Dividend Growth For Couch Potatoes

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Includes: DON, NOBL, SCHD, SPHD, VNQ
by: David Van Knapp

Summary

Dividend Growth Investing can be accomplished through ETFs.

We build on the foundation laid by pioneering Couch Potato and Lazy portfolios to build some dividend growth portfolios from ETFs.

Sample portfolios with core holdings, plus REITs and mid-cap dividend stocks.

Many of you know of Scott Burns. He published his first book on personal finance in 1972. His financial column, begun at the Boston Herald and later the Dallas Morning News, was syndicated beginning in 1981. He retired in 2017.

In 2006, Burns doubled up to become one of the founders of AssetBuilder as well as its Chief Investment Strategist. AssetBuilder is a money management firm that emphasizes asset allocation using DFA funds. They illustrate a variety of fund recipes for different goals and levels of risk (volatility) tolerance.

In 1991, Burns proposed what became known as the Couch Potato portfolio. It was a 50-50 portfolio in U.S. stocks and U.S. bonds using mutual funds.

The Couch Potato idea has since grown a little more involved, but the underlying principles remain the same for most "lazy investor" portfolios:

  • Simple
  • Cheap
  • Effective

For example, here is one of AssetBuilder's portfolios. You can see how it mixes 6 asset classes, using funds, to create an overall investment portfolio:

If you move clockwise around the portfolio, you can see an order of adding assets that is typical of many lazy portfolios:

  • Fixed income (our dividend growth portfolios will have 0 allocation here)
  • U.S. Large-cap stocks
  • U.S. Small-cap stocks
  • REITs
  • International stocks
  • Emerging market stocks

My purpose in this article is to outline a framework for designing and building dividend growth portfolios for couch potatoes.

Please note that these are not asset-allocated modern portfolio theory [MPT] portfolios. They contain no bonds. They only contain stocks. Whether one wishes to have 20% or 30% or 50% of their investments in bonds is up to each individual.

In my own dividend growth investing, I focus not on total return, but rather on growing my portfolios' cash flow toward an eventual long-term target amount of income. The idea is that I will eventually live off that income in retirement.

I attempt to achieve income that is:

  • Enough (obviously how much is "enough" varies from person to person)
  • Reliable
  • Growing

I will apply these goals to the couch potato portfolios:

  • Enough: 3% yield or more across the total portfolio
  • Reliable: ETFs with regular distributions from dividend stocks
  • Growing: ETFs that have raised their annual dividends most years of their existence

Before we get started, I need to insert a note on what is known as "smart beta." For background, please refer to this article that I wrote in 2015. It lays out the foundation - both academic and non-academic - behind smart beta funds.

In a nutshell, smart beta employs "factors" believed to enhance returns. Smart beta often weights portfolios to "tilt toward" the factors rather than using traditional weighting by cap size. Note that equal-weighted portfolios automatically create a tilt toward smaller cap stocks.

Dividend growth itself is one enhancement factor, recognized in the fund industry but not academically. Thus, dividend growth exists automatically in all of the ETFs used here. Other factors typically include:

  • Value (recognized academically)
  • Quality (beginning to be recognized academically)
  • Low Volatility (not recognized academically)
  • Small Size (recognized academically)

The Dividend Fund Universe

ETFdb lists 161 ETFs as the top "Dividend" ETFs by size of fund (meaning how many assets it controls). I constructed the following table to show the vital statistics of the largest 20 such funds.

Of course, many ETFs beyond the 161 have dividend yields, but they are not designed specifically for dividends nor marketed that way.

An obvious example of dividend funds that are not usually categorized that way would be ETFs focused on REITs. Here is how a couple of REIT ETFs would look in the same format as above.

Introducing Dividend Growth Portfolios for Couch Potatoes

There are countless recipes one could follow in constructing dividend growth portfolios for couch potatoes. What I have done here is try to follow the general model described earlier, again noting the obvious exception that these portfolios will contain no fixed income components.

The usual approach is to have two "core" components to cover the field generally. One can stop there, just as Scott Burns did with his original Couch Potato Portfolio.

Or, one can add other components to pick up factors or themes that one wants. In the lazy portfolios that I looked at, themes such as REITs, foreign, and small cap size were often among the first added to the core funds.

The number of funds generally ranges from two to 11. Once you get past that point, it is hard to say that it's simple any more. I will stop at five funds.

The data in this article has been sourced from Morningstar, ETFdb.com, ETFreplay.com, and the funds' own sites and fact sheets. Notes:

  • Dividend growth streaks include the fund's inception year for funds less than 10 years old.
  • Dividend growth with ETFs can only be measured annually because quarterly distributions vary. I have measured growth streaks over the past 10 full years (2007-2016). Not all ETFs have existed that long.
  • Total returns are with dividends reinvested, and come from the calculator at ETFreplay.
  • The average portfolio yields, expense ratios, and returns are weighted averages (weighted by the proportion of each ETF in the portfolio)

Two-fund Dividend Growth Couch Potato Portfolios

I offer two 2-ETF portfolios. I would consider either of these as basic core starter kits for lazy dividend growth investors.

My first portfolio consists of the only two dividend funds that I myself invest in. I chose these after quite a bit of research into my own needs and goals. I have confidence in them, but note that they are both relatively new and have not existed through a bear market or recession.

  • 50% - SCHD - Schwab US Dividend Equity ETF
  • 50% - SPHD - PowerShares S&P 500 High Div Low Vol ETF

I used the Morningstar Portfolio X-Ray to pull a few stats about this portfolio. First, the portfolio is (unsurprisingly) heavily tilted toward large-cap value stocks. (The figures show the percentage of the total portfolio that are in each portion of the style box.)

This graphic shows the breakdown of holdings using Morningstar's classifications of Supersectors (Cyclical, Sensitive, and Defensive) and sectors.

Morningstar's Portfolio X-Ray has many other breakdowns for any portfolio you insert.

The second starter portfolio contains 2 ETFs with 10-year+ track records.

  • 50% - VYM - Vanguard High Dividend Yield ETF
  • 50% - DVY - iShares Select Dividend ETF

Here are the X-Ray graphics for this portfolio.

Note that we picked up more mid-cap and small-cap exposure with this second 2-fund option.

Three-fund Dividend Growth Couch Potato Portfolio

Now we start to add ETFs one at a time to capture themes or factors that we want. Many lazy portfolios have a REIT component. REITs, of course, are common dividend growth investments anyway, so that seems like a good next step.

In these additional portfolios, I will use the first "core" portfolio (with SCHD and SPHD) as the foundation. Obviously, any one- or two-fund basic portfolio could be used as the foundation.

The REIT component is held to 20% weighting; that is the upper level of REIT holdings that I have seen many commenters mention that they are comfortable with.

  • 40% - SCHD
  • 40% - SPHD
  • 20% - VNQ - Vanguard REIT Index ETF

Real estate jumped from almost nothing to about 20% of the portfolio.

Four-fund Dividend Growth Couch Potato Portfolio

Next, we explicitly bring in the size factor by including an ETF that emphasizes mid-cap dividend stocks. The size factor was already somewhat present, as shown by the percentage of small- and mid-cap stocks in earlier portfolios.

  • 30% - SCHD
  • 30% - SPHD
  • 20% - VNQ
  • 20% - DON - WisdomTree MidCap Dividend ETF

That did not change things much. The holdings in medium and small stocks only went up by 1%.

Five-fund Dividend Growth Couch Potato Portfolio

This portfolio brings in an ETF specifically containing Dividend Aristocrats, which are S&P 500 companies with dividend increase streaks of 25 years or more. I did not introduce it earlier because its yield is so low that it is hard to include it when your target yield is 3%.

  • 30% - SCHD
  • 30% - SPHD
  • 15% - VNQ
  • 15% - DON
  • 10% - NOBL - ProShares S&P 500 Dividend Aristocrats ETF

Summary

The next likely step would be to add a component to capture foreign stocks, but I will stop here. I am sure you get the general idea.

Clearly, couch potato dividend growth investing is possible. Many dividend ETFs have been introduced in the last few years, so more and more options are available for both core choices and thematic or factor additions.

The big downside to using ETFs are their expense ratios. Every fraction of a percent paid in expenses reduces the fund's yield. For example, NOBL's yield would be around 2.5% instead of 2.1% but for its expense ratio.

Stated another way, 14% of the cash you could receive from a portfolio like NOBL's never gets to you - it is withheld by ProShares as their fee.

For me, there are two main types of investors who might be attracted to approaching dividend growth investing via Couch Potato portfolios.

  • People who like the general dividend growth investing strategy, but who do not have the time, inclination, and/or knowledge to assemble portfolios of individual stocks that might be more directly targeted to individual goals.
  • Self-directed investors who may wish to convert existing dividend growth portfolios into simpler models that can be passed on to surviving spouses or children who themselves do not have the time, inclination, or knowledge to assemble portfolios of individual dividend growth stocks.

I am in the second category, which is why I keep coming back to this subject. As mentioned earlier, I have already converted some of my investments into SCHD and SPHD.

The portfolios suggested in this article are examples only. Different choices could be made for core funds, add-on funds, and the like. Also, some may wish to emphasize total return, or perhaps trade current yield for faster dividend growth, by selecting different funds than the ones I have chosen.

Similarly, funds could be weighted differently to achieve different mixtures of results. And to repeat, there are no fixed income components illustrated here. That said, any of these models could be the "stock components" of more rounded asset allocations that include bonds or other asset classes.

Disclosure: I am/we are long SCHD, SPHD.

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.

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