The Retirees' Dividend Portfolio - John And Jane's March Taxable Account Update - Tax Season

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Includes: AAPL, ABR, ADM, APD, APLE, BP, BPL, CAH, CLX, CMI, DOV, EAFAX, EMR, EPR, ET, GIS, HP, HRL, IRM, JCI, LEG, LTC, MIC, MO, MSB, NRZ, O, ORI, PSXP, R, SCHW, SKT, SLB, SO, SPG, SWVXX, T, TXN, UTX, VZ, WASH, WLKP, WPC, XOM
by: Matthew Utesch
Summary

The Taxable account generated $1,117.34 of dividends in March of 2019 compared with $932.71 of dividends in March of 2018.

The Fixed Income segment was lower than expected due to the impact of maturity dates associated with its short-term CD holdings.

Two stocks in the portfolio paid increased dividends in the month of March.

We did not add to any positions in March as most stocks appear to be fully valued.

The cash holdings of the Taxable Account dropped by $13,000 as John and Jane each made $6,500 contributions to their Traditional IRA's.

Is it just me, or does everybody love Tax Season?

I can think nothing I love more than searching for useless pieces of paper that help the government interpret how much money I owe. Nonetheless, taxes are a necessary evil and I'll consider it a reasonable price for the privilege of living in such a wonderful country.

Now that I put my two cents in, this is the time of year where John and Jane get to interpret the impact of their income, investments, and any other taxable events for the year. Fortunately for them, I take taxes quite seriously because poor stewardship/planning can result in major taxable events that can really leave an individual with a bad taste in their mouth. For example, when both John and Jane were working, they reached a point where they could no longer contribute to their Roth IRAs because they made more than the contribution limits allowed. At the same time, John and Jane's financial advisor failed to let them know that they could still contribute to their traditional IRAs. In failing to do this, John and Jane missed two full years of potential contributions that could've at least lowered/reduced their taxable liability.

2018 was a year full of changes as we converted John and Jane's Taxable Portfolio from the mutual fund-based portfolio to one that is more focused on dividend stocks, floating rate loans/debt securities, and fixed income investments primarily consisting of certificates of deposit (CDs). The capital gains associated with these mutual funds were considerable (a little over $12k), which is why John and Jane's Traditional IRA contributions were helpful in offsetting this.

In total, the Taxable Account had a Gain/Loss of $13,416.79 in 2018 (when it comes to realized capital gains). Because I do not actively trade in this account, the only time changes are made is when a stock becomes ridiculously overvalued/significant downside is expected, or when the time has come to replace an investment that isn't meeting expectations.

2018 Realized Gains Source: Consistent Dividend Investor, LLC.

While I am not a tax professional, I believe in taking basic steps and arming myself with the knowledge necessary to solve most problems. By doing this, it can go a long way in mitigating the risk of an above-average tax bill.

Client Background

John and Jane are two real people who asked me to help manage their retirement portfolios. It is important to understand that I am not a financial advisor and merely provide guidance for my clients' account based on a friendship that goes back several years. I call them my clients for simplicity sake, but I do not charge them for what I do. The only request I made to them was that they allow me to anonymously write about them so that I can potentially help others who are wanting to achieve the same thing.

John retired in January of 2018 and is collecting social security along with other benefits while Jane is still working with aspirations of retiring in the next two years. John and Jane have done an excellent job heading into retirement because they currently have no debt or mandatory monthly obligations other than what is expected (such as property taxes, water, etc.)

John and Jane have adopted my philosophy of focusing on cash flow from investments instead of drawing out large sums of money by selling shares of currently held investments. In a nutshell, what John and Jane want is a portfolio of stocks, bonds, and other investments that will provide a steady stream of growing dividend income that will supplement their income during retirement. At some point, it will be necessary for John and Jane to sell shares from their Traditional IRA, the goal of the Taxable and Roth IRA is that they will never need to sell any shares (unless they want to) because the income generated will prevent them from needing to sell shares as a means of "funding their retirement."

Here are some important characteristics to keep in mind about the Taxable Portfolio:

  1. Capital appreciation is the least important characteristic of this portfolio. This doesn't mean we don't care about it (because all investors do to some degree) but it does mean that we are less concerned about the day-to-day fluctuations of stock prices. Since the goal is to never sell (although I make occasional changes by eliminating or adding positions), a focus on capital appreciation doesn't mean a lot when it comes to the game plan.
  2. In the past year, I have typically focused on stocks that paid a qualified dividend because they qualify for the lower long-term capital gains tax rate vs. ordinary dividends which are taxed as ordinary income. This has become less important now that 2018 was John's first year of retirement. Changes in the tax brackets also support this approach because the ranges have been expanded and include basically all of their income in the 22% bracket. (Qualified dividends are subject to a 15% tax so the difference has become less-important).

Fixed Income

I have chosen to separate the fixed income figures from the rest of the portfolio in order to avoid confusion which allows those reading to gain a better understanding of how John and Jane's Taxable Portfolio is generating interest and dividend income.

Certificates of deposit (CDs) are the primary recipient of these funds because we are looking for zero volatility and FDIC insured product. Typically I invest only in short-term CDs (1 to 3 months) because the increase 20 bps in yield isn't enough to justify a year-long CD in my mind. It should also be noted that a number of companies where we live are offering better CD specials than what can be found on Charles Schwab (SCHW) (at the moment).

We recently shifted everything from the Schwab Value Advantage Money Fund (SWVXX) because their slightly higher yield does not justify the higher fees associated with the account (thanks to the reader who brought this to my attention). Although I like the idea of having next-day access to these funds, there hasn't been much need because most segments look overvalued.

  • SWVXX - 7-Day Yield = 2.30% but comes with a Gross Expense Ratio of .47% which results in an effective yield of 1.83%.
  • 1 Month CDs - Current Yield between 2.15% and 2.25% and no transaction fees/costs.

March - Fixed Income Source: Consistent Dividend Investor, LLC.

As you can see, short-term CDs are one of the most conservative and safe methods an investor can use but their return isn't something worth getting too excited over. With the dovish Fed making it clear that they don't see any major increases in the near future, we have seen the CD specials and promotions dwindle to the point where I can't remember the last time I saw one worth considering at some of the nearby institutions.

It should also be noted that March was a light month for fixed income interest and was largely due to the conversion of SWVXX to short-term CDs. I expect that this will result in a higher than normal interest income for the month of April.

The following colors were used to represent the following details:

  • Green - Dividend received confirmed (actual dollar amount).
  • Red - Security has been sold or has expired and no longer exists.

In total, interest from fixed income provided John and Jane with an additional $171.47 in the month of March. Looking at this figure on a YTD basis we can say that the fixed income portfolio has added approximately $226.66 of monthly income.

Dividend And Distribution Increases

March was a light month for companies that paid an increased dividend and includes the following two companies:

  • Archer Daniels Midland (ADM)
  • Old Republic International (ORI)

Archer Daniels Midland: Weather-related issues have caused Credit Suisse and JPMorgan to remain cautious on stock price targets. The situation has been bad enough that management announced they expect Q1 operating profit to be reduced by $50M-$60M. While this news isn't my favorite, I expect that it could provide investors with a sub-$40/share entry point. With more than 43 years of continuous dividend growth and a payout ratio of approximately 45%, ADM is definitely on my radar for adding to the position after Q1-2019 Earnings on April 30th.

Archer Danield Midland FastGraph The dividend was increased from $.335/share per quarter to $.35/share per quarter. This represents an increase of 4.5% and a new full-year payout of $1.40/share compared with the previous $1.34/share. This results in a current yield of 3.27% based on a share price of $42.78.

Old Republic International: ORI is one of my favorite long-term investments because it has a highly diversified revenue stream and the credit quality of its fixed securities is strong. While we can't rely on low double-digit or high single-digit dividend increases, we have benefited from consistently increasing dividends with the occasional special dividend. The financial crisis impacted ORI in an extreme way but its business has since recovered and used the opportunity to build a strong balance sheet that any conservative investor can appreciate.

ORI - FastGraphs The dividend was increased from $.195/share per quarter to $.20/share per quarter. This represents an increase of 2.6% and a new full-year payout of $.80/share compared with the previous $.78/share. This results in a current yield of 3.88% based on a share price of $20.96.

Positions

The Taxable Portfolio in 2018 had 40 different positions and currently includes 42 unique positions as of 4/10/2019. We do not have any plans to add new positions to the portfolio, but it is likely we will increase positions if they reach our price targets. In March, we added to the following positions:

  • Simon Property Group (SPG) - Bought 15 Shares @ $175.14/share.
  • Westlake Chemical Partners (WLKP) - Bought 50 Shares @ $22.30/share.
  • Washington Trust (WASH) - Bought 25 Shares @ $48.84/share.
  • Washington Trust - Bought 25 Shares @ $48.23/share.

March Income Tracker - 2018 Vs 2019

March 2019 saw income increase by 19.7% over the previous year and was partially due to the additional funds invested throughout the year in addition to the regular dividend increases.

None of the following images take into consideration the income generated by the Fixed Income holdings.

March Taxable Account Income

Source: Consistent Dividend Investor, LLC.

Here is a graphical illustration of the dividends received on a monthly basis.

Monthly Dividend Graph

Source: Consistent Dividend Investor, LLC.

Based on the current knowledge I have regarding dividend payments and share count, the following table is a basic prediction of the income we expect the Taxable Portfolio to generate in 2019 compared with the actual results from 2018.

Monthly and Annual Income Estimates

Source: Consistent Dividend Investor, LLC.

As a new feature going forward I also want to include account balances to help readers' understand how the size of the portfolio has changed over time. By showing when additional funds were added to the account I hope it will help explain certain changes in income, etc. Please note that this includes the Fixed Income holdings in the total account balance.

Month End Statement Balance Source: Consistent Dividend Investor, LLC.

To wrap up March's assessment I always like to include a gain/loss for each position in the Taxable Portfolio because it is important to consider that some positions will be the gain and others at a loss. If you plan to have your own dividend growth portfolio you will need to learn to live with this volatility because even the highest quality portfolio will be subject to some degree value of fluctuation.

March Gain Loss Figures

Source: Consistent Dividend Investor, LLC.

Values are fairly comparable to what they were at the end of February (total balance of $295.7k). One major impact that was discussed at the beginning of this article is the loss of $13,000 from the Taxable Account that was used to cover both John and Jane's Traditional IRA contributions for 2018.

Conclusion

As expected, we have seen a handful of companies increase their dividends in the first two months of 2019 but dividend growth appears to be slowing compared with many of the increases in 2018. When I create a forecast for dividend growth I assume a minimum of 3%, a midpoint of 5%, and a rating of exceeds with the goal of 7%. Based on the increases seen in 2019 I expect that we will see something closer to the midpoint of 5%.

April has offered very few buying opportunities as the market continues to hold near all-time highs.

Chart Data by YCharts

In fact, stocks have ascended to levels that haven't been seen since the beginning of October and 2018 when we saw the big three indexes drop as much as 20% in value. While pockets of value exist, it is becoming more difficult to find truly undervalued stocks that make sense in John and Jane's Taxable Account.

If we include the fixed income holdings in John and Jane's Taxable Portfolio it results in a total income of $1,288.81 in the month of March. At present, the Taxable Account is estimated to be generating $1,115.76/month of regular dividend payments.

What about your dividend growth portfolio? I'd love to hear feedback on your personal strategy and potential stocks you think I should consider.

In John and Jane's Taxable account, they are currently long the following mentioned in this article: Apple (AAPL), Arbor Realty (ABR), Archer Daniels Midland (ADM), Air Products & Chemicals (APD), Apple REIT (APLE), BP (BP), Buckeye Partners (BPL), Cardinal Health (CAH), Clorox (CLX), Cummins (CMI), Dover Corporation (DOV), Eaton Vance Floating-Rate Advantage Fund A (EAFAX), Emerson Electric (EMR), EPR Properties (EPR), Energy Transfer (ET), General Mills (GIS), Helmerich & Payne (HP), Hormel (HRL), Iron Mountain (IRM), Johnson Controls (JCI), LTC Properties (LTC), Leggett & Platt (LEG), Macquarie Infrastructure (MIC), Altria (MO), Mesabi Trust (MSB), New Residential (NRZ), Realty Income (O), Old Republic International (ORI), Phillips 66 Partners (PSXP), Ryder Corporation (R), Tanger Factory Outlet Centers (SKT), Schlumberger (SLB), Southern Corp. (SO), Simon Property Group (SPG), AT&T (T), Texas Instruments (TXN), United Technologies (UTX), Verizon (VZ), Washington Trust (WASH), Westlake Chemical (WLKP), W.P. Carey (WPC), and Exxon Mobil (XOM).

Disclosure: I am/we are long APLE, ET, GIS. 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.