Constructing A Monthly Income Portfolio

by: Eli Inkrot


When constructing a portfolio investors look at a variety of options including: asset allocation, capitalization size, whether the company pays a dividend and the dynamics of the expected income.

However, what is often overlooked is the timing of the expected cash flows.

This article brings this distinction to light and suggests a few methods of dealing with a potential cash flow hiccup.

When we think about constructing a portfolio you probably imagine figuring out the proper allocations between stocks, bonds, liquid investments and other options. When you drill down to just the equity portion, you likely think about large vs. mid vs. small cap or dividend paying vs. non-dividend paying. Within dividend payers, you could further subdivide it to include high-growth, low-yield options like IBM (NYSE:IBM) and low-growth, high-yield alternatives like AT&T (NYSE:T). We have all these different types of classifications to consider.

Yet a distinction that rarely receives attention is the timing of your income. Now certainly you shouldn't allow the income schedule tail wag the investment thesis dog. That is, you shouldn't buy a certain security simply because it pays a dividend in January, as an example.

However, for some investors this might be become a further consideration. For instance, if you're approaching retirement, you might be more inclined to think about the income component of your portfolio rather than finding the next high-flying tech company. More specifically, a retiree is often more focused on the safety of their income rather than eking out an extra percent in capital gains. As such, a dividend growth strategy or something similar is appealing to this crowd.

This is great. Nevertheless an issue could arise in that many dividend payers happen to make their payments on a similar schedule. This is particularly true in the months of March, June, September and December. Over half of the Dow Jones Industrial Index (NYSEARCA:DIA) pays on this schedule, whereas you might only expect a third to do so if the payments were evenly distributed throughout the year.

Obviously this holds beyond the Dow as well. As an illustration, I went back and looked at David Van Knapp's survey of the most widely held dividend growth stocks. There were 53 remaining companies mentioned from his survey of the dividend growth community. Here were the results:

March, June, September, December = 41.4% of the companies paid on this schedule.

February, May, August, November = 29.3% paid in these months.

January, April, July October = 22.4%.

Monthly = 3.45%

Semi-annual = 3.45%.

(Note that a few companies had irregular schedules and thus I categorized them based on their most frequent payout timetable)

Much like the Dow Jones example, the majority of companies happen to pay dividends in the 3rd, 6th, 9th and 12th months of the year. So why is this a potential problem? After all this isn't exactly a secret -- that the majority of your income tends to come in certain months -- and you could just plan for it right? Well, consider it from the retiree or approaching retiree perspective.

Imagine you have fixed expenses of $24,000 annually -- $2,000 per month -- and your dividend portfolio also generates $24,000 in yearly income. All appears well, correct? Not exactly -- while it is true your annual expenses meet your annual cash flow this does not take timing into consideration. Think about what happens if 50% (not unrealistic considering the numbers above) of the retiree's income is received in just 4 months of the year -- March, June, September, and December.

In January, they might make $1,500. In February, they might also make $1,500. When March comes around, their assets generate $3,000 in income. So it averages to $2,000. However, if they need $2,000 per month, the first two months result in a deficit. As such, it could put an unnecessary strain on your budget and in fact you might have to sell a portion of your wonderful business partnerships to make up for the shortfall. Thus, when taking distributions from an asset base, you probably want to think about timing: an annual income stream certainly isn't the same thing as a monthly one.

Of course, there are a variety of solutions to this timing issue.

Although you don't want this to direct your partnership decisions, I do believe it's possible to create a balanced portfolio of high-quality companies with relatively even payouts. I'll even prove it. Here's a mock portfolio that one could consider today:

March, June, September, December payers: Chevron (NYSE:CVX), Exxon Mobil (NYSE:XOM), McDonald's (NYSE:MCD), Emerson Electric (NYSE:EMR), Johnson & Johnson (NYSE:JNJ) and Southern Company (NYSE:SO). This group has an aggregate dividend yield of 3.34% and a history of not only paying but also increasing the dividend for 37 consecutive years. (Southern Company drags the average number of years down a bit, but certainly helps on the yield side.) With just these 6 names, you're on your way to a very solid portfolio.

February, May, August, November payers: Procter & Gamble (NYSE:PG), General Mills (NYSE:GIS), AT&T , Clorox (NYSE:CLX), Colgate-Palmolive (NYSE:CL), and Abbott Labs (NYSE:ABT). These 6 companies have aggregate yields that stand at 3.21%. This time General Mills and Abbott Labs are the technical "Southern Companies" of this group, but it seems that all are very strong companies -- few would argue with General Mills 115 year streak of paying a dividend "without interruption or reduction" while Abbott had a 40-year increase streak prior to the AbbVie (NYSE:ABBV) spin-off. Now we have a 12 stock portfolio that is quite fundamental.

January, April, July, October payers: Kimberly-Clark (NYSE:KMB), Kraft (KRFT), General Electric (NYSE:GE), Medtronic (NYSE:MDT), Leggett & Platt (NYSE:LEG) and Sysco (NYSE:SYY). Collectively, these 6 companies would yield 3.17% if held in equal weighting. Kraft and General Electric are waiting to truly prove themselves, but the other 4 listed have increase streaks surpassing the three and a half-decade mark. Surely one could argue for more diversification, but with just these 18 companies we have a solid span of industries, economic moats and pertinent to this article dividend timetables.

Based on today's payouts, that same ill-timed portfolio described above might produce $2,200 in the 3rd, 6th, 9th and 12th months of the year, $2,100 in the 2nd, 5th, 8th and 11th months of the year, and another $2,100 in the 1st, 4th, 7th and 10th months of the year. In other words, it's certainly possible to create a high-quality portfolio that produces regular and consistent income. Moreover, I would surmise that your income would continue to increase with these companies as time went on.

Now I'm not necessarily advocating that you go out and buy all of these today -- I would never provide a blanket recommendation. However, I at least find it interesting that the timing issue can be solved relatively painlessly while keeping your investment thesis intact.

Beyond this solution, there are of course numerous more. For instance, perhaps you might build up a cash reserve prior to retirement to soften the irregular cash flows. Conceivably you could look to higher yield options like MLPs, REITs or Preferred equities whereby these securities act as a compliment to your holdings. For that matter, perchance you simply look to investments that pay monthly like Realty Income (NYSE:O).

Here's the bottom line: for most, the timing of when a company pays a dividend shouldn't have much effect on your partnership decision. Yet if you're approaching a "distribution phase" with a strict monthly guideline, this concept becomes a bit more important. As such, it could be prudent to begin thinking about some of the solutions that I have described above.

Disclosure: The author is long CVX, GIS, T, IBM, PG, JNJ, MCD, GE, SO. 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.