I have commented on many articles over time that cash reserves are part of a portfolio's balance. I use a sliding scale of cash reserves (10%-30%) of total portfolio. In times of volatile markets like today I set a limit price (usually 4% yield point) on dividend stocks I wish to add to my portfolio. I usually save the 30% cash allocation for the end of the business cycle and the 10% allocation for post purchase in downdrafts. I also use the cash reserve as a rainy day fund during these times of Great Recession and economic upheaval. I have children and grandchildren who find themselves out of work, needing an education, needing to pay rent on their homes or warehouses or needing to repair the well pump, and the list goes on.
David Van Knapp asked how this cash drag affects my portfolio's returns. Unfortunately, I don't have good data on this due to mixing withdrawals for expenses with portfolio returns since before retirement in 1994. I can say that I had 45% of my portfolio in Cash Bonds and Notes in 2000 when I retired. However, that figure was depleted year-by-year during the technology bubble bust to 32.6% by 2003. It held steady at about 30% until 2008 when the bonds ran out in the Great Recession. Until last week when I purchased Nucor (NYSE:NUE) and Raytheon (NYSE:RTN) at the 4% yield points, cash was holding steady at around 20%—I'm now down to 9% cash. Since I have been using the portfolio for expenses in retirement as well as covering emergencies for my extended family, good figures on portfolio drag are difficult to obtain. I will say that I am positive 6.9% total since 2000.
If one has an allocation to cash, limit orders can be set long in advance for several positions in securities desired, without selling anything. This provides flexibility in portfolio design. What stocks to buy in this up and down market with huge swings? I have three which have been good dividend stocks for me and should prove to be good for yield + dividend growth in the future.
VOD—Vodafone dividends have increased 20% per year over the last 10 years. This is a European stock with normal payments twice per year. I use the payments received during 1 calender year to determine the yield, which is presently 5.55%. The dividend growth rate for the last 5 years has been 11.7% per year. There will be a special dividend in early 2012 due to a Verizon Wireless (NYSE:VZ) dividend. The current ttm p/e is 11.33, which is more than justified by the 5 year dividend growth rate + yield. This company has 42.1% total debt/total assets ratio and a 23.73% projection for earnings per share growth next year (First Call).
ABT—Abbott Labs is a Dividend Champion with 39 years of dividend increases. The yield is 4% at $48. The p/e of 14.79 is justified by the 9.7% 5-year dividend growth rate + 4% yield. The total debt/ total assets ratio is 63%. The earnings growth projected for next year is 7.78%
JNJ—Johnson & Johnson is a Dividend Champion with 49 years of dividend increases. The yield is 4% at $57. The p/e of 13.3 is justified by the 5-year dividend growth rate (10.6%) + 4% yield. This company is AAA credit rated with a total debt/total assets ratio of 42.7%. The earnings per share growth rate projected for next year (First Call) is 6.44%.
The price charts for these stocks for the last year show the last several days of extreme volatility. It is critical in this type of market to have cash at the broker to make quick buy moves or have long term limit orders in place.
click on charts to enlarge