind of money for serving my parents so poorly.
I spoke to my parents and told them that I felt that Fidelity was not doing a good job for them, and asked if I could take over their portfolio and work with them to invest their money better. I explained the basics of DGI to them, and the concept that we would be focusing on the income we could produce, rather than the capital gains. It made sense to them and they agreed to fire PAS and let me become their manager.
To begin the process I spoke to my brother. He is a CPA, and between the two of us we decided that the appropriate weighting for the account would be to invest 70% in dividend stocks and 30% in bond funds. Since I feel very comfortable and confident with DGI, but know very little about bonds and bond funds, we decided that I would control the dividend part and he would take the bond part. For the rest of this article, and for all future portfolio updates I will be discussing just the DGI part of the portfolio.
Since my parents are already in retirement I want to make sure that the dividends they collect are adequate to cover their Required Minimum Distribution (RMD). So I felt that a total portfolio yield of at least 4% was necessary. To do this I decided to focus on higher yielding investments such as MLPs, REITs and utilities. In a previous article I discussed my criteria for picking DGI stocks. In preparing to redo my parent's portfolio I started with these criteria, but modified them somewhat. As always, I started with David Fish's CCC list. I looked at all the MLPs, REITs and utilities on the CCC list and eliminated all those with a yield below 3.0% and a Chowder number (yield + 5yr DGR) less than 8%. I then looked at the passing stocks for their 1yr, 3yr, 5yr and 10yr DGRs, looking for consistency. For example, Plains All American (PAA) has the following DGR for the different time periods; 8.6%, 5.4%, 5.2%, 7.2%. This is a steady 5-8% growth rate, with the added bonus that the past year's rate was higher than it had been in previous years. Finally, I looked at the FAST Graph of the remaining stocks, looking for a general uptrend in the Funds From Operations (FFO) over the past ten years, and to see that the stocks are not overvalued, as determined by the True Worth line on the FAST Graph.
This is the list of MLPs, REITs and utilities that made the cut.
Alliance Resource Partners LP (ARLP)
Kinder Morgan Energy Partners* (KMR)
Williams Partners LP (WPZ)
Buckeye Partners LP (BPL)
Plains All American Pipeline LP
Sunoco Logistics Partners LP (SXL)
Omega Healthcare Investors (OHI)
Digital Realty Trust (DLR)
Realty Corp (O)
Wisconsin Energy (WEC)
Avista Corp. (AVA)
Alliant Energy Corp. (LNT)
Dominion Resources (D)
Northeast Utilities (NU)
New Jersey Resources (NJR)
*Bought KMR rather than KMP, as discussed below.
Since a strong, safe and stable yield is my main goal, these are the stocks that are going to make up the core of my parent's portfolio.
But In addition to my core stocks I wanted to include some more "regular" stocks to try to get some extra dividend growth into the portfolio, just to keep the income rising year after year. I went back to the CCC list and screened the stocks for a yield > 2.0%, a payout ratio < 60%, a Chowder rule > 12% and a quality rating of A- or better by S&P. Again, I looked at the FAST Graph of the passing stocks looking for an uptrend in the 10 year earnings history and good valuation. From all the stocks that passed the screen I picked out the highest yielding stocks, and a few that, even though they have a lower yield, have a high DGR and appear to be especially undervalued at this time. And I also made sure that I picked stocks in a variety of industries to ensure I had good diversification. The stocks I picked are:
Lockheed Martin (LMT)
McDonald's Corp. (MCD)
Microsoft Corp. (MSFT)
General Mills (GIS)
Baxter International Inc. (BAX)
Raytheon Company (RTN)
Target Corp. (TGT)
Norfolk Southern (NSC)
First of Long Island Corp. (FLIC)
Deere & Company (DE)
CSX Corp. (CSX)
AFLAC Inc. (AFL)
Qualcomm Inc. (QCOM)
My parents actually have two accounts, a taxable WROS account and a traditional IRA. I recently learned that holding MLPs in a tax deferred account may not be the best idea, so I used the WROS account to buy the MLPs. All except Kinder Morgan. I bought Kinder Morgan in the tax deferred account, but I bought Kinder Morgan Management LLC , which pays distributions in extra shares, rather than in cash, instead of KMP, since owning KMR in a tax deferred account does not have any extra tax implications. All other stocks, including the REITs and utilities were bought in the tax deferred account. I bought equal positions in each stock. The starting yield of the portfolio is 4.03%.
Now that the portfolio is set I will follow it closely, make sure the income is adequate to my parents needs, and make changes as is required, focusing at all times on the income produced.
If you, or anybody you know, are having your portfolio managed by a "professional", make sure you check your results to be sure that you are satisfied with their performance. Don't assume that they are doing well by you. My parents learned the hard way that their money managers were not always looking out for their best interests, or doing everything they could to maximize their clients' returns. It is my opinion, and everything I learned here on SA supports my feelings, that by using a strict DGI philosophy I can do a significantly better job managing my parents account than the PAS did. As this portfolio progresses we will see how I do. I will post updates here on SA to show the progress of the portfolio, and to show whatever transaction I make.
And finally a question for the SA community. Whatever income is received in my parent's account will be used for the RMD. But I don't actually have to take the distribution until the end of the year. If I set up dividend reinvestment for all the stocks, it will increase my yield and improve the returns, but then I will have to sell some stock at the end of the year to come up with the money to withdraw the distribution. This means paying commissions on the sales. Is it worth it to reinvest the dividends throughout the year and pay the commissions at the end of the year when I have to make the sales? Or should I just hold the dividends in cash and use that for the distribution? I'm not sure which way would be most cost effective. Any thoughts?
Thank you for reading my article. I welcome your comments and criticisms.