Diversification is a process that allows dividend investors to spread their risks between different sectors and asset classes. The goal of this exercise is to minimize the risk of ruin and ensure portfolio longevity, while minimizing fluctuations in income and principal.
Many dividend investors perceive diversification as a dirty word, given the fact that not every sector of the stock market delivers consistent dividend payouts. As a result, the portfolios of many novice dividend investors tend to be concentrated in higher yielding sectors such as MLPs, Utilities, REITs and Financials. Even such sectors as consumer staples could pose risks to dividend investors, if they have a disproportionate allocation there.
The risks of concentrated dividend portfolios could best be evidenced by the events that occurred during the financial crisis of 2007-2009. Financial stocks were some of the favorite picks for many dividend investors, given their long histories of dividend growth and above average yields. The dividend cuts that started in 2007 and escalated by 2009 lead to elimination of dividend income for bank investors and big capital losses as well. Investors who had allocation to the other sectors of the S&P 500 would have been able to withstand the wave of dividend cuts in the financial sectors.
Diversification is not a cure for failure to properly analyze investments however. Investors should not diversify at all costs. Most sectors have specific risks associated with the, which is why getting invested ina sector just for the sake of diversification is seldom a good idea. Careful investors should instead select companies from as a many sectors as possible which make sense for an investment.
Some of the factors that dividend investors should asses include:
2. Moat/ Competitive Advantage
3. Earnings and Dividend Growth Potential
4. Dividend sustainability
Below I have listed examples of attractive dividend companies by sector for 11 sectors:
Procter & Gamble (NYSE:PG)
Kinder Morgan Energy Partners (NYSE:KMP)
Chubb Corp (NYSE:CB)
Johnson & Johnson (NYSE:JNJ)
Automated Data Processing (NASDAQ:ADP)
Air Products and Chemicals (NYSE:APD)
Dominion Resources (NYSE:D)
National Retail Properties (NYSE:NNN)
This list is just an example of diversifying by sector. Investors should own at least 2- 3 stocks from each sectors in order to minimize company specific risk. This will not happen quickly, which is why the process of creating a diversified dividend portfolio takes time. Some of the stocks with the best potential for dividend growth could be overpriced, which requires patience on the part of the investor in order to wait for the right moment.
Disclosure: Long MCD, PG, KMP, CB, JNJ, MMM, ADP, APD, D, NNN