Challenging A Dividend Growth Investing Myth With A Hybrid Portfolio Of Stocks And ETFs

by: Bob Johnson

The rather well known phrase, "there is more than one way to skin a cat," was first recorded in American literature by Maine born and Bowdoin educated humorist Seba Smith in a short story, "The Money Diggers", in 1840. Perhaps I heard this phrase so many times growing up because this story was set in my native State of Maine, though I do not know that the saying originated "Down East." We may infer from the title of Smith's story that there are many ways to dig for money. Some of the best of them in the area of investments are at Seeking Alpha.

However, you may have noted if you have read a few dozen articles, or written one, or read the comments following most articles, that there are sometimes strong differences of opinion on how one should dig. Some authors and commenters insist that their point of view or method of investing is superior. They believe that "their truth" has nearly universal application and that you should embrace it. I try to use the word "should" very sparingly. I have come to believe that to "should" on a person is wrong in most cases. I do not know what you "should" do, especially in the case of a specific investment or method of investing. I am going to address one small area of investing in this article, and my thesis is that there is "more than one way to skin a cat."

Dividend Growth Investing is a very popular topic on Seeking Alpha. While I believe there is general agreement on the principles involved, there is room for much speculation about specifics. One idea is so prevalent that I believe it is part of the DGI worldview, part of the realm of generally accepted traditions of many followers. That, by definition, qualifies it as a myth. The specific myth I want to address is the conviction that the portfolio should be made up solely of individual dividend growth stocks. Not only is this not true, it may be detrimental to your investing success and your general wellbeing to practice it.

Some authors and strategists say you should not mix ETFs into your dividend growth portfolio with your individual stocks. If the is anything worse than someone telling you what you should do, it is perhaps someone telling you what you should not do.

Other authors and strategists maintain an opposite view. They say the individual investor should not buy individual stocks at all, but should stick to ETFs. Often they present their arguments with convincing statistics showing that on average, professional mutual fund managers do not beat the indexes over the long term, and neither do average individual investors in stocks.

Your First Investment

Let us say that you have got half a year's pay tucked away in an emergency fund in your local bank, and you want to start investing in "the market" to get better returns. Do you search for a stock to buy with the $3,000 you have saved? Or do you invest in a fund. While some might disagree, most professionals would steer you to an ETF; a fund would greatly lower your risk through diversification into many stocks. A broad index fund, like a S&P 500 fund, SPY or VOO, might be a good place to start. If you want a fund with more of a dividend growth emphasis, you could look Wisdom Tree Equity Income (NYSEARCA:DHS) or at Vanguard High Dividend Yield Index ETF (NYSEARCA:VYM).

Going Abroad

One way to reach the far away markets of Europe, Asia, Latin America and Africa is simply by holding U.S.-based companies, many of which often do over 50% of their business abroad. That would include Coca-Cola (NYSE:KO), McDonald's (NYSE:MCD), Proctor & Gamble (NYSE:PG), Johnson and Johnson (NYSE:JNJ) and Colgate (NYSE:CL). I assure you that if you have $100,000 invested in either of the above funds, these companies are well represented. However, you could also own an ETF that holds the large successful firms of other countries. Companies like Nestle (OTCPK:NSRGY), Toyota (NYSE:TM) and Glico Smith-Kline (NYSE:GSK). I hold Vanguard FTSE Developed Markets ETF (NYSEARCA:VEA) for just that reason, along with 30 stocks traded on the NYSE. Let us look at that possibility and add an allocation for the Vanguard Short-Term Corporate Bond Fund (NASDAQ:VCSH) of 20%. Something like the below is a very safe way of investing. You will do better than the average investor who is picking individual stocks or selecting the hottest funds.

Focused Selections

Some like to add emphasis to their portfolio by adding some other slices to their investment pie. You could boost yield a little with a Utility Fund (NYSEARCA:VPU) or add a little of a Country Fund, such as the Chile Fund (BATS:ECH) if you have a special interest in that country. I would keep the slices thin, perhaps under 5% of your total holdings each, so that you do not throw away the benefit of the primary fund. My other caution to you is that you may be adding complexity without adding much benefit. But, you probably won't realize that until you do too much of it. No big deal, just undo it if that is the case.

A Best Ideas Mix

Let us say that you have invested wisely, well and most important, regularly, and as your fund reaches $100,000 you would like to make some other investments. If you invested in VYM, a great choice for a younger person with a plethora of dividend growth stocks, the average of your top 10 holdings is over $3,000 each. If you invested in DHS, a great choice for an older person, more heavily weighted to the higher yielding stocks, the average value of the top 10 stocks is $4,200. So, now if you invest $3,000 in an individual stock, or eventually after making careful selections and doing due diligence, $5,000 in 5 individual stocks, you still have ample diversification through holding the fund, and the minimum of maintenance that holding only 5 stocks requires. Note: This is an example, not a magic formula.

Expanding Your Individual Holdings

If you have the time, the inclination, the knowledge and skill to do so, you may wish to increase the number of individual stocks you own. You might be a person who is very handy with spreadsheets, enjoys doing analytical assessment of opportunities with quantitative tools and knows the market, financial language and how businesses work. You can carefully expand your selections one at a time, using a good plan upon which to base your decisions. Perhaps, you will find this to be an interesting and fruitful hobby. Perhaps, you will make more time and available keep building your collection. You could end up eliminating the ETFs and owning 30 to 50 stocks. Theoretically, one can achieve specific focused goals better this way than with ETF holdings.

Simplify, Simplify, Simplify

Then again, you might get tired of the whole thing as you get busy with other endeavors. Perhaps as you age it will seem like too much trouble. I feel tired on some days, and this is what my portfolio looks like to me on those days.

A Simpler Portfolio for Retirement

So, you just move back to a very simple portfolio holding only two or three funds. As the French say, et pourquois pas?

There is More than One Way…

There is more than one way to be a successful Dividend Growth Investor. I cannot tell you what you should do. I do not know your goals and aspirations, your skills or limitations. One ETF? Three? Five? Three plus a handful of stocks? An all stock collection of 50 stocks? All of those will work. It is a matter of personal preference. It is up to you. As the old storyteller said, "There is more than one way to skin a cat."

Disclosure: I am long JNJ, PG, VEA, MCD. 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.