Maintaining A Diversified Portfolio And Income Stream During Volatile Times

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Includes: ABBV, AFL, APPL, BA, COP, CVS, CVX, GE, GILD, GIS, JNJ, JPM, KO, LUV, MA, MMM, MO, MSFT, O, PG, PM, SBUX, T, TGT, V, VTR, VZ, XOM
by: The Dividend Bro

Summary

Maintaining a diversified portfolio can protect you against a downturn in a particular sector.

Keeping a diversified dividend stream can help protect your retirement income.

We'll look at our sector allocations to see if they are diversified.

Imagine having a portfolio that is made up mostly of financial companies in 2009. Or how about being overweight in energy companies right before the price of oil crashed? What if your current portfolio is heavily concentrated in biotech? Chances are, having a heavy allocation in these areas would have crushed your portfolio. If you are relying on dividends from these areas to fund your retirement, your income stream could have been negatively impacted.

Diversifying your holdings among different sectors is one way to protect yourself from crashes that happen in a sector from time to time. I am not a fortune teller and I don't have a crystal ball, so I don't pretend to know what is going to happen in the market today, tomorrow or next year. The goal for our portfolio is to purchases shares of companies that pay and raise their dividends. Aside from that, we want to own stocks in different sectors of the economy so if one sector, say energy or financials, enters a bear market, our overall portfolio can be protected against a steep loss. By diversifying where our dividends come from, we can protect our income stream as well. That is why before we consider adding a stock to our portfolio, we make sure that we aren't already too concentrated in that sector.

Our current portfolio is made up of our Roth IRAs, two share builder accounts and 403b retirement accounts through our work. Between our IRAs and share builder accounts, our goal is to hold 30 to 35 stocks.

Because of the number of holdings, some overlap is unavoidable. We don't want any one sector to be more than 20% of our total portfolio and ideally, not over 12%-15%. We break down our position into Core Holdings, Supporting Holdings and Speculative Holdings. A description of the break down and selection criteria we use to purchase stocks can be found here.

Sector Allocations and Dividend Stream

In addition to the diversification of holdings, we also want to be diversified in where our dividends come from. At the end of each year, we estimate the next year's income by multiplying the current share count by the current dividend. As we initiate a new position or add to a current holding, we update the estimated dividends for the year. At the end of the year, we compare actual dividends to what our estimate was. For 2015, we received 7.5% more dividends than we had expected. One reason for the increase is that the average dividend raise for each stock in our portfolio was just over 7.5%. We reinvest all dividends, so this also has a role in the larger than expected income payments for the year. This shows you the power of dividend increases as well as what can happen when you reinvest the dividends. Simply by focusing on dividend growth companies and reinvesting the income, we gave ourselves a 7.5% raise last year. Just imagine getting that raise each year for the rest of your life. That is what we are trying to do.

The following table is the breakdown of our portfolio as well as the estimated dividends for 2016. We would like each sector to contribute no more than 20% of our total dividends. This way, if something happens to a particular sector that caused several companies to cut or suspend their dividend payments our income stream wouldn't be completely obliterated.

% of Portfolio

% of 2016 Estimated Div

Consumer Discretionary

7.30%

4.11%

Consumer Staples

18.33%

22.37%

Energy

6.99%

11.98%

Financials

9.74%

6.18%

Healthcare

12.94%

13.95%

Industrials

9.26%

9.63%

REITs

7.88%

11.79%

Technology

7.12%

5.59%

Telecommunications

8.74%

14.40%

NY Life 403b

9.86%

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Cash

1.83%

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One issue you might notice right away is that the consumer staples portion of the portfolio account for more than our target of 20%. If this was another sector, we would be slightly concerned. As you can see below, our consumer staples holdings include a wide variety of staples. Producers of sodas, tobacco, laundry detergent, deodorant and cereal make up these positions. That is a fairly diverse group of products that people buy every day in both good and bad times. Also, the staples sector is our largest sector and accounts for just over 18% of our total portfolio. This number is relatively close to the percentage of dividends that the sector contributes to our portfolio.

A few sectors contribute significantly more dividends than their portfolio weight might suggest they should. One such area is telecommunications. We only hold two companies, AT&T (NYSE:T) and Verizon (NYSE:VZ), in this sector so that is a lot of income from a small portion of the portfolio. Both dividends seem to be safe, so we are content to hold both positions. As you can see below, AT&T is our fourth-largest holding, so we may shy away from adding to that position.

One area we are looking to add to is technology. We are currently underweight in technology, with Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL) being our only holdings. In a previous article, we discussed Cisco (NASDAQ:CSCO) being one of the stocks we are looking to purchase. The company has a solid yield (currently 3.60%) and though the dividend growth streak is not long, it has been very strong (31.60% average over the last three years). Our shopping list of possible new purchases as well as additions to companies we already own can be found here and here.

Holdings

The following are our current holdings. We try to keep each holding to under 10% of the total portfolio. To make sure we aren't over reliant on one position to provide our income, we aim to keep each holding's dividend contribution to below 10% of total dividends.

Portfolio Holdings

Core Holdings

Sector

% of Portfolio

% of 2016 Estimated Div

3M (NYSE:MMM)

Industrials

0.51%

0.48%

AbbVie (NYSE:ABBV)

Healthcare

4.44%

5.55%

Aflac (NYSE:AFL)

Financials

1.77%

1.63%

Altria (NYSE:MO)

Consumer Staples

9.25%

11.47%

AT&T

Telecommunications

5.55%

9.79%

Chevron (NYSE:CVX)

Energy

2.83%

4.68%

Coca-Cola (NYSE:KO)

Consumer Staples

3.05%

3.09%

Exxon Mobil (NYSE:XOM)

Energy

2.09%

2.46%

General Mills (NYSE:GIS)

Consumer Staples

0.06%

0.06%

Johnson & Johnson (NYSE:JNJ)

Healthcare

5.86%

5.87%

Microsoft

Technology

4.37%

3.89%

Philip Morris (NYSE:PM)

Consumer Staples

4.30%

6.45%

Procter & Gamble (NYSE:PG)

Consumer Staples

1.33%

1.37%

Realty Income (NYSE:O)

REITs

3.78%

5.16%

Target (NYSE:TGT)

Consumer Discretionary

2.07%

2.15%

Ventas (NYSE:VTR)

REITs

3.92%

6.66%

Verizon

Telecommunications

3.00%

4.66%

Total

58.18%

75.43%

Supporting Holdings

Boeing (NYSE:BA)

Industrials

2.71%

2.56%

ConocoPhillips (NYSE:COP)

Energy

1.92%

4.88%

CVS Health (NYSE:CVS)

Healthcare

1.39%

0.80%

General Electric (NYSE:GE)

Industrials

6.34%

6.62%

JPMorgan Chase (NYSE:JPM)

Financials

3.40%

3.39%

Starbucks (NASDAQ:SBUX)

Consumer Discretionary

3.80%

1.66%

Total

19.56%

19.91%

Speculative Holdings

Apple

Technology

2.59%

1.72%

Gilead (NASDAQ:GILD)

Healthcare

2.34%

1.41%

MasterCard (NYSE:MA)

Financials

3.04%

0.85%

Southwest Airlines (NYSE:LUV)

Consumer Discretionary

1.27%

0.32%

Visa (NYSE:V)

Financials

1.32%

0.36%

Total

10.56%

4.66%

Cash

1.83%

NY Life 403b

9.86%

Total

100%

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First thing to discuss is Altria. The issue with Altria in that it provides a larger portion of our total income then we would like. This is because of the company's dividend when we first bought the company as well as the fantastic dividend growth Altria has had since our first purchase. In 2009, Altria paid $1.30 in dividends. In 2015, the company rewarded shareholders with $2.64 in dividends. The company is also very close to the 10% portfolio that we target for each holding. Altria was first purchased in 2009 at a price of $19.24. The average purchase price for the position is just under $30. The capital gains for the position have been simply outstanding, so we are quite okay with the size of the position. Some might suggest trimming the position, but we will stand pat because the company is a dividend machine and our cost basis is almost half of the current stock price. In the interest of remaining diversified, we will probably not add to Altria for quite some time. We will, however, continue to reinvest those dividends.

Also included in the table is the estimated dividend allocation to the core, supporting and speculative holdings. The core holdings make up more than 75% of our income. This is no purpose as these companies are dividend champions and contenders. They have at least 10 years of dividend growth. These are the companies that will do the heavy lifting for us in our retirement years. The supporting holdings are made up of companies that have at least five years of dividend growth or 10 years of paying uninterrupted dividends. These companies have a good chance of moving to the core holdings portion of our portfolio in the future. The speculative holdings produce the smallest amount of our income. This too is on purpose because this is where the more growth-oriented names of our portfolio are found. With just over 4% of income from this section, we protect ourselves in case one of these companies decides to end their dividend payments. Because most of these companies have just recently started paying dividends, they often offer higher dividend growth rates than more mature dividend payers. The hope is that eventually these stocks become supporting and core holdings.

The General Mills, 3M, Exxon Mobile and Procter & Gamble portions of the portfolio are relatively small because they are part of our Early Retirement Portfolio. Each month, we are purchasing $50 worth of each stock through computershare.com and shareowneronline.com. Over time, these positions will grow and contribute more to the portfolio's income stream.

Conclusion

By diversifying our holdings and income stream, we can reduce the risk any one sector can have on our portfolio or dividends. Because we plan to live off dividends in retirement, diversification helps us to weather a storm that may impact the value or dividends in a singular sector.

Disclosure: I am/we are long MMM, ABBV, AFL, MO, T, CVX, KO, XOM, GIS, JNJ, MSFT, PM, PG, O, TGT, VTR, VZ, ,BA, COP, CVS, GE, JPM, SBUX, AAPL, GILD, MA, LUV, V.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: We are not investment professionals. Please do your own research prior to making any investment decision

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.