Portfolio Prime Directive

by: Inzkeeper


Portfolios need a set of guiding principles.

One can control contributions and dividends, but not capital gain.

Creating a growing income is my prime directive.

Each individual portfolio should have a set of guiding principles which includes goals, and strategy. These items will vary significantly based on many factors. The most amazing thing about being a self-directed investor is that instead of an advisor telling us these things, or convince us of his perspective, we can decide - and in my case, discover - these things for ourselves. Our past experiences, stage of life, risk tolerance, time horizon, needs, and desires, among others, all play roles in determining goals and strategy.

I have been enjoying the discussions about Total Portfolio Value. There are varying opinions of its importance and role in portfolio management. Some say, "Total return is everything." Others consider total portfolio value irrelevant.

In the past I have said that Total Portfolio Value is important to me because the income I will need is directly related to the Total Portfolio Value. I thought that as I moved closer to the retirement distribution phase from my current accumulation phase, total return will be gradually less important and the portfolio income will take over as most important.

My mind has changed.

In establishing my main goals and strategies, my "Prime Directive", or main guiding principle, is to be able to afford to retire at a typical age, able to live off the dividends and income from our investments without needing to spend down the principal. I am only trying to fund our retirement, not a lifestyle. My three-fold current strategy is to build a growing income stream, contribute heavily, and create windfalls to be lump-sum additions to the portfolio. Of course, I have various sub-strategies, such as; strategically redeploying dividends collected as cash in most cases, doing careful due diligence, and buying on price dips, but those are not the focus here.

What I have realized is that even with last year's amazing returns, capital gain is a comparatively small and uncontrollable factor in my portfolio's big picture. I would rather focus my energy on the metrics that I can control and play a larger role in my success as an investor. As a result Total Portfolio Value is now merely a measuring stick at the end of the quarter or year, a way to judge if my portfolio is on track, not at all a goal and certainly not "everything."

Focusing on Total Portfolio Value will not get me to my end goal. So far, pursuing Total Portfolio Value has led me to trade too often, increase my risk, and act emotionally. I am ever and increasingly glad I have been leaving that approach.

I have control over whether my regular monthly contributions happen. Barriers crop up. Just this past year, a wedding, a car accident, and the refrigerator dying, have all been the cause of planned contributions not happening. Fortunately, more careful personal spending, extra jobs, and windfalls have more than made up the difference and accounted for approximately 70% of my portfolio's increase last year.

I have control over the dividend income. As I purchase new stocks, and convert former non-dividend paying trades into dividend growers, I increase the income of the portfolio. I do not chase yield and do tend to have a little more than most allocated to lower yielding, more growth oriented names. It is inspiring to track the dividends and watch them collect into a significant amount. Additionally, the kind of company that pays a growing income stream tend to be steady, slower growers, so that choosing them lowers risk, while steadying the Total Portfolio Value. Choosing DGI companies seems to be the only way to have any form of control over capital gain as well, though that is fleeting.

Focusing on Total Portfolio Value gives far too much faith in unrealized gains. Realizing those gains either creates a trading environment - which I am trying to move away from - or destroys the income.

In a comment to my last article, Dale Roberts wrote: "Total return is everything (while you also pay attention to your risk tolerance level). In the end it will all come down to how much you have to go shopping for said income. Track the portfolio value, not the portfolio income."

I agree with Dale that in the end, at retirement and beyond, income is a critical factor and your ability to "go shopping" determines your ability to meet your needs and desires. For me, the income level at retirement compared to expenses will be the ultimate determination of the success of my portfolio. Fortunately there is significant flexibility in the income a portfolio can generate and the expenses a retiree might have.

However, his three statements appear contradictory to me and only underscore the importance of income, not Total Portfolio Value. Experienced dividend-oriented investors have been also concluding directly the opposite from the same focus of income at retirement. They advise to track the income and ignore the total portfolio value, using share price weakness as opportunities to purchase income producing shares at a discount. Establishing that growing-faster-than-inflation income is the true portfolio prime directive.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.