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Establishing A Core Portfolio

Investing is much like parenting or learning to play sports. It all starts with the fundamentals. Fundamentals give you a solid base from which to develop as a person, as an athlete and as an investor. In times of adversity, we always go back to the fundamentals to pull us through.

As a person, our morals and values are the fundamentals that define us as a person. As an athlete our fundamentals may center around technique, footwork or arm motion. In investing, our fundamentals are based around our "core" positions.

A well defined investing strategy is one of the cornerstones of a successful financial life. While investing techniques may vary, a solid foundation is what will help you weather the storms the market is sure to throw your way.

The number 1 principle in investing comes not from hoping for the best, but in knowing how you will handle the worst.

Nobody really knows what's going to happen next. Some things can be predicted, most things can't. Since nobody really knows what's going to happen, your plan must allow for the fact that the markets will experience some unexpected downturns every now and then.

As a Marine we were taught to always be aggressive, always on the attack, always move forward. There were times when you had to stop and regroup. When forward progress was stalled, we put out a perimeter. That perimeter was our first line of defense against attack. How well you were protected was defined by the skills and alertness of your perimeter team.

In investing, as you organize, plan or simply regroup, it's your core positions that you will send out as your perimeter.

A core holding is the central part of your portfolio. The core requires investments that will be reliable year in and year out. They are the solid foundation of the rest of your portfolio. The rest of your portfolio is spice, something to sprinkle on, in or around your core positions.

In 1999, The Single Best Investment by Lowell Miller was published. If you haven't read it, I highly recommend that you do. There should be a law that requires all dividend growth investors to read it. And when you are finished reading it, do it again and again and again. Each time you read it, you'll have different things reach out and grab you.

Miller suggests that your core positions should represent at least 50% of your portfolio value because you are relying on these long term investments to help you achieve long term success.

It was suggested that a portfolio contain 25-30 holdings and of those holdings, at least 50% of them should be core holdings. It was also suggested that the smaller the number of your holdings, the more conservative they should be.

In 1999, when the book was published, the top two sectors that Miller suggested you focus your core holdings on were REIT's and utilities. He also lists MLP's under the utility umbrella. He wanted to add consumer companies to the list but at the time the consumer stocks were way overvalued.

Miller even went as far to state that if you only held 5 positions, they should all be utilities and REIT's.

His advice came prior to the Lost Decade. The top three sectors coming out of the Lost Decade were:

1. MLP's

2. REIT's

3. Utilities

How was that for excellent advice? He had no idea The Lost Decade was coming!

What constitutes a core position? In my opinion, and the way I have our portfolios established, is that I want companies that offer a product or service that we must, or will use, regardless of economic conditions. I refer to them as the "necessity companies." These are the companies we need for our everyday living basics.

My core positions survived the recession of 1987, the recession of 2000-2002, the Lost Decade and the Great Recession of 2008-2009. Not only did they survive, they increased dividends as well during those volatile times.

What made MLP's, REIT's and Utilities so valuable as core positions?

They all have guaranteed revenues regardless of economic conditions. THey all have long term contracts in place with their customer bases.

High quality utility companies have been solid investments for decades. Utility companies aren't seen as terrific growth prospects, but they do perform under the very basic concept of, it's not how much you make, it's how much you keep. Here is a 20 year total annual return performance sample.

20 Years: (Annual Return)

SO - 15.7%

D - 13.9%

SPY - 8.1%

In looking at the REIT's, I only have stats for the past 18 years.

18 Years: (Annual Return)

O - 23.1%

HCN - 14.0%

NNN - 12.9%

SPY - 8.0%

In looking at MLP's, I used data when EPD went public and that was 14 years ago.

14 Years: (Annual Return)

EPD - 20.9%

KMP - 19.4%

SPY - 4.4%

(I own all of the above except SPY.)

These core positions not only played defense, they achieved excellent total return as well, but it takes time for that return to develop.

In addition to the sectors above, I also include consumer companies as part of my core positions. I prefer the companies that sell products we must use everyday of our lives. These necessity items have reliable earnings due to repeat sales.

In the consumer arena I look to companies like PG, CL, KRFT and GIS as core positions. I even include CVX and COP under this umbrella.

In closing, what is the moral of the story?

If you want to be successful as a long term investor, you must invest in companies that have reliable earnings. Reliable earnings come from companies that offer a product or service we must use regardless of economic conditions. You can lose your job and you'll still find a way to use the product or service of a long term core company. Make your core positions at least half of your portfolio, if not more. It's your core positions that you will have to fall back on in times of adversity.