Buy And Monitor Vs. Trading Around A Core: One Investor's Experience

Includes: ABT, CLX, ED, HCN, KMB, KMP, PEP, PG, SYY, T
by: Parson

I expect that most people who read this article will be those who already believe in dividend growth investing (DGI) and a few who seek to discredit the practice. But even among those who believe in DGI there are different opinions on how to best implement the strategy. The purpose of this article is to briefly outline one method of implementing the strategy and examine how the method has fared for one year in a real brokerage account.

About three years ago, Dividends4Life wrote an article about dividend growth investing and included a link to David Fish's Champions, Contenders, and Challengers (CCC) spreadsheet. It piqued my interest because after years of investing for capital gains, I had watched as the value of my portfolio was cut in half from 2008 to March 2009. There had to be a better way.

After reading more articles and carefully considering the DGI approach, I took the following actions starting in July 2009.

  1. Sold all mutual funds whether open-end, closed-end, managed or indexed.

  2. Sold all Exchange Traded Funds.

  3. Sold all stocks that did not pay a dividend or only a small dividend (3% was the lower limit).

  4. Sold all stocks that had cut their dividends in the last 5 years.

The cash raised from selling most of the portfolio was reinvested in stocks from the CCC list plus one stock that I believe will soon be on the list. I chose to concentrate on companies which had 10-year histories of increasing revenues, increasing earnings, and increasing dividends at a healthy rate. Ten years was chosen simply because that is how far back a current S&P stock report goes.

By March 2010 I had a collection of about 25 stocks varying from $10K to over $100K but no systematic method to determine what to buy or sell next. Clearly, a simple but disciplined approach to managing the portfolio was needed. After giving that some thought, I decided that the smallest position should be no less than half the largest position, reasoning that if a stock didn't deserve significant representation in the portfolio it shouldn't be owned at all. On the other hand, no one stock should be as much as 10% of the total. This required thinning the herd and painful decisions, but by February of this year the process was complete. The result was 15 core stocks assigned to either a $50K, $75K, or $100K allocation.

As to buy and sell decisions during the two years it took to reconfigure the portfolio, I watched two technical indicators; Moving Average Convergence Divergence (MACD) to some extent, but mostly the Relative Strength Index (RSI). The basic rule is to buy when RSI is below 40 and preferably below 30. Sell when the RSI is above 60 and preferably above 70. Don't buy or sell all at once. I limited transactions to about $10K, and then waited to see what would happen next. Often the price would go against my wishes over the next few weeks and I would have to wait a few months to resume buying or selling that stock. Hence the reason it took two years.

To be clear, "the portfolio" consists of five brokerage accounts held in my name, my wife's name, a joint account, and two traditional Individual Retirement Accounts. The consolidated portfolio is all that is considered for purposes of diversification and the holding value of each position. No attempt is made to achieve diversification or stock weighting within a particular account.

Having achieved the goal of accumulating 15 core stocks within plus or minus 5% of their target values, the portfolio entered into maintenance and promotion mode. Maintenance means that if a stock position is more than 5% above its target allocation, then an appropriate number of shares are sold to bring it back to the allocated target, but only if the RSI indicates the stock is overbought. Similarly, stocks that are 5% below target are purchased in sufficient quantity to return the position to target if the RSI indicates the stock is oversold. MACD serves to reinforce or temper the decision to buy or sell immediately or wait until extreme oversold or overbought conditions arrive. Obviously, there must be some continuing due diligence before blindly following any rule of thumb. Examine the reasons for the price change to the extent that the reasons can be determined. In most cases it is just market noise and nothing fundamental about the company or its performance has changed.

In due time, sufficient cash from dividends and capital gains will accumulate until a stock can be promoted to a higher allocation. Again, don't do this all in one transaction and an investor can always change his mind about which stock to promote if the price goes against him.

One reason for writing this article is the number of articles and comments I see on Seeking Alpha implying that selling a stock is an all or none decision. A typical example is a recent article by Dividends4Life regarding Illinois Tool Works (NYSE:ITW) and the first six comments.

There is some middle ground such as selling a small part of an arguably overvalued stock and reallocating the capital to cash reserves or an undervalued stock, but there are many who would argue against such an approach. The usual arguments against the approach are:

  1. No one can time the market consistently.

  2. The taxes incurred will negate any benefit.

  3. The transactional costs will negate any benefit.

  4. Missing out on dividends will negate any benefit.

  5. Selling winners to buy losers is backwards. Sell losers and let winners run.

All of these are valid considerations, and since I have been following this approach for years, it seemed prudent to examine my results and see if there is any actual benefit. As many have pointed out, individual investors frequently deceive themselves about how well they are doing because the truth might be painful.

There are complexities in trying to calculate a rate of return on an account where deposits and withdrawals are happening on a frequent basis. To avoid these complexities, I will use the example of my Individual Retirement Account (IRA) to which I have not contributed in many years and from which I have never made a withdrawal. Also, most of my trades occur in the IRA because whether the capital gain is long term or short term doesn't matter. It's tax deferred in either case.

The two tables below summarize the positions and values of my IRA at the end of August 2011 and the end of August 2012 under two scenarios. The first is a hypothetical Buy and Monitor approach where no shares are bought or sold. The only income is dividends and some pocket change from interest on the cash balance (the brokerage pays 0.01% on cash.) The other scenario is what actually happened by following a disciplined sell high, buy low approach as outlined above, a.k.a. Trading Around a Core.

As of August 31, 2011 the IRA held shares of the following companies:

Abbot Laboratories (NYSE:ABT), Clorox Company (NYSE:CLX), Consolidated Edison Inc. (NYSE:ED), Health Care REIT Inc. (NYSE:HCN), Kimberly-Clark Corp. (NYSE:KMB), Kinder Morgan Energy LP (NYSE:KMP), Pepsico Inc. (NYSE:PEP), Procter & Gamble (NYSE:PG), Sysco Corp. (NYSE:SYY), AT&T Inc. (NYSE:T).

August 31, 2011 August 31, 2012










440 52.51 23,104.40 871.20 65.54 28,837.60
CLX 350 69.70 24,395.00 854.00 72.75 25,462.50
ED 200 56.21 11,242.00 482.00 60.62 12,124.00
HCN 100 50.96 5,096.00 293.50 58.44 5,844.00
KMB 200 69.16 13,832.00 576.00 83.60 16,720.00
KMP 365 70.16 25,608.40 1,733.75 82.77 30,211.05
PEP 160 64.43 10,308.80 333.28 72.43 11,588.80
PG 400 63.68 25,472.00 869.60 67.19 26,876.00
SYY 600 27.93 16,758.00 642.00 30.30 18,180.00
T 500 28.48 14,240.00 875.00 36.64 18,320.00
CASH 5,681.87 .96 13,213.16
Total 175,738.47 7,531.29


The hypothetical Buy and Monitor approach would have resulted in a gain of about $31,639 or an 18.00% increase from the starting value. Over the same time period, the S&P500 index increased from 1,218.89 to 1,406.58 for an 15.40% increase.

It isn't reasonable to assume that over $13,000 cash would have been allowed to accumulate in an account paying .01% interest. Typically, no more than $3000 in cash is allowed to gather in my IRA before it is invested in a stock. To give the Buy and Monitor approach the benefit of the doubt, let us assume that $1500 in cash was in the account at the end of August 2012 and one half the difference (($13,213.16-1,500.00)/2=5,856.58) was invested over the year and achieved the same rate of return as the portfolio. The hypothetical account value for August 2012 would have been improved by about $1054 to $208,431.

The next table has the same starting point as the first table, so the August 31, 2011 information is omitted. Note that by August 31, 2012 ABT had been sold and Emerson Electric Co. (NYSE:EMR) and McDonald's Corp. (NYSE:MCD) had been added.

Trading Around the Core
August 31, 2012




CLX 300 72.75 21,825.00
ED 370 60.62 22,429.40
EMR 120 50.72 6,086.40
HCN 170 58.44 9,934.80
KMB 40 83.60 3,344.00
KMP 360 82.77 29,797.20
MCD 125 89.49 11,186.25
PEP 120 72.43 8,691.60
PG 800 67.19 53,752.00
SYY 1480 30.30 44,844.00
T 100 36.64 3,664.00
CASH 1,206.45
TOTAL 216,761.10

The Trading Around a Core approach resulted in a net gain of $41,022.63 or a 23.34% increase. The difference between the Buy and Monitor strategy (with cash reinvested) and the Trading around a Core strategy is about $8,330. Because this is an IRA account with no inputs or outputs of cash, the commissions and dividends are baked into the results and taxes are deferred until some unknown time in the future.

I am well aware that anecdotal results over a one year period in a generally rising market do not prove anything conclusively. It's possible that I just got lucky. Nonetheless, establishing target amounts in historically strong stocks, buying when they are 5% below target and selling when they are 5% above target, and using a few relevant technical indicators, almost dictates that the investor buy low and sell high.

Disclosure: I am long ABT, CLX, ED, EMR, HCN, KMB, KMP, MCD, PEP, PG, SYY, T. I have no position in ITW and no present intention of buying or selling shares of any stock mentioned in this article. 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.