Several months ago, Seeking Alpha contributor David Van Knapp wrote an article about developing a business model for dividend growth investing which encouraged DG investors to formulate a strategy to achieve their goals and follow it.
It occurred to me after reading this article that this would benefit any investor if done thoroughly. I had only recently started my portfolio in May of 2011, and although I followed a general idea of what I wanted to achieve, I truly had no road map in place to guide me. I decided to take DVK's recommendation seriously and I thought I would share the strategy and tactical vision I adopted in the hope that it might inspire others to formalize their own plans. If you have an experience that was anything like mine, you may discover that there are things you want out of your investments that you hadn't considered before. Rather than generalizations, I now have specific goals to strive for and know exactly how I want to achieve them.
Here is my example:
The core philosophy of my strategy is based on the belief that it is better to live off the income your assets produce in retirement rather than by liquidating those assets. Therefore, assets not only need to generate a stream of income, they need the ability to grow that income at the rate of inflation and, ideally, beyond it. For this purpose I have created the GOD (growth-of-dividends) Portfolio, with three fundamental goals:
- Accumulate a steadily growing stream of dividends that match or outpace the rate of inflation.
- Preserve and grow capital.
- Leave behind one million dollars to each of my children.
The first goal will be achieved by investing in companies with a history of strong dividend growth. The second goal will be achieved by investing in these companies only when they can be bought at fair value or discount. The third goal will be achieved through following the first two combined with the passage of time. It also serves as a motivator to stay the course.
Criteria for Stock Selection:
- Primarily use stocks from the U.S. Dividend Champions list published monthly.
- Minimum projected yield at least 3.0% with exceptions allowed for companies with high dividend growth rates.
- Understandable business model.
- Trustworthy management team.
Criteria for Stock Valuation:
- Select companies that you believe are fairly valued or undervalued based on your research.
- Compare your findings with estimates from various resources you trust.
Criteria for Portfolio Construction:
- The minimum dividend required to purchase a company at fair value is 4.0%.
- Companies paying a dividend within the range of 3.5%-3.99% may only be purchased when trading at a 10% discount to fair value.
- Companies paying a dividend within the range of 3.0%-3.49% may only be purchased when trading at a 15% discount to fair value.
- Companies paying a dividend below 3.0% may only be purchased when trading at a 20% discount to fair value as long as they meet my criteria for having a high dividend growth rate.
- A company's value as a percentage of the portfolio will be monitored. Any company with a value between 5 - 10% will only be considered for future purchases if no other company can be found. Any company with a value over 10% will not be considered for future purchases. Values will be monitored at quarter end.
- A company's dividend income as a percentage of total portfolio dividend income will be monitored. Any company with a value between 5 - 10% will only be considered for future purchases if no other company can be found. Any company with a value over 10% will not be considered for future purchases. Values will be monitored at quarter end.
A note about diversification: I intend to monitor diversification across sectors and industries, but allocation will not be subject to any set percentage of the portfolio. I believe that my selection and valuation method will result in adequate protection of capital.
A note about the number of companies held: There will be no set limit on the number of companies held in the portfolio. The number will be based on my ability to actively evaluate the holdings in a timely manner.
Dividends will be reinvested in existing companies within the portfolio until such time as dividends become the primary funding source. Upon the final dividend payment of the quarter all dividends for that quarter will be reinvested in the most under valued company in the portfolio assuming it passes the percentage of portfolio requirements listed above. Once dividend purchases become the primary funding source they will be bound by the requirements found in my criteria for portfolio construction.
Criteria for Selling:
Consider selling a company for these reasons:
- It freezes, suspends, or cuts its dividend or appears to be in danger of taking one of these actions.
- New knowledge of significant changes that might affect business model, competitive advantages, or management team.
- It becomes significantly overvalued.
This section is designed to establish a set of specific goals that can be used to measure the performance of the portfolio with regard to its mission.
The income goal of the GOD Portfolio is to provide sufficient dividends to live on in retirement. As of 2012 I have determined that the bull's-eye should be annual income of $60,000, adjusted for inflation.
Funding of the portfolio will come primarily from cash assets held in short term CDs that have matured and Money Market accounts, as well as the dividends the portfolio generates.
I have carefully weighed the benefits with the risks of easing in over the course of several years, as opposed to going "all in" at this time, and have decided the current course is more suitable to my risk aversion. However, should another crisis ensue and the market plummets, or we enter into a considerable bear market over a longer period of time, I will re-evaluate this position to possibly take advantage of such circumstances. In short, easing into the market is the current policy, but that could change if the price is right.
The road map shows approximate goals for each year. These goals are to be reached by 12/31 on the year of age shown. Taxes are not deducted. I am aware of the fact that taxes will significantly affect the numbers as the years play out. I will pay the taxes out of my own salary for as many years as possible, but there will come a time when I will have no choice but to use a portion of the dividends to pay the tax bill. When that day comes I will recalculate.
The purpose of the Road Map is not to convince myself, or anyone else, that I might be worth millions some day. It's purpose is to show the power of dividend growth investing and compounding, and to keep me motivated for the long haul. As long as I can achieve my retirement income goal, and the goal for leaving something behind for my children, then it truly doesn't matter how the numbers come out in the end.
Road Map assumptions: The dividend growth rate is 6%. In order to keep the yield constant the growth rate of the value of the portfolio is also 6%. All contributions and dividends during any year are reinvested at the beginning of the next year.
This article lays out the strategy, and the tactics, for achieving the mission of the GOD Portfolio. The strategy, or the tactics, can change at any time and are subject to constant review. It is expected that adjustments will be made as the time horizon for this plan is roughly three decades.
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. I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: I am not a licensed financial adviser and no information provided should ever be construed as investment advice. It is for educational and informational purposes only.