Wednesday, July 30, 2014

What's Your Weight?

No I'm not asking you to divulge your body weight, although if that will help you with any weight loss goals you have feel free to do so.  The weight I'm referring to has to do with your portfolio.  I think we all understand the importance of diversification, especially for those looking to live off the dividends your portfolio churns out.  You don't want to be left owning a few companies or a be highly concentrated in one segment of the economy as we all know how that worked out for those that were heavily invested in the finance sector during 2008/9.

Most dividend growth investors that I've spoken with agree on the importance of diversification and fall somewhere in between wanting to own 20-50 companies in their portfolio.  I currently own 41 companies and I'm trying to really focus on building positions up rather than continually expanding into new positions.  So when it comes to diversification you can either weight your portfolio based on capital value or on dividends paid.  In a perfect world all companies would pay the same yield to make this a lot easier but we have to work with what's available.  I created a chart showing the weighting of my taxable portfolio based on current capital value and on the dividends each position provides.




For the most part my portfolio is fairly balanced between a positions size and its corresponding dividend income.  32 of the 41 positions provide dividend income that is +/- 1% of its portfolio weighting and 24 of the positions are +/- 0.5%.  The biggest outlier as far as portfolio weight being larger than dividend weight is my position in Visa (V).  That's not a surprise at all because it's yield is much lower than the majority of my portfolio.  The inverse relationship, portfolio weight being less than dividend weight, leader is Kinder Morgan (KMI) and that's because Kinder Morgan is currently my second largest position and also has a yield that is much higher than the average position in my portfolio.

Ultimately though it's the future growth of the company and the dividend that is the most important.  Past results are not indicative of future returns.  Each company is different and has a completely different risk profile.  I wouldn't want to weigh a company like Coach (COH) or Darden Restaurants (DRI) on anywhere near the same level as I would a Johnson & Johnson (JNJ) or Procter & Gamble (PG).  The safety and stability of the company completely different between those four.  We will all need Band-Aids and laundry detergent but do we all need $500 purses or to eat out every week?  I think it's pretty easy to tell which will be the most stable and consistent over the next 10-20 years.

I'd hate to be relying on my dividend income to pay for living expenses and then suffer a dividend cut from a position that is overweight on either metric.  So I tend to have the majority of my portfolio with the same general yield/growth mix and then sprinkle in some high yield/low growth and low yield/high growth companies around the edges.  So naturally the portfolio weights and income weights should be fairly consistent from position to position.  The reason being is that with a fairly standardized yield and growth mix you can weather the storm of a dividend cut through growth from the rest of your positions and reallocating that capital.  But if you suffer a cut from a very high yield position good luck replacing that lost income.

I'm not anywhere close to being finished building out my portfolio so there's still time to correct some of the imbalances through additional contributions.  Ultimately I expect to own somewhere between 40-50 companies although I think 50 will be a pretty hard max. That should provide ample diversification and allow for relatively equal weighting along both the capital size and dividend income from each position, at least for the majority of my portfolio.  Realistically though I'll probably be overweight the core positions and underweight the slightly riskier holdings when it comes time to call it quits from my day job.

So my question to you is how do you weight your portfolio?  Based on dividend income or capital value?


18 comments:

  1. I keep track of both capital and income weightings and have it on my spreadsheet. If I had to pick the more important to me it would be the capital. On of the few reasons a dividend investors sells is when a dividend cut comes and they need to redeploy their money. How much will the price go down leading up to and after the cut because presumably the economic condition of a company warranting the cut also is causing cap gain investors to sell too.

    My capital average weighting is 4.11%
    My dividend average weighting is 5.56%

    While I consider myself an income investor, I am focusing my income from Lending Club and doing more cap gain investing than I have in the past. Though my portfolio yield has increase thanks to LC.

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    1. PMU,

      I also think capital weighting is probably the more important of the two and more relevant when comparing companies. If I wanted to have T and V to have the same dividend weight then my exposure to V is going to far outweigh the investment in T. If I wanted to get $100 per year from each position T would need to be a $1,900 investment whereas V would need a $13,100 investment. That's a big big difference.

      I'm still hoping that Texas will start allowing P2P lending so I can get in on that. If not then I guess I might have to see about owning some of the companies when they become public.

      Thanks for stopping by!

      Delete
  2. I had written about the exact same thing a while back. I noticed that 6 stocks was contributing close to 60% of my projected dividends and that is definitely risky if 1 or 2 of the 6 cuts/eliminates dividend. Another reason that led to this is because of my holdings in growth stocks like CMG that do not pay dividends, but have increased quite a bit in the recent past. Therefore, it skews up my portfolio weight versus the dividend weight. I wanted to diversify the portfolio in order to ensure that there is not too much weight on a few stocks with respect to dividend income.

    http://dividendgrowthjourney.wordpress.com/2014/06/07/dividend-risks/

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    1. DGJ,

      Luckily I haven't been that heavily weighted in a while but you're right because that definitely increases the risks of a potential dividend cut/elimination. As your portfolio continues to grow things will balance out and get more evenly spread out.

      Thanks for stopping by!

      Delete
  3. I usually like to look at the capital weightage. The dividend weightage will eventually come into play - but since my investments are long term, a lot of them are low yielders with good growth. Hopefully they will stabilize and balance out eventually. Nice graph you got there, I should put my portfolio in a similar graph to see if somethign stands out visually.

    Great post, JC. Keep it up.
    R2R

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    1. R2R,

      For portfolio building purposes I mainly look at capital weighting but the dividend weighting still comes in to play. For investors with a lot of investing still to do I don't think it's as big of a deal to focus on dividend weight because the portfolio is still in flux.

      Thanks for stopping by!

      Delete
  4. As I am just starting my dividend journey I am not too concerning with the weight of my portfolio right now. My actual weight is a bit more of a concern... with that said I am still trying to buy in different sectors, but I am not overly concerned until my portfolio is reaching 6 figures, at which point it will be of more importance to track it.

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    1. Kipp,

      I hear ya. I need to get my actual weight in better shape than my portfolio/dividend weight.

      If you're just starting out then I wouldn't worry too much about either weighting except your capital weighting if you have say a $25k portfolio and $10k+ with one company. As you continue to add capital and companies the risks for any one position will decline. Since I'm now at the $150-160k mark I've started to watch it some but generally I'm focus on finding great values first. There's still a lot of time for me to get things balanced out.

      Thanks for stopping by!

      Delete
  5. At this point in the game I only take mild interest in weighting. I check it and try to balance things, but I don't go bonkers making sure everything is weighted. In general if I find a good deal I buy it. In the case of PM I did set a limit to how much of my portfolio I would allocate to it (or any one stock).

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    1. WE,

      It definitely seems like the smaller portfolios aren't quite as concerned with weighting as the larger, and rightfully so. If your portfolio is only $10k and you invest another $1,500 in a company well heck the capital weight is over 13%. I would definitely focus on value first and figure out the weighting later once your portfolio is at least six figures.

      Thanks for stopping by!

      Delete
  6. Hi PIP, Great article!

    I have only general rules about weighting:
    I can't add to a position if its forward yearly dividends are more than 5% of the total portfolio forward income.
    I can't add to a position if its value is more than 7.5% of the portfolio value.

    So I do calculate and view individual stock weightings but only care about them for the sake of the above 2 rules.
    I tend to buy new positions in the industry sector with the lowest weight in my portfolio.

    Best wishes!
    -DL

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    1. DL,

      I don't have any rules set up yet because there's still a long way to go until I'm thinking about this being a sustainable lifelong portfolio. Although the rules you have seem pretty good. What's your target amount of companies to hold? If each is 7.5% that's 13-14 companies.

      Thanks for stopping by!

      Delete
  7. I currently have 14 different dividend stocks in my portfolio. I Think I can have enough diversification with 15-20 stocks, covering something like 10 sectors (Industrial, Finance, Consumer cyclical, consumer defensive, Health, Real estate, material, Energy, Utilities, telecom). I Right now, I am overweight in Finance and Energy, so I strive to buy in other sectors. I might add a position in a new sector, Technology, something like Apple or Cisco or something like that... Will continue to look for nice stocks and also focus on increasing my positions in current stocks when I deem the price OK. So, this week, I added to my Rogers and GE positions.

    I think with 40-50 stocks, it's more difficult to review them all every quarter, I mean, that's a lot of stocks to review.

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    1. Anon,

      40-50 stocks is quite a bit to keep up with but it's definitely doable for those that really like investing/reading. I'm hoping to keep it closer to 40 and when I reach FI then I might reconsider and drop it down a bit more. Who knows.

      Personally I'd be more comfortable with 20 stocks covering 10 sectors. That way you could have 2 companies per sector. That way you're diversifying through sectors and companies within that sector. Have you had any issues with not finding companies at a good enough value since your "universe" is smaller? Or in that situation do you just add to whichever sector/company is underweight and at a decent/fair value?

      Thanks for stopping by!

      Delete
  8. I have weighting goals but right now I'm just trying to pick up good companies at good values. I prefer dividends of 3% or higher but still consider the 2%-3% range if it is a good company. Right now, I mainly focus on my dividends and I prefer established companies with good dividend-paying histories.

    Regards,
    Dear Dividend

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    1. deardividend,

      When you're in the accumulation phase I'm wouldn't be as worried about weights, especially if you're just starting out. Even now with $150-160k I still don't focus on it too much as I'm still looking to find the better values. Once I get closer to FI then I'll be paying a lot more attention to the weights.

      Thanks for stopping by!

      Delete
  9. We currently have 23 companies in our dividend stocks portfolio and also expect to reach 40-50 holdings one day. But I think that the amount of holdings one has really should depend on the size of their portfolio. For instance, let's just say you built your portfolio to a tune of $1 million dollars. I understand that the percentages don't change, but would still want $20K invested in one stock? I'd like to say that it shouldn't matter, but a part of me might want to increase my total holdings to maybe 75. Just food for thought. :)

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    1. AFFJ,

      I've thought about that before but part of me thinks I'll stay with around the 40-50 companies. Although if you want to give me $1 million to see what I'd do then feel free to do so. The reason I'll probably try and stay closer to 40-50 is that the goal of FI is to give you freedom. Don't get me wrong, I like investing and researching investments but do you really want to read through 75 quarterly reports 4 times per year? In addition to keeping tabs on the companies you own during each quarter? My gut says that I won't want to.

      Thanks for stopping by!

      Delete