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Long-term horizon, portfolio strategy, bonds, dividend investing
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Summary

  • I only hold three stocks to date, most of my holdings are by the way of ETFs.
  • Many studies show that one can achieve diversification with 15-20 companies, perhaps I can lower the fees I pay by purchasing enough members of an index that I want to.
  • In the end the most cost effective solution may lie with purchasing an ETF combined with a few individual stock selections.
  • I am looking to capture the market-topping performance of the Dividend Aristocrats and Vanguard's VIG and VDIGX.

There's only one reason to be a stock picker in the accumulation phase, and that is to beat the market. The market in the U.S. is usually represented by the S&P 500 (NYSEARCA:SPY). That broad market index offers 500 of the most influential companies across various sectors in the U.S. economy and that index delivers very generous returns over many periods. Over the last ten years the index has delivered about 7.3% annualized total returns. Nothing spectacular, but nothing to sneeze at just the same. And certainly the market has delivered much more generous returns in other periods, and much less in others. Any monies invested from 1999 to 2001 would have delivered very paltry returns when we factor in inflation.

Looking at things from early 2014, I am in protection mode. There's likely not much money to be made from here, and that is from dollars invested at the current prices and current valuations. That does not mean that investors should sit on their hands. Quite the contrary, investors in the accumulation phase should still invest on their regular schedule and stick to their investment plan. For me that means continuing to invest on my regular schedule. I still put into my registered retirement plan as Tangerine has a very generous matching program. I purchase every two weeks on that plan. I also move funds from my Tax Free Savings Account (our Roth equivalent) to an investment fund. Both of those amounts go into our Tangerine Balanced Portfolio that offers 60% stocks and 40% bonds.

I also have a series of self-directed retirement accounts with the discount brokerage, TD Waterhouse. Those accounts are currently in the range of 50% stocks and 50% bonds. In those accounts I have been attempting to fix a couple of shortcomings - sure we can call them mistakes. I suffered a very pronounced home bias. That allowed me to have a very significant market outperform during the U.S. market's lost decade of 2000-2010. Monies put into the market in January of 2000 would have lost significant spending power through that decade, even with dividend reinvestment if we use the S&P 500 as the benchmark. But for us Canucks, and for U.S. Canucks who made the mistake of having a Canadian home bias, we got lucky and made out like bandits. Sometimes you gotta be "ill informed" to get lucky.

Here's the Canadian vs. U.S. market through much of that decade.

(click to enlarge)

My market beat was perhaps even a little more pronounced as I got lucky with a few gold companies and ETFs, and I also invested in the Sprott Canadian Equity Fund. Eric Sprott was a perma gold and resources guru. The fund was certainly not a Canadian equity fund. It held gold and silver assets directly and also invested in many smaller cap resource companies. Here's how Mr. Sprott performed during that decade vs. the Canadian markets.

Yes Mr. Sprott was the Warren Buffett of resources and precious metals.

I certainly moved to safety early in the bull run, moving to that less volatile mix of stocks and bonds. And currently our considerable portfolio income is largely reinvested in Vanguard's High Yield Dividend Fund (NYSEARCA:VYM). I also hold the Dow Jones (NYSEARCA:DIA) on the U.S. side of the equation. The reason for becoming a "stock picker" would generally be to lower the fees that I pay for the ETFs, and also to find that market beat.

On the market beat front, it may be time for me to shift gears. Dividend growth does offer a historical market outperform. VYM is a high yield dividend ETF first, that does offer some very decent dividend growth. But as I suggested in this article, dividend growth's market beat is due to the combination of dividend growth and a low payout ratio. That's certainly not what VYM is all about.

The reason I selected VYM is for the income in case I did need to spend some of the income. I made a recent career change from the higher paying world of advertising to essentially starting over (at age 50, ha) to the world of finance. We have had to use our emergency savings account fund during this transition. How many times can you cut your salary in half before something has to give? LOL.

But moving forward, I am confident enough that I will not have to spend registered funds. I can move away from the income focus (that does not provide that market beat) to the land of dividend growth and lower payout ratio that delivers that market beat. And we can find that market beat in simple indexes such as the Dividend Aristocrats (S&P 500 constituents that have raised their dividend for 25 years and counting, plus Vanguard's Dividend Appreciation ETF (NYSEARCA:VIG) and their managed dividend growth fund VDIGX.

Many studies show that purchasing 14-18 companies within an index can replicate the returns. There is certainly the opportunity for me to replicate the index, or engage in the practice of many mutual fund managers, and simply skim the index. As I have demonstrated in articles, simply buying VIG's top 10, 15 and 20 would give you that market beat. Over the last few years buying VIG's top 20 would get you quite close to the fund's total return.

So here's the strategy I would employ. For starters, I would go to the most successful long term investor on the planet, Warren Buffett. He does buy dividend companies; not for the dividends of course, though he's happy enough to take them and reinvest them in the most skillful manner. He finds value, that's what Mr. Buffet is all about. So I am going to go out on a limb and suggest that when the oracle purchases dividends he selects companies with the potential to deliver on total return, they offer that long term value.

Given that, here are the top 8 dividend payers in the Berkshire Hathaway Fund. (NYSE:BRK.A) (NYSE:BRK.B). Special thanks to Seeking Alpha author Eddie Herring who presented an article on Warren's dividend payers, and the chart below.

That's my starting point. From there I was looking to add or skim the best from those market beating dividend aristocrats. So I looked at the aristocrats that the Vanguard Funds hold - again trusting the value filters that they use in their selection criteria.

I also wanted to own those top 20 from Vanguard's VIG. Because of overlap (I'll call that consensus) it led me to 32 companies. The "+" sign denotes that the company or aristocrat is held in that fund. VIG -A and VDIGX -A denotes that the artistocrat is held in that fund.

Again, we have Warren's top 8, the aristocrats held in VIG or VDIGX and members of VIG's top 20.

Company

Payout Ratio

VIG -A

Yield

VDIGX - A

BRK

Aristocrat

VIG T-20

VIG

EOG Resources

9

.5%

+

+

American Express

18

1.1%

+

Chubb Corp

19.0

+

2.3%

+

+

+

CVS Caremark

24

1.15%

+

+

IBM

26

2.0%

+

+

+

Ecolab Inc

28.5

+

1.01%

+

+

+

Wells Fargo

30

2.45%

+

Caterpillar

30

2.33%

+

+

U.S. Bancorp

30

2.3%

+

Medtronic

30.7

+

1.91%

+

+

+

+

Nike

31

1.3%

+

+

Monsanto

32

1.6%

+

+

QUALCOMM

33

2.2%

+

+

Exxon Mobil

33.1

+

2.51%

+

+

+

+

+

Lowe's

32.5

+

1.54%

+

+

+

United Technologies

35

1.99%

+

+

Occidental Petroleum

35

2.98%

+

+

Abbott Labs

35.0

+

2.26%

+

+

+

Wal-Mart

38.59

+

2.47%

+

+

+

+

+

Walgreen

40.9

+

1.89%

+

+

+

Target

43.4

+

2.87%

+

+

+

3 M Co

49.3

+

2.48%

+

+

+

PepsiCo

51.26

+

2.65%

+

+

+

Johnson & Johnson

52.7

+

2.67%

+

+

+

+

Texas Instruments

55

2.6%

+

+

McDonald's

55.7

3.23%

+

+

Colgate Palmolive

56.0

+

2.15%

+

+

+

+

Coca-Cola

57.7

+

3.0%

+

+

+

+

+

Emerson Electric

59.0

+

2.51%

+

+

+

Procter&Gamble

60.6

+

3.15%

+

+

+

+

Automatic Data & Processing

61.0

+

2.52%

+

+

+

Cardinal Health

108

1.78%

+

+

Here are the tickers for those 32 holdings: EOG Resources (NYSE:EOG), American Express (NYSE:AXP), Chubb (NYSE:CB), IBM (NYSE:IBM), Ecolab (NYSE:ECL), Wells Fargo (NYSE:WFC), Caterpillar (NYSE:CAT), U.S. Bancorp (NYSE:USB), Medtronic (NYSE:MDT), Nike (NYSE:NKE), Exxon Mobil (NYSE:XOM), Lowe's (NYSE:LOW), United Technologies (NYSE:UTX), Occidental Petroleum (NYSE:OXY), Abbott Labs (NYSE:ABT), Wal-Mart (NYSE:WMT), Walgreen (WAG), Target (NYSE:TGT), 3M (NYSE:MMM), PepsiCo (NYSE:PEP), Johnson & Johnson (NYSE:JNJ), McDonald's (NYSE:MCD), Colgate Palmolive (NYSE:CL), Coca-Cola (NYSE:KO), Emerson Electric (NYSE:EMR), Procter & Gamble (NYSE:PG), Automatic Data Processing (NASDAQ:ADP), Cardinal Health (NYSE:CAH), Monsanto (NYSE:MON), Qualcomm (NASDAQ:QCOM), CVS Caremark (NYSE:CVS), Texas Instruments (NASDAQ:TXN).

What's not surprising is that 6 of the Buffett dividend picks are in that low payout ratio sweet spot of under 40%. The other two, Coca-Cola and Procter & Gamble are certainly two of the aristocrat stalwarts with higher payout ratios. It would cost me $320 to purchase these companies, plus the cost of liquidating VYM and the Dow Jones ETF . From there, I would only have trading fees. But surprisingly, given that one can purchase VIG for 10 basis points, the most cost effective approach is still indexing.

That means that I would have to get creative by combining the purchase of Vanguard's VIG and then add the individual stock picks. I would then pay .10% for the VIG holdings and would then purchase the other 5 companies directly. I would then of course lose the equal weighting option from individual stock selection. The portfolio would fall in potential yield as well.

That modified stock pickers portfolio would then look like this; VIG plus American Express, U.S. Bancorp, McDonald's, Cardinal Health and Wells Fargo. Yes, you may notice that McDonald's, an initial staple with VIG is no longer a VIG holding.

On fees, indexing is still more cost effective than purchasing those 32 individual companies. It's all even on fees at $270,000. The most cost effective route is VIG plus those individual stock holdings until the portfolio value crosses above $270,000 for my U.S. holdings. Also, it would be cheaper to manage the new purchases along the way as well. Depending on performance and rebalancing, at times new purchases would total $10 to buy the whole basket of VIG vs. many individual stock purchases.

Essentially, what I would be accomplishing is buying the market beat history or potential of VIG and Warren Buffett plus altering the sector exposure. Here's VIG's sector breakdown.

VIG is a little light on the financials, I would be topping that up at the suggestion of the greatest stock picker in history. If Warren's good with the financials in this environment, who am I to argue? His guess is better than mine, and maybe yours.

Given that this is a very cost effective approach, I would then move to my next target and that would be adding in the top holdings from VDIGX that are not in VIG, or the lowest payout ratio companies from the dividend aristocrats list and VIG. I would not be a stock picker, but simply an index skimmer, adding more from a value-seeking formula of stock selection that has proven to outperform to date.

One of the greatest advantages is, there is no evaluation for me to do. I don't have the time to evaluate individual companies. And frankly, in line with those who share their results on Seeking Alpha, I don't think my expertise would deliver in the way of returns above what the index is providing. Quite simply, the Aristocrats index and the index that Vanguard's VIG tracks (the NASDAQ US Dividend Achievers Select Index) have a history of outperforming the broader market. That's more than good enough for me. Another option for investors would be to simply buy VIG and the dividend aristocrats available in the ETF (NYSEARCA:NOBL).

What's next?

Sometimes writing an article leads to conclusions and actions. I am confident with this simple approach. I will go ahead and make the moves for my U.S. holdings and also do more research to discover if I can replicate the Canadian index in a simple and cost effective manner.

What was most interesting is that given the very low fees of Vanguard, it is still more cost effective to buy the index. That may be the reality for a while.

Happy investing and be careful out there.

Disclosure: I am long VYM, DIA, SPY. 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. Dale Roberts is an investment funds associate at Tangerine Bank (formerly ING Direct). The Tangerine Investment Portfolios offer complete, low-fee index-based portfolios to Canadians. Dale's commentary does not constitute investment advice. The opinions and information should only be factored into an investor's overall opinion forming process.

Source: If I Was A Stock Picker, Here's What I'd Do