What is Your Portfolio's Design?
Are you preparing for retirement? Already in retirement? Have you thoughtfully designed your retirement portfolio? Do you have a portfolio of individual equities or mutual funds/ETF? Bonds or preferred stocks? What about gold, other commodities, or rental property?
This article will be of particular interest to investors who focus on a portfolio of individual stocks. Regardless of one's choice of investments, it is crucial to have a plan. Bob Wells has demonstrated the success that can be achieved by having a solid, written plan. The design of a portfolio is a critical element for those preparing for retirement and for those in retirement who are managing their portfolios. A clear design helps reduce the emotional element of investing.
A Traditional Design May Limit Growth
A traditional model of portfolio design has been to divide a portfolio into two parts: equity (i.e., common stocks) and fixed income (i.e., bonds). One theory is that the percentage of bonds in a portfolio should equal one's age. For example, a 60-year-old would have 60% in bonds and 40% in stocks. A 70-year-old would have 70% in bonds and 30% in stocks. Critics of this approach point out that one may need a heavier weighting of stocks later in life in order to enhance a portfolio's continued growth.
How Many "Buckets" Are Available to You?
I view retirement income as coming from five "buckets." Bucket #1 is an IRA. Bucket #2 is a pension annuity. Bucket #3 is Social Security income. Bucket #4 is savings in a taxable account. Bucket #5 is income generated from work done in retirement.
I consider buckets #2 and #3 (pension and Social Security) to be fixed income investments. I have calculated the "annuity value" of both of these buckets. In a later article, I plan to discuss the importance of calculating the annuity value of one's Social Security account. I suggest you view Social Security as an annuity, and I encourage you to calculate the implied annuity value of your Social Security account if you start drawing from it at age 70 compared to the annuity value if you start drawing from it at 65 or 62. But, for the purpose of this article, the main idea is to see Social Security (and any other annuity you receive--such as a pension annuity) as fixed income.
For me, bucket #1 (my IRA) is an equity account. One major decision every investor must make regarding the equity portion of his or her account is whether to invest in common stocks, equity mutual funds, equity ETFs, or some combination. That, too, is a discussion for another article. The focus of this article is about investing in individual companies, which is the path I have chosen.
Forty-Four Equity Holdings In My "IRA Bucket"
I currently have 44 equity holdings in my IRA. Here are the holdings by sectors. Dividend Champions are in italic bold. Dividend Contenders are in regular italics. Dividend Challengers are noted with an asterisk.
Energy (target sector allocation is 10.0%; current allocation is 14.9%):
Kinder Morgan Partners (NYSE:KMP),
Enterprise Products Partners (NYSE:EPD), and
I am currently overweight KMP and LNCO. My target goal of 10% for the energy sector is represented by a 2.5% allocation for each of these three holdings, and another 2.5% in a yet-to-be determined alternative energy stock, such as a "YieldCo" stock that is being planned by companies such as NextEra Energy.
Materials (target sector allocation is 2.5%; current allocation is 3.1%):
Industrials (target sector allocation is 10.0%; current allocation is 6.4%):
Emerson Electric (NYSE:EMR),
Deere & Company (NYSE:DE), and
I am currently underweight DE. My target goal for the sector is 10%, with 2.5% in each of three companies above, plus another 2.5% allocation in the 3M Company (NYSE:MMM)--which has yet to be purchased.
Consumer Discretionary (target sector allocation is 10.0%; current allocation is 8.7%):
Genuine Parts (NYSE:GPC),
Leggett & Platt (NYSE:LEG),
Tupperware* (NYSE:TUP), and
EPR Properties (NYSE:EPR).
Consumer Staples (target sector allocation is 10.0%; current allocation is 8.8%):
Procter & Gamble (NYSE:PG),
PepsiCo (NYSE:PEP), and
General Mills (NYSE:GIS).
Healthcare (target sector allocation is 12.5%; current allocation is 12.0%):
Johnson & Johnson (NYSE:JNJ),
HCP Inc (NYSE:HCP),
Universal Health Realty Income Trust (NYSE:UHT)
LTC Properties (NYSE:LTC),
Ventas (NYSE:VTR), and
Real Estate Investment Trusts (target allocation for this part of the Financial Sector is 15.0%; current allocation is 23.9%):
National Retail Properties (NYSE:NNN),
Realty Income (NYSE:O),
WP Carey (NYSE:WPC),
Starwood Properties Trust* (NYSE:STWD),
Chambers Street Properties (NYSE:CSG), and
American Realty Capital Properties (ARCP).
I am overweight O, WPC, and STWD.
Other Financials (target allocation for this part of the Financial Sector is 5.0%; current allocation is 4.5%):
Old Republic International (NYSE:ORI),
Triangle Capital* (NYSE:TCAP), and
Main Street Capital (NYSE:MAIN).
Hercules Technology Growth Capital (NYSE:HTGC) is on my watch list but I have not yet made a purchase.
Information Technology (target sector allocation is 2.5%; current allocation is 2.0%):
Digital Realty Trust (NYSE:DLR).
Telecommunications (target sector allocation is 2.5%; current allocation is 2.8%):
AT&T (NYSE:T), and
BCE Inc* (NYSE:BCE).
Utilities (target sector allocation is 15.0%; current allocation is 12.3%):
American States Water (NYSE:AWR),
Northwest Natural Gas (NYSE:NWN),
Consolidated Edison (NYSE:ED),
WGL Holdings (NYSE:WGL),
PPL Corp (NYSE:PPL),
Southern Company (NYSE:SO),
Wisconsin Energy (NYSE:WEC), and
Westar Energy (NYSE:WR).
Cash (target allocation is 5.0%; current allocation is 0.6%).
David Fish's CCC Lists
Many Seeking Alpha readers are familiar with David Fish and his "CCC lists" of Dividend Champions, Contenders and Challengers.
Sixteen of the current 44 holdings (36.4%) are Dividend Champions. These companies have increased their dividends annually for at least 25 consecutive years.
Thirteen (29.5%) are Dividend Contenders. These companies have increased their dividends or distributions for at least 10 consecutive years.
Six (13.6%) are Dividend Challengers. These companies have increased their dividends or distributions for at least five consecutive years.
Nine (20.5%) are in a category I have creatively named "Others." These companies have increased their dividends or distributions for less than five consecutive years.
Designing a Portfolio for the Long Term
I am currently 63 years old. One of my friends believed he would die before age 70 because his father and grandfathers had died in their 60s. My friend retired in his mid-50s and designed his retirement portfolio to provide substantial income through age 70. He is now in his mid-70s and going strong. He is scrambling to figure out how to provide income in a retirement that has already lasted longer than he anticipated. Most of us do not know how long we will live, so it is prudent to plan to live a long time. You've heard people say, "If I had known I was going to live this long, I would have taken better care of myself." The same principle holds true for taking care of one's portfolio.
Designing a Portfolio Around Dividend Champions, Contenders and Challengers
To enhance the SWAN (Sleep Well at Night) factor, I'm designing my portfolio around Dividend Champions, Contenders and Challengers. It is actually a rather simple design: As I get older, I want to add more Champions. Hopefully, each of the current 44 holdings (and 5 potential holdings) will continue to grow their payouts each year and they will all graduate to Champion status one day.
In the next two or so years, my goal is for 50% of the holdings in the portfolio to be Dividend Champions. NNN has raised their dividend for 24 consecutive years. One more year and they will be a Champion. That would give me 17. I have three Champions on my watch list. If I add them to the portfolio by age 65, that makes 20. You can see the path toward implementing the design.
Much can change with markets over time. A portfolio is not static. It is a dynamic, "living" reality. Some companies may fall away from David Fish's lists. But some (hopefully most) of the Dividend Contenders in the portfolio will be Dividend Champions by the time I'm 75. Some of the Dividend Challengers in the portfolio could be Champions by the time I'm 85. You get the idea. Changes will occur as new opportunities arise. As an old friend was fond of saying, "Make firm plans and stay flexible." This plan is not written in stone, but it feels good to have on paper.
Here's a table that I keep on my spreadsheet. It reflects the goals I have set for age 65, age 75, and age 85. It gives you a quick picture of what this transition toward a Champion-heavy portfolio design could look like over the next two decades:
|Current||Portfolio||%||@Age 65||@Age 75||@Age 85|
A Summary of My Thesis
1. The "fixed income" part of my retirement income will be provided by a pension annuity and Social Security. The longer I wait to apply for Social Security benefits, the greater the implied annuity value of the monthly benefit. (The difference in the annuity value at age 62 compared to age 70 is rather dramatic. If one's health and circumstances permit, delaying this benefit can make a big difference in one's monthly income.)
2. I believe an 85-year-old (particularly an old cuss who has been studying stocks for---by then--over 50 years) would be better served with an equity IRA portfolio comprised completely of Champions, Contenders and Challengers, rather than a traditional "balanced" portfolio of stocks and bonds.
3. Withdrawals from the portfolio will be designed (insofar as possible) to use dividend income rather than selling securities. When the IRS required minimum distributions begin, over time it may involve moving some equities from the IRA to a taxable account. As David Van Knapp reminds us, just because you must receive a RMD, there is nothing to prevent you from re-investing those proceeds into a taxable stock account. (In the example above, this would involve moving assets from "bucket #1" to "bucket #4.") Here's a comment from David Van Knapp to an article by Regarded Solutions: "The point that many people seem to miss is that the withdrawal (the RMD) does not have to be disposed of or spent. It just has to be removed from the tax-advantaged account and the tax paid on that amount. You can turn around and reinvest it in a regular taxable account."
I offer this portfolio design to the Seeking Alpha brain trust, with full confidence that many of you will have suggestions (and perhaps rebuttals) that will enable me to improve the design as it unfolds.
Disclosure: I am long AWR, NWN, GPC, PG, EMR, KO, JNJ, SYY, LEG, PEP, ED, WGL, ORI, T, HCP, UHT, NNN, O, KMP, WPC, EPD, PPL, SO, AVA, WEC, GIS, DE, DLR, WR, TCAP, STWD, BCE, MAT, ETN, TUP, LNCO, EPR, LTC, VTR, RYN, MAIN, MRK, CSG, ARCP. 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.
Additional disclosure: This portfolio is presented to give you a "real-world" glimpse of how one investor is approaching retirement income. It is not meant to advocate the purchase of any particular security. Everyone's needs and risk tolerance are different, so please perform your own due diligence before purchasing any security.