It's hard to believe, but 2016 is already starting to wrap up (where has the year gone!?). Ohio is getting its seemingly annual labor day heat wave and the NFL will soon be upon us, which means the cold weather and year's end will be upon us in no time. 2016 has flown by so far, but it has been a pretty good year as we got to see friends married, college graduations and the Cavs complete a comeback and win a title. It also brought a new job, travel to Punta Cana and even more additional great memories. However, no matter how much fun the year may have been, 2016 was also a year of work. It was a year my investing strategy came into clearer focus, and trajectories were set for future growth and wealth building. With the fourth quarter rapidly approaching, it is a good time to take stock of the year so far and set a course for its remainder.
2016 in Review
Earlier in the year I spelled out my strategy for building wealth over the long term. The strategy began to crystallize and come into focus in 2015 and early 2016, and in 2016 I sought out ways to implement the strategy. At first, storing wealth was a haphazard approach. If I had cash, I would put a few bucks in Coca-Cola (NYSE:KO) here, a few in IBM (NYSE:IBM), and some in Hershey (NYSE:HSY). The transactions were all well timed and weren't placed into speculative stocks, however, there wasn't much rhyme or reason beyond them being all high-quality blue chips. It also was easy to get carried away with the purchases, and could leave little cash left over for larger, more strategic purchases. Lastly, much of it came from having a lack of new investment ideas at the time and being uncomfortable with cash holdings. So while the transactions may have occurred on a regular basis and fit within my long term goals, this was not a sustainable process as it was not systematic enough.
With this mind, 2016 was about setting up a permanent system that could be sustainable and also make a large enough impact on investment totals on a regular. It needed to be more disciplined, and not as haphazard as previous purchases. That led us to first draw up a list of stocks that we wanted to hold long term, have either a long term dividend history or a sustainable dividend payout, and couldn't be a new position. The list was longer than expected, but still manageable:
· Johnson and Johnson (NYSE:JNJ)
· Diageo (NYSE:DEO)
· AT&T (NYSE:T)
· Altria (NYSE:MO)
· Coca-Cola (KO)
· Dr. Pepper (NYSE:DPS-OLD)
· McDonald's (NYSE:MCD)
· Exxon Mobil (NYSE:XOM)
· Proctor & Gamble (NYSE:PG)
The first four stocks will have capital committed to them once a year, beginning with JNJ in the first quarter and proceeding down the list throughout the year. These were not randomly chosen to be done this way, as each is held in a brokerage and therefore will incur commission. With a yearly purchase, the average transaction cost will be kept down. Each purchase will be about 1% of current portfolio value, but the ratio will shrink as the portfolio grows through the year. The purchases will not be timed, but instead will occur on the first business day of the quarter. It will take any decision making out of the process, and will only stop if earnings are materially impaired and/or the company approaches what even Jeff Bezos would consider an inflated valuation. This will allow us to systematically place wealth away, and in stocks where we are comfortable with the payout value. The companies purchased may change in a few years, but this is our way to grow our interest in these firms in a manner that is proportional to the growth of the portfolio as a whole. I look forward to cashing some large checks in the future from this strategy.
The next three stocks are all held at Loyal3, and incur no commission costs. Therefore, all three of those will be purchased once a quarter for an amount approximately .25% of portfolio value. A quarterly purchase will also allow us to dollar cost average a little more frequently than JNJ and Diageo. They were also chosen for the same reason as the previous stocks: they are high quality dividend stocks that we want to hold long term. Again, the firms purchased could change in a few years, but we like these firms currently and also wish to grow them slowly as the portfolio increases in value over time. The same goes for Exxon Mobil and Proctor & Gamble, which are held at their respective transfer agents. Low transaction costs there will also allow us to keep building our positions over time, and on a once a quarter basis like the stocks at Loyal3.
Building Up Cash
The second big priority for the year was to build up a large cash stockpile that could be deployed advantageously. During the downturn in August of 2015, we held nearly no cash in our portfolio. This led us to be unable to take advantage of any of the short term fluctuations that month, and made me start to build a cash position up. There can be a debate on how much cash is optimal for your portfolio, but having some on hand in your brokerage accounts at all times allows you to take advantage of opportunities that present themselves to you. Having cash on hand allowed us to take advantage of both Brexit and the downturn in the beginning of the year, both of which produced positions that have produced a 15% return or better (plus dividends).
So far, the goal was to accumulate 8% of the portfolio in cash for the event of a market event like 2008 or the 2011 debt ceiling negotiations, and another 4% to take advantage of opportunities that might present themselves. If a scene like Friday repeats itself a couple more times, such an opportunity might present itself soon (And I hope so, as we are currently at 15% cash). The percentages aren't arbitrary either; an unscheduled purchase not like the ones described above are for now around 2% of portfolio value, and this would allow us to make two purchases immediately if an opportunity presented itself. Those opportunities could be in stocks on a watchlist, or stocks that temporarily become discounted. One such firm could be Dollar General (NYSE:DG), as it has dropped further than recent earnings suggest it should have. Once any of this cash is used, it must be replenished before any new purchases can be made (This does not include the regular purchases discussed before).
The Rest of 2016
Having a more disciplined approach to systematic purchases also leaves extra cash for more strategic purchases. Right now, our watchlist is National Grid (NYSE:NGG) and Cardinal Health (NYSE:CAH). NGG is a British utility with a favorable valuation as compared to its American counterparts, and pays a 4.4% dividend. Thanks to its lower valuation, it also has a comparably favorable payout ratio of only 70%. The stock took a dive post Brexit, recovered a good portion of the decline, and declined nearly 3% on Friday. I have been looking to add utility exposure, and it looks like a good place to start adding cash. Further research will be done over the next few days to see if this is an opportunity worth committing funds to.
Cardinal Health also looks to present a compelling opportunity when compared to its peers. It is growing earnings, has a better valuation when compared to peers in the healthcare sector, and has retreated from its highs on the year. The firm also declined significantly around Brexit and has recovered most of the decline, but uncertainty still exists around the stock due to Hilary Clinton's statements around pharmaceutical stocks and their profits. This has helped the stock retreat around 15% from its highs, and seeing as the ex-dividend date is within three short weeks, a purchase might be in order soon. Further research will also be done on this over the next few days.
Beyond that, we will also be looking to either add to existing positions that had become over-extended and might be on the verge of a pullback after Friday's results, or start some new ones. Thanks to Friday, the rest of the year might have gotten slightly more interesting. Many popular dividend stocks decreased around 3-5%, which while not at all a significant decrease in the long run, added to some of the slow motion decline stocks like Altria had experienced over the past couple of months. Hershey finally came back down from its Mondelez (NASDAQ:MDLZ) takeover rumor market highs, and thanks to that, we are now slowly building back up our Hershey position (We took profits at 115). Many high-quality firms such as Realty Income (NYSE:O) tumbled several percentage points, and very little green could be found throughout the market. It may turn out to be nothing, but Friday had the feeling of the beginning of a slight downturn. Considering we have seen volatility the last few years around this time of year, it would not be shocking to see blue chips take some time off from their recent run up. Thankfully, with our cash buildup we will be in position to take advantage of any deep discounts that present themselves.
2016 has been a great year so far, and 2017 will be hard pressed to top it. However, the year is not up. So while we have set our investing strategy into place and built up a cash buffer, there is still work to do. Our short watchlist will be looked at even more closely, and more opportunities may present themselves soon after Friday's downturn. With 2017 not far off, it will also be time to start developing a strategy for next year to meet even more long term goals, but more on that to come. So what about you? How are you planning on spending the rest of your 2016?
Disclosure: I am/we are long HSY, PG, DEO, KO, DPS, XOM, MCD, JNJ, MO, T. 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.