I have been thinking about writing an article about what I would invest in if I was much younger and just starting out. Anyone who has read my last article here knows that I have a unique approach to attaining my income needs. My dividend portfolio has been exceeding my expectations over the last 3 years. For anyone who missed my personal portfolio article, it's here: My High Dividend Yield Retirement Portfolio Delivers 8.8% Of Income For This Retiree
Many believe I am not diversified and that eventually my portfolio will not perform as I envision it will. However, this article is not about my portfolio, it is about a portfolio I have designed for a young investor, one who has time on their side. It is also a portfolio for a retired investor who is satisfied with a yield of 4.8%. I know a 4.8% yield is considered high, however, research shows that higher yielding dividend stocks have historically outperformed lower yielding dividend stocks. According to Heartland Funds,
"Stocks with higher dividend yields have historically outperformed stocks with lower dividend yields. The highest-yielding quintile of stocks outperformed the lowest-yielding quintile by 1.76 percentage points per year from 1928 to 2013".
When I mention dividends reinvested, I am referring to the younger investors or the retirees who do not need to collect all their dividends.
My top 10 dividend stocks/MLPs:
Altria (NYSE:MO), Philip Morris (NYSE:PM), Kinder Morgan Management (NYSE:KMR), Kinder Morgan Energy Partners (NYSE:KMP), Plains All American(NYSE:PAA), Consolidated Edison (NYSE:ED), GlaxoSmithKline (NYSE:GSK), McDonald's (NYSE:MCD), Lockheed Martin (NYSE:LMT), Kimberly-Clark (NYSE:KMB)
These are my top 10 at the current time. If you feel they fit your needs after you do your own due diligence, now would be a good time to buy. You might feel you need 20-50 stocks to feel comfortable, that is your personal choice.
I am going to invest $10,000 into each stock/MLP for a total portfolio of $100,000. I understand that few young investors have $100,000 to invest. This is only a benchmark to track the portfolio. I could have chosen to use $1,000 into each stock or $100, the percentages will be the same in the end.
I am going to track this starting today with $10,000 in each using Tuesday's closing price (8/5/2014). I will report the number of shares for each and all the metrics I feel are important in Part 2.
I did not include AGNC or PSEC (2 of my stocks I own) in this portfolio because they require daily to weekly monitoring. This is not something I recommend for most investors.
When to buy:
1) I always try to buy after the stocks on my watch list or in my portfolio go on sale. This takes patience. One must also have a target buying price. For instance, I recently bought KMR shares on 6/4/2014 for $72.87 when it was trading approximately 10% below its 52-week high. I accumulated AGNC shares well below their BV during 2013. I bought PSEC when it went on sale due to an SEC request requiring the company to restate its financials. This approach to buying requires a constant eye on the market.
2) A second approach to buying is to decide on a good entry point and then put in a good-to-cancel order with your brokerage firm. For instance, I feel that a good price for LMT would be $152 which would deliver a 3.5% yield. LMT is currently trading at $163.91 (intraday on 8/6/14, down 1.8%) and it is currently yielding 3.2% -- not too shabby.
3) A third approach (the easiest one) is to dollar cost average into your stocks on a regular predetermined schedule. For instance, on the first of every month.
Personally I like to watch the market and decide when a sale becomes available. However, I imagine most investors do not have the time or inclination to determine when a stock is undervalued, so they should start with the dollar cost average approach. After they have built up their portfolio over the course of a year and have seen how their stocks trade, they may want to pull the trigger if and when one of the stocks has a nice pullback (8-10% or more).
You will make more money in the long-run when your reinvested dividends/distributions are done at lower prices. Start as soon as possible, more time in the market will pay off. A bear market correction is an opportunity to add to your stock/MLP positions and even a recession is not an issue for the long-term dividend/distribution investor.
Where to hold your dividend stocks/MLPs:
The best place to hold your dividend stocks is in a Roth IRA or a traditional IRA. The best place to hold an MLP (KMP and PAA) is in your taxable account. You will receive a K-1 annually for KMP and PAA, I suggest you use a tax expert to file your tax return regarding the K-1, unless you are familiar with K-1's and are capable of doing your own tax returns. I always used a CPA during my working years and still do in retirement. I am not saying to hold all your dividend stocks in retirement accounts. They can work well in a taxable account also. Each person has different tax issues, therefore you must check with a tax expert in order to determine the best place for these positions.
The Roth IRA will enable you to reinvest all your dividends without incurring taxes, and when you meet the Roth IRA requirements to take distributions without taxes or penalties, you will be able to collect your dividends tax free. This is my personal strategy that I have implemented over the last 22 years.
Currently I have 73% of my retirement money in Roth IRA accounts. I have done large Roth conversions and bit the bullet and paid my taxes prior to retiring in order to collect my dividends as tax free distributions when they are needed. I plan to continue to do more Roth conversions from 2015-2017 (in retirement). My goal is to have my Roth IRAs comprise 90% of my retirement accounts and to have 10% in a SEP IRA. This will enable me to collect our dividend income as distributions from these accounts and have a low tax bill. I am willing to bite the bullet and pay the increased tax bill now when I am still in my 50s. Please do your own due diligence in order to decide if a Roth conversion would benefit you. Only you can decide if it fits your personal situation.
If you have determined a taxable account is the best place to hold your dividend stocks/MLPs or if your situation makes it difficult to own the positions in retirement accounts that is fine. I hold KMR in my taxable account because there are no taxes on the share dividend/distribution paid. As I mentioned above KMP and PAA are MLPs which generate a K-1 and therefore should be held in a taxable account not IRAs (traditional or a ROTH) to avoid tax headaches. It might seem redundant to own both KMR and KMP in a taxable account, however one can own KMR in a Roth and KMP in their taxable account. KMR pays a share dividend. KMR and KMP have the same assets. I will recommend two different dividend stocks (in Part 2 of this article) as an alternative to KMP and PAA for investors who are not comfortable owning MLPs and the K-1 that is involved. The alternative portfolio will have a lower yield, probably around 4.4% -4.5%.
I have designed a dividend/distribution portfolio of 10 dividend stocks/MLPs that have an exceptional past track record, I will go into the details of that track record in Part 2 of this series. This portfolio is for someone who has a moderate risk tolerance and can hold and add to their positions in a market downturn. Dollar cost averaging is the best way to start investing. After one gains more experience they can decide for themselves when a stock is undervalued and add to their position at that time.
I believe dividend growth stocks are the safest way to grow your portfolio and create an income stream for retirement.
Disclosure: The author is long AGNC, MO, KMR, PSEC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Final Note: Each investor's BUY, SELL, or HOLD decision is based on one's risk tolerance, time horizon, and dividend income goals. My personal recommendation may not fit each investor's current investing strategy.