During the week, I read articles from fellow bloggers and participate in blog carnivals. Once a week I highlight some of the articles that I enjoyed reading. I have named this section as Dividend Tree Potpourri. Similar to a potpourri, this section will be a collection of posts from fellow bloggers which will spread the constructive scent of differing viewpoints.
I had initiated a started position in WisdomTree International Basic Materials Sector Fund (DBN) in middle of October 2008 at $22.13 per share. At the time of purchase, my yield on cost was 1.16%. This index-based ETF is derived from the WisdomTree’s DEFA Index. It is based on dividend-paying companies in developed markets outside US and Canada. The companies in this index are weighted based on regular cash dividends.
My primary reason for investment in this fund was exposure to international developed countries and material sector. Investing in one index-based ETF provided me exposure to two different aspects. The secondary reason was that the fund is over weighted to top 15 companies. The top 15 companies have close to 55% weight in the index fund.
Since October 2008, the funds value has declined to $16.15 per share (from $22.13). Conversely, the cash dividend paid for year 2008 increased to $1.094 per share (from $0.26 per share). My YOC is now at 4.86%. Now let us look at funds performance in context of my portfolio?
Risk analysis of DBN in my portfolio
This fund continues to meet my buying objective of exposure to international assets and materials sectors.
The fund being top heavy is a two edge sword. This fund does not provide true diversification one would expect from an ETF. On the other hand, it provides concentrated investment in top 15 dividend paying companies from developed international market. In essence, the dividend performance of the top 15 companies will drive the performance of this fund.
At least for the first year, the fund had a growing dividend. Although I do believe that this will not be case in future years. I fully expect that dividends from this fund will be erratic at best.
The fluctuation of US dollar vis-à-vis other currencies is another aspect that will affect the dividends paid by this fund.
Dividends from DBN are only 2% of my total dividends, while the capital allocation is only at 4% or less. With is small position, any dividend cuts or volatility does not have a significant effect on my total dividend portfolio.
The issue that I have with this fund is that it provides dividend only once a year. I am not happy about this characteristic of the fund. It slows down my dividend compounding machine.
My plan with DBN
I will continue to hold DBN in my dividend portfolio. It continues to meet my buying objective. Since I have small position, my expectation is it with not have significant effect on my performance. My expectation is over the next 3 to 5 years, this fund will aid in my capital appreciation. However, I will not be adding any new capital in this fund because of only one dividend per year and expected lack of consistency in dividend growth.
This fund does not fall in the dividend growth classification. It only provides international materials exposure with cash dividends still being the criteria.
One of basic tenets of portfolio construction is following the principles of asset allocation. This is much more applicable and valid for do-it-yourself individual investors. In this context, at a minimum, I need to look at and at least consider evaluating all possible asset classes. While doing this, I also have to keep in mind that my portfolio is based on dividend growth philosophy. Among others, a commodity is also one asset class which I believe I should be investing. The next question is what should be my investing vehicle.
Since 2001, quite a few commodity index based Exchange Trade Funds (ETF) and Exchange Traded Notes (ETN) were introduced in the market. There are more than 30 commodity ETFs/ETNs of various flavors based on agriculture, raw metals, coal, water, oil, natural gas, gold, silver, different combinations of these in index format, etc. And how can we forget, the biggest sham of all investment vehicles, futures-based index ETFs/ETNs. My viewpoint is, futures-based index are just designed for speculation. As it always happens, during the speculative boom of late 2007 and early 2008, every month a commodity ETF or ETN was launched in market in one form or other. continue reading rest of the article….
Last weekend we had a mild snow storm (6-8inch of snow), and as it is customary, I had to go and shovel my car out. Next to me was a young gentleman who was doing the same. He had just moved in our apartment complex, in same floor as ours, from Florida and this was his first ever snow storm. He had BMW 3 series which he is trying to sell. He seemed to be enjoying it (I was not!). I finished my car in less than 15 minutes and he mentioned it’s been 30 minutes and he is still working on it. Anyways, I just asked him one question, why are you selling the car? And that was it! Two weeks, two football games, and perhaps two twelve packs later, I realized we had discussed everything that affects personal finance and investing for a new college grad. While he was under water (student loans, car loans), I was impressed by his sincere efforts to put his house in order. Since I never went through the student debt phase, I had no idea what it means to be under student loan debt. For me, this discussion was a great learning experience.
Although this discussion was not directly related to dividend investing, but think it followed the essence of dividends investing (i.e. strong foundation and small building blocks). I thought it would be worth presenting the high level framework that came out of that discussion. So following is the summary of what should be focus after graduation.
Assess state-of-finance: The new grads should start with assessing their finance with reference to incoming cash flow and outgoing cash flow. Once these two factors are mapped out then it is time to figure out how to optimize both sides (i.e. maximize incoming, and minimize outgoing). For the first two years after graduation, debt elimination or reduction should be the primary goal.
Emergency funding: This should be the first step. Instead of investing, create an emergency funding for self. Depending on your expenses and comfort factor, create a cash buffer of $2500 to $5000. Keep it invested in high yield money market accounts. It can be done over a period of 5 to 6 months. The faster you accumulate, the faster you will have additional cash at your disposal.
Student loan debt reduction: This is perhaps the first big ticket item that new grads need to worry about. Identify a solution for this. It is a small amount and may not seem obvious, but it is drain on outgoing cash flow. Since it remains for a long time it just takes forever. My personal opinion is, if possible, discuss with your friend and family member (with whom you can), and borrow small amounts to immediately reduce your principal amount. Over a long term, it has a significant impact. This not only reduces your monthly payments, but also the overall interest that one would pay over a period of time. In fact this applies to any other loans. Avoiding additional loans for first two years after college will go a long way in building a strong financial foundation.
Share apartment: Hey what’s wrong with this one? Didn’t you do in college for four years? why not for additional one year. This helps in reducing outgoing cash flow.
Part time money making activities: This is where I believe most college grads miss the bus. Being out of college and money in their pocket makes them loose focus. I believe if college grads can spend some extra time in part time jobs they can increase their incoming cash flow. They continued to do in college, why not one extra year. This in turn can be used for debt reduction.
I believe for the first two years after graduation, new college grads should focus on debt reduction (instead of investing). Investing can be done under the umbrella of retirements accounts. When the debt level has been reduced by 75-80% then one should start thinking about investing. Having a continued debt will always remain a week link in one’s foundation.
These few things may seem trivial, but two or three years down the line, it can help lay a strong foundation.I believe it is very important to have a strong foundation and then use small building blocks to construct your majestic empire state building.
In an earlier article, I discussed about the importance of quality of stocks in a portfolio rather than number of stocks for risk management. The common notion is that higher number of stocks in a portfolio provides better diversification (i.e. better risk management). In today’s post, I am presenting a probabilistic mathematics to demonstrate the relationship between number of stocks and its impact on diversification.
I am using a stock being positive or negative as measure of diversification. In an ideal scenario, at a minimum, one would like to have all stocks to be positive relative to the buy price. For example, if a portfolio has 5 stocks, one would like to have all positive. If a portfolio has 10 stocks, one would like to have all positive and so on. At this point, I am not thinking about what would be the value of individual stock or portfolio. It is likely that a positive value in one stock can offset the negative value of other stock.
Here, my interest is to break it down to the best possible scenario, and that is, stocks being +ve or stocks being –ve. I am calculating the probability of 1 stock being +ve in 1 stock portfolio, in a 2 stock portfolio, in a 5 stock portfolio, in a 10 stock portfolio, and in a 20 stock portfolio. Furthermore, this probability can the extended to 2 stocks being positive or 3 stocks being positive. The results are then plotted for graphical presentation and discussion.
The chart below shows the plot of probability of stock being positive vs. number of stocks in a portfolio. This chart is read as follows:
The curve 1 +ve stock is the curve (topmost curve) for probability of one stock being positive for a portfolio with 5 stocks, 10 stocks, 15 stocks, and 20 stocks.
If a portfolio consists of only one stock, then probability that it will be positive is 0.5 (i.e. 50% chance that it will be positive).
If a portfolio has 5 stocks, then the probability that at least one will be positive is 0.9.
If a portfolio has 10 stocks, then the probability that at least one will be positive is 0.95.
If a portfolio has 20 stocks, then the probability that at least one will be positive is 0.98.
The chart shows similar curves for probability of 2 positive stocks, three stocks, 4 positive stocks, and 5 positive stocks.
In general, it can be observed that there is a significant increase in probability of stocks being positive until 5 or 10 stocks in the portfolio. Beyond that the change in probability of stocks being positive is very very small.
We want to have higher probability for stock to be positive. Let us say we want to have 0.8 probability, so we look at this chart horizontally at 0.8. We can have that with 5 stocks, 8 stocks, 10 stocks, and 12 stocks (intersection points between curve and full digit stock). As an individual investor what would you do? If the odds are same wouldn’t you try to use lesser number of stocks?
These simple probability curves show that there is an optimum point beyond which more stocks will not have any diversification benefits.
A Customary Caveat: The results from these plots are good for understanding the relationship among different variables (in this case number of stocks vs. diversification). These may not be used for making portfolio decision. While it correctly explains the fundamentals, it is not designed for portfolio construction or decision making. This is for informative-purpose only.
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Commodity Asset Class in Dividend Growth Portfolio
One of basic tenets of portfolio construction is following the principles of asset allocation. This is much more applicable and valid for do-it-yourself individual investors. In this context, at a minimum, I need to look at and at least consider evaluating all possible asset classes. While doing this, I also have to keep in mind that my portfolio is based on dividend growth philosophy. Among others, a commodity is also one asset class which I believe I should be investing. The next question is what should be my investing vehicle.
Since 2001, quite a few commodity index based Exchange Trade Funds (ETF) and Exchange Traded Notes (ETN) were introduced in the market. There are more than 30 commodity ETFs/ETNs of various flavors based on agriculture, raw metals, coal, water, oil, natural gas, gold, silver, different combinations of these in index format, etc. And how can we forget, the biggest sham of all investment vehicles, futures-based index ETFs/ETNs. My viewpoint is, futures-based index are just designed for speculation. As it always happens, during the speculative boom of late 2007 and early 2008, every month a commodity ETF or ETN was launched in market in one form or other. continue reading rest of the article….