Seeking Alpha
Value, long only, dividend growth investing, portfolio strategy
Profile| Send Message| ()  

This article is meant to be an introduction of my income-oriented portfolio, which consists of dividend growth stocks and Lending Club notes for now. For those who don't know what Lending Club is, I briefly explain later in this article, but will explain more comprehensively in a future article.

I hope to inspire other new, incoming investors to take a look at this lucrative investment strategy that is commonly tossed aside by young investors as the "retirement investment strategy" for other strategies focusing on capital gains. If you're like me and you don't have the time nor energy to keep thinking about whether your portfolio is in the green or red every week, then this strategy is for you. With passive income from dividends and interest, you earn money just for waking up in the morning -- and that's what investing should be all about, your money working for you to generate more money without worry.

This is my first -- and hopefully last -- investment portfolio. By documenting my process, I want to provide readers with a real-life example of a young investor's income-oriented portfolio starting from the accumulation phase -- growing pains and all. I hope to also get constructive feedback on my Incomers portfolio, and to spur educational conversations about all things investing. I have gained most of my dividend growth investing knowledge from articles and comments on Seeking Alpha, so I have much respect for all contributors, readers and commenters. As Bill Nye the science guy wisely reminds us, "Everyone you will ever meet knows something you don't."

A Little About Myself

I have traded stocks, options, and forex since my third year of undergrad. It has been three years since then, and despite my anemic trading performance, I have soaked in an immeasurable amount of knowledge about capital markets. I now work full time in the structuring and issuance of municipal bonds. I came across the concept of dividend growth investing on SA, and I got hooked. One cannot find many things better than an entrée of consistently growing dividends with a side of natural stock appreciation from the dividend growth, and free DRIP for dessert. My only regret is not discovering DGI earlier.

Starting Point

We are in a very interesting market right now. Stocks are at all-time highs, bonds yield close to nothing, gold has fallen from grace, and it seems like everywhere I turn, risk-on, offensive investments are where it's at. I'm coming into a market where every equity investor has made a killing the past few years and everyone and their mothers are bullish. So it is very easy for a young investor to get caught up in all the hype and just start buying stocks, expecting this bull market to continue without looking down. Hey, that method may work; it has in the past few years, right? But as much as I'd like to hurry up and get rolling with this DGI portfolio, my gut just does not feel right building my core stock portfolio at these high prices. So I have decided to approach my initial portfolio allocation a little differently.

In its ideal form, my entire Incomers Portfolio will be made up of three sub-portfolios: a dividend growth stock portfolio, bond portfolio, and Lending Club portfolio. However, I have no treasuries or bonds yet, but will begin investing in bonds if and when yields rise to higher levels.

Here is the initial makeup of my Incomers Portfolio:

  • Dividend Growth Portfolio ("DGP") ~ $5000 (25%)
  • Lending Club Portfolio ("LCP") ~ $15,000 (75%)
  • Bond Portfolio ("BDP") = $0 (0%)

Contribution plan:

  • DGP = $8,040/year ($670/month)
  • LCP = $3,900/year ($325/month)
  • BDP = $0

By weighing my Incomers portfolio heavily towards LCP right now, I am taking advantage of the high yields of Lending Club notes (11% the past year) while I dollar cost average my way into my core DG stocks. I can live with this lopsided weight since I am contributing twice as much to the DGP for the next few years until I reach a more desirable weighting. Ideally, stock prices will fall or dip in the near future and I can accumulate stocks at higher dividend yields with all the cash I will be depositing into the account. But even if they don't fall, I have some skin in the game, and I will still dollar cost average into the market. I believe there will always be undervalued stocks in any market - it is just a matter of finding them. For now, with my LCP generating over 10% annually for me, I am not too worried about the opportunity cost of not being invested in stocks.

The Risks

The obvious risk is that I am heavily depending on Lending Club to continue generating a large return. I am confident my annual return will continue to be at least > 8% since the highest A grade notes generate 6% interest. This is the lowest interest rate, given to the highest rated notes on Lending Club, for now. My B and C grade notes boost my total return up to around 10-11%. So unless a large amount of notes default in a short amount of time (which seems unlikely, but is always a possibility) I am confident that I can continue generating a minimum of 6-8% return over the long run.

Another risk is the opportunity cost of missing out on dividend payments that I would get if I had allocated more money toward stocks. This is fine with me for now as I'd rather take the risk of missing out on some divvies to hopefully buy the same stocks at lower prices, and therefore at higher dividend yields.

Goals

Every investment portfolio should have some kind of goal. My investment goal is to generate regular income from my investments. In the following table, I show how I arrive at my specific income goals. My conservative assumptions include: 7% annual return for LCP (vs. my current 11% return) and yearly compounding (instead of the actual monthly compounding). For my DGP - 3.5% dividend yield, 5% dividend growth rate, and no price appreciation, with yearly compounding (instead of the actual quarterly compounding).

My aggressive assumption is my contribution amounts. This is a challenge to myself to be more disciplined in saving more money. It is a stretch for me to say that I will contribute almost $12k starting next year, but since this is the part of the investing process that I have most control over, I'd like to push myself on this front.

Goals:

  • Reach $20,000 annual passive income from the Incomers Portfolio by 2030, age 40.
  • Retire or semi-retire by age 50 with $40,000 annual income from the Incomers Portfolio, while hopefully also receiving rental income from investment properties.

I have no goals for future fixed income investments, like treasuries, since there are so many uncertainties with where rates will go right now. I will add that goal if and when the time comes to invest in bonds. It will be a judgment call on my part as well as dependent on my cash flow.

Dividend Growth Portfolio

DGR: 5%

Lending Club Port.

Total Portfolio

Age

Year

Contribution

Portfolio Value

Annual Income

Contribution

Portfolio Value

Annual Income

Portfolio Value

Annual Income

3.50%

7.00%

24

2014

$5,000.00

$175.00

$15,000.00

$1,050.00

$20,000

$1,225.00

25

2015

$8,040

$13,266.75

$465.15

$3,900

$19,950.00

$1,396.50

$33,217

$1,861.65

26

2016

$10,000

$23,869.22

$838.41

$3,900

$25,246.50

$1,767.26

$49,116

$2,605.66

27

2017

$10,000

$34,954.70

$1,230.33

$3,900

$30,913.76

$2,163.96

$65,868

$3,394.29

28

2018

$10,000

$46,546.88

$1,641.84

$3,900

$36,977.72

$2,588.44

$83,525

$4,230.28

29

2019

$11,000

$59,670.61

$2,108.94

$3,900

$43,466.16

$3,042.63

$103,137

$5,151.57

30

2020

$11,000

$73,397.34

$2,599.38

$3,900

$50,408.79

$3,528.62

$123,806

$6,128.00

31

2021

$11,000

$87,756.70

$3,114.35

$3,900

$57,837.40

$4,048.62

$145,594

$7,162.97

32

2022

$12,000

$103,779.76

$3,690.07

$3,900

$65,786.02

$4,605.02

$169,566

$8,295.09

33

2023

$12,000

$120,544.53

$4,294.57

$3,900

$74,291.04

$5,200.37

$194,836

$9,494.95

34

2024

$12,000

$138,087.49

$4,929.30

$3,900

$83,391.42

$5,837.40

$221,479

$10,766.70

35

2025

$13,000

$157,446.96

$5,630.77

$3,900

$93,128.82

$6,519.02

$250,576

$12,149.78

36

2026

$13,000

$177,708.51

$6,367.31

$3,900

$103,547.83

$7,248.35

$281,256

$13,615.65

37

2027

$13,000

$198,916.57

$7,140.67

$3,900

$114,696.18

$8,028.73

$313,613

$15,169.40

38

2028

$14,000

$222,117.81

$7,987.70

$3,900

$126,624.91

$8,863.74

$348,743

$16,851.45

39

2029

$14,000

$246,406.57

$8,877.09

$3,900

$139,388.66

$9,757.21

$385,795

$18,634.30

40

2030

$14,000

$271,836.50

$9,810.94

$3,900

$153,045.87

$10,713.21

$424,882

$20,524.15

41

2031

$14,000

$298,463.92

$10,791.49

$3,900

$167,659.08

$11,736.14

$466,123

$22,527.63

42

2032

$14,000

$326,347.96

$11,821.07

$3,900

$183,295.21

$12,830.66

$509,643

$24,651.73

43

2033

$14,000

$355,550.72

$12,902.12

$3,900

$200,025.88

$14,001.81

$555,577

$26,903.93

44

2034

$14,000

$386,137.37

$14,037.23

$3,900

$217,927.69

$15,254.94

$604,065

$29,292.16

45

2035

$14,000

$418,176.34

$15,229.09

$3,900

$237,082.63

$16,595.78

$655,259

$31,824.87

46

2036

$16,000

$453,739.48

$16,550.54

$3,900

$257,578.41

$18,030.49

$711,318

$34,581.03

47

2037

$16,000

$490,992.92

$17,938.07

$3,900

$279,508.90

$19,565.62

$770,502

$37,503.69

48

2038

$16,000

$530,020.30

$19,394.97

$3,900

$302,974.52

$21,208.22

$832,995

$40,603.19

49

2039

$12,000

$566,909.42

$20,784.72

$3,900

$328,082.74

$22,965.79

$894,992

$43,750.51

50

2040

$13,000

$606,571.09

$22,278.96

$3,900

$354,948.53

$24,846.40

$961,520

$47,125.35

You may have noticed I do not include a contribution for the first year 2014, this is to act as a buffer since I am going to contribute throughout the year and not all at the beginning of the year 2014. So, in my table, I am assuming the first contribution is made entirely at the end of year 2014 or the beginning of 2015 -- however one prefers to look at it. Also, this buffer will help me stay on track if I end up not being able to contribute $12k to the account the first year.

Dividend Growth Portfolio Guidelines

I will split the rest of the article up between the Dividend Growth Portfolio and Lending Club Portfolio. For my DGP, I will focus on the dividend yields, dividend growth rates, and dividend history of the stocks. I will only deal with the price of the stock when it comes to entry points, and sometimes exit price points. After buying, I don't plan to sell for decades if I don't have to. If a stock is consistently raising dividends and paying them out, it is doing well enough for me. Results speak for themselves.

Here are my guidelines for this DG portfolio:

1. Purchase Guidelines

  • The stock is on David Fish's CCC list (This in itself tells me the company has a history of strength. In my search for new stocks to buy, champions get priority over contenders, which get priority over challengers.)
  • Yield > 3.5%
  • Five-year DGR >= 8.5%
  • If the above two aren't met but the Chowder Rule (Yield + 5y DGR >12%) is met in a different variation, I may still consider the stock. I just prefer starting an investment with close to 4% current yield.
  • Stock price is preferably in a dip or at some sort of technical support.
  • I must believe in the lon- term profitability of the company or industry since I plan to hold forever (may be an obvious requirement, but needs to be said)
  • If a stock declines by 20% from my buy price, look to buy more shares (assuming long term view is still intact and the position is not overweight in the portfolio)

2. Selling Guidelines

  • Dividends are cut or frozen
  • Take partial capital gains profit if a stock rises very quickly in a very short amount of time. This really will be a judgment call on my part. Also, if I have 100 shares, I may prefer implementing covered call strategies instead to get some more income without necessarily selling the stock.
  • Unforeseen circumstances occur such as unfavorable economic or business impacts, merges, spinoffs, political and legal issues, etc.

3. House Rules

  • All dividends are reinvested through my broker's free DRIP service
  • Options may be used to hedge downside risk (sell calls) or to buy shares at desirable prices (sell puts)
  • First year: Contribute $333.33/month ($4,000/yr) to Roth IRA and $336.67/month ($4,040/yr) to taxable account. (may change due to my cash flow volatility)
  • $5 commission to buy/sell shares, and $1.50/option w/ no base

These guidelines will change as I learn and grow. I am trying to keep this DGP simple and easy to manage. Suggestions and constructive criticisms are always welcome.

My current DGP holdings:

Symbol

Shares

Price

Yield

Div/Share

Div/Year

5Y DGR

Value

Weight

KMI

55.63

$32.58

5.28%

$1.72

$95.68

7.40%*

$1,812.43

37.97%

MO

54

$37.67

5.10%

$1.92

$103.68

14.30%

$2,034.18

42.62%

HCP [R]

12.16

$35.84

5.86%

$2.10

$25.54

2.40%

$435.81

9.13%

OHI [R]

16

$30.65

6.26%

$1.92

$30.72

9.40%

$490.40

10.27%

Total/Avg

5.36%

$255.62

10.09%

$4,772.82

100%

Tax Cash

$313.62

Roth Cash

$11.63

[R] = Holdings in Roth IRA
* Five-year DGR of KMP since KMI does not have five years of dividend history. It is a conservative figure considering KMI declared an expected 10% increase of their dividend payout recently.

Notes: I bought HCP and KMI before I came up with these guidelines. I realize that HCP does not meet my five-year DGR requirement, but since I own it already, I will keep it and sell if my selling guidelines are met. My diversification is whack in terms of weights because of the small account value; I am not stressing about this yet since I am in accumulation phase, and MO and KMI are not going anywhere anytime soon. As my portfolio matures, I plan to keep each individual stock under at least 5% of my portfolio.

Lending Club Portfolio (LCP) Guidelines

Lending Club ("LC") is a peer-to-peer lending and borrowing platform where borrowers request for loans and investors fund these loans in $25 increments. In return, the borrowers pay investors back monthly interest + principal (amortized loans). I have invested in Lending Club notes for a year now, and my ROI was about 11.80% the past year. I am expecting my return for the next year to lower (~9-10%) due to multiple late loans and my goal to invest in higher grade (lower interest) notes.

Guidelines:

  • Invest in notes with average 8% interest or better
  • My filter requirements for the notes I invest in:
    • Borrower is requesting for a loan under $25,000
    • If A grade note: credit score must > 720
    • If B grade note: credit score must be > 680
    • If C grade note or lower: prioritize those with the highest credit scores and other factors in this list.
    • Employment history > 3 years, they must be employed.
    • Income > $4,000/month and preferably 10 times the amount of their monthly loan repayment
    • Verified Income borrowers get priority
    • Zero delinquencies in the past 2 years
    • Debt-to-Income ratio under 50%
    • Revolving credit line under $50,000
    • Prioritize those who own a house over those who rent over those with a mortgage
  • Contribute $125/month ($1,500/yr) to my Roth IRA LC account
  • Contribute $200/month ($2,400/yr) to taxable LC account

Lending Club Portfolio:

In Funding

Current

Late

Default

Cash

Charged off

Value

NAR

Worst NAR

Worst Interest/Yr

LC Roth

$125

$10,462

$185

$23

$3

$45

$10,800

11.77%

9.82%

$1,027.37

LC Tax

$150

$4,055

$87

$0

$15

$46

$4,308

12.98%

11.50%

$466.33

Total/Avg

$275

$14,517

$272

$23

$18

$91

$15,108

12.11%

10.29%

$1,493.69

In Funding = Amount of notes still in funding or under review by Lending Club before they finalize the loan and transfer the funds to the borrowers and interest begins to accrue. This category will not earn interest until they are issued and "current". A good way to view this category is to see it as unsettled funds waiting to be settled after you put an order in.

Current = Amount of notes that are issued and current -- these funds are earning interest.

Late = Amount of notes that are either in Grace Period or late on payments by 16-120 days. These borrowers have not paid on time, and could potentially default.

Default = Amount that has defaulted but has not yet been finalized, therefore they are still a part of my portfolio Value - these funds are rarely retrieved, can be considered unsettled realized losses, and will most likely join the Charged off column soon.

Charged Off = Total amount of finalized defaulted notes that are no longer calculated in my portfolio Value. These funds are realized losses.

NAR = Net Annualized Return -- the average annual return of my portfolio calculated by Lending Club taking the default rates into account.

Worst NAR = The worst case scenario annual return, also provided by Lending Club. If all of my Late notes defaulted on me today, this adjusted NAR would be my annualized return. I project my annual income with this rate because to me, it is better to expect and plan for the worst and hope for the best.

Conclusion

As of now, my portfolio is on track to generate more than enough income to meet my goals for year 2014. Plus I will invest more funds as the year goes on. It may seem odd that I am starting off my goals so much lower than what I am actually getting, but again, I like to stay conservative and there may be hiccups along the way that may take me back a few steps. In those cases (that hopefully never happen), my buffer will allow me to still stay on track for $20K/year by age 40.

I have now laid out the foundations of my Incomers portfolio. In my next few articles, I will detail why I bought the stocks I did for my DGI portfolio, as well as what stocks I am looking to acquire in the future. I will also provide a more comprehensive introduction to Lending Club, shedding light on how LC really works. Here I will talk about some pros and cons as well as the risks and rewards of investing in Lending Club. Lastly, I plan to post quarterly updates for my Incomers portfolio on top of these "content" articles. Stay tuned and I welcome any comments, questions, or constructive criticisms.

Disclaimer: I am not a professional investor or adviser, so all information provided is for information purposes only and shall not be construed as investment advice. Before investing, one must do his or her own due diligence and understand all the risks involved.

Source: Young 'Incomers' Portfolio: An Introduction