I was recently asked what I would do if I had a million dollars. I was surprised by how quickly the answer rolled off my lips. Before I'd even consciously processed the question I heard myself reply, "Easy, I'd retire!"
That got me focused on thinking about my ultimate investing goal: to obtain a portfolio that throws off enough current income in dividends to fund my expenses without selling any shares, and whose dividends are expected to grow at a rate exceeding the rate of inflation. My current expenses are about $30,000 per year (including health insurance), so I figure a portfolio yielding $40,000 in dividends this year has a sufficient margin of safety against dividend cuts and also allows for some savings. At 4% yield, such a portfolio would have a market value of $1 million.
As an experiment I decided to see if I could put together a portfolio, at today's stock prices, having a 4% yield and an overall dividend growth exceeding the long-term rate of inflation (estimated to be 3%). Furthermore, for diversification and safety I required that
- no position should account for more than 5% of the portfolio's current income,
- no position (except for select, extremely high-confidence positions) should account for more than 4% of the portfolio's current value,
- no industry should be represented by an unreasonably large portion of the portfolio, and
- all positions in the portfolio should be stable and high-quality, with low chances of future dividend cuts.
At today's prices I found this quite difficult to accomplish. In addition I assumed that no new money would ever be added to the portfolio, so item 4 was particularly important in the construction. Here's what I came up with.
Here is the portfolio, arranged by position size. Positions were established based on closing prices on June 5, 2014.
|Shares||% of portfolio||Yield (%)||
Estimated Dividend Growth (%)
Dividends This Year
|Procter & Gamble Co||(NYSE:PG)||50,068.75||625||5.01||3.21||6||1609|
|Philip Morris International Inc||(NYSE:PM)||49,927.20||568||4.99||4.28||6||2135.68|
|Kinder Morgan, Inc.||(NYSE:KMI)||39,986.10||1,155||4||4.85||5||1940.4|
|National Retail Properties Inc||(NYSE:NNN)||39,978.18||1,098||4||4.45||1.5||1778.76|
|Altria Group Inc||(NYSE:MO)||39,968.72||968||4||4.65||5||1858.56|
|Verizon Communications Inc||(NYSE:VZ)||39,966.08||811||4||4.3||2||1719.32|
|Realty Income Corp||(NYSE:O)||39,963.66||906||4||4.95||2||1983.91|
|General Mills Inc||(NYSE:GIS)||39,955.48||722||4||2.96||6||1184.08|
|Johnson & Johnson||(NYSE:JNJ)||39,946.14||387||3.99||2.71||6||1083.6|
|Royal Dutch Shell PLC ADR Class B||(NYSE:RDS.B)||39,939.75||485||3.99||4.57||2||1823.6|
|Kraft Foods Group Inc||(KRFT)||24,999.04||424||2.5||3.56||5||890.4|
|Visa Inc Class A||(NYSE:V)||24,829.74||117||2.48||0.75||12||187.2|
|Piedmont Natural Gas Co||(NYSE:PNY)||19,998.96||552||2||3.53||3||706.56|
|Wisconsin Energy Corp||(NYSE:WEC)||19,994.96||436||2||3.4||5||680.16|
|EV Tax Adv Global Div Opps Common||(NYSE:ETO)||19,989.14||779||2||7.01||0||1402.2|
|Aberdeen Asia-Pacific Income Common||(NYSEMKT:FAX)||14,809.82||2,381||1.48||6.75||0||1000.02|
|Overall portfolio||$1,000,000||100%||4.01%||3.85% (yr 1)||$40,107.39|
The "estimated dividend growth" column is my own conservative estimate of the short-to-medium-term dividend growth potential of the position, taking into account past dividend growth behavior and forward earnings growth estimates. The portfolio has an estimated overall income growth of 3.85% from year 1 to year 2, but this will accelerate as the lower-yield higher-growth positions begin to comprise a larger part of the overall income from the portfolio.
The only two positions I considered to be high enough quality to comprise more than 4% of the portfolio were PG and PM.
The portfolio contains no BDCs, mREITs, retail companies, banks, or technology companies (other than Visa). These kinds of stocks were excluded based on quality and long-term dividend growth concerns.
The portfolio contains no MLPs, so it is possible that including them would allow for a better portfolio design.
The portfolio has an overall weighted beta of 0.59.
Here is the portfolio breakdown by industry:
- Consumer staples (non-tobacco): 23%
- Tobacco: 10%
- Energy: 18%
- Healthcare REIT: 8%
- Healthcare (non-REIT): 4%
- Retail REIT: 8%
- Utilities (non-telecom): 8%
- Telecom: 7.5%
- Restaurants: 5.5%
- Financial services: 4.5% (BLK and V)
- Closed-end bond funds: 3.5%
The two bond funds (ETO and FAX) were included in the portfolio because I was simply unable to bring the yield of the portfolio up to 4% without them without sacrificing quality or breaking my rules on position sizing.
Assuming the dividend growth rates are those in the table above and inflation is 3%, here is what the portfolio's income will be in future years.
|Year||Portfolio Income||Income Goal (3% inflation)|
As you can see, as time goes on and the lower-yield/higher-growth companies in the portfolio begin contributing more to the overall portfolio income, the income from the portfolio grows faster. The annualized income growth from year 25 to 30, for instance, is 5.34% per year.
The role of the portfolio segments
I view this portfolio as being made up of three distinct parts:
- High-yield/slow-growth (approx. 45% of portfolio).
- Medium-yield/medium-growth (approx. 48% of portfolio).
- Low-yield/high-growth (approx. 7% of portfolio).
The high-yield portions of the portfolio are meant to provide the bulk of the current income. However, this income will likely grow slower than the income from the rest of the portfolio, so over time these positions will contribute less and less to the overall income.
The medium-yield/medium-growth positions - the positions with 3-3.5% yield and 6% growth - will be the main income sources in the portfolio 10-30 years down the line. After 10 or 15 years it should be possible to sell some of the slower-growing positions in the portfolio and replace them with medium-yield/medium-growth positions.
The high-growth positions (mainly BLK, SBUX, and V) are meant to be held for capital gains and long-term income growth. Despite being responsible for practically none of the present income of the portfolio, after 30 years they should be able to throw off a significant portion of the portfolio's income and have generated large capital gains along the way. They can also be sold off at any time and rolled into higher-yield positions if necessary, for example if an early dividend cut materializes.
Thoughts on the 4% yield requirement
While the portfolio seems solid to me, I am unhappy with the income growth rate it offers. While the actual income growth rate will probably be higher than the initial 3.85% growth rate estimated above, I would prefer a portfolio with an initial dividend growth rate closer to 6%. It is much easier in today's market to put together a portfolio yielding 3-3.5% with an acceptable dividend growth rate than it is to do the same for a 4% yield.
Thoughts on valuations
Although I don't consider many of the positions in the portfolio to be overvalued today, I consider many of them to be on the very upper end of their fair value ranges. The combination of yield, value, and growth is quite difficult to find in today's market.
Disclosure: I am long BLK, COP, CVX, FAX, GIS, JNJ, KMI, KO, KRFT, MCD, MO, O, PEP, PG, PM, SDRL, SO, V, VTR, WEC. 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.