Being a dividend investors, I am looking for companies that have potential to grow their dividends over time. I have observed that companies that grow their dividends, with good quality of earnings, the market value (or share price) also grows. This not only provides dividend cash flow, but also the capital appreciation over time.

Now, in case of concentrating the portfolio to small number of stocks will increase my risk. Assuming equal allocation in 10 companies, when any one company suspends dividends, it will reduce my dividend cash flow by 10%. That is a very large drop. Therefore, I am targeting to build my portfolio with 30 to 35 companies.

• The reason for using 30 to 35 companies is that I want to limit the risk if dividend cash flow to any single company to maximum of 5%. In one my earlier post, I have discussed the process of risk management.
• It would be a folly to expect that all companies in the portfolio would continue to pay growing dividends. 100% success rate is purely an illusion. However, I would expect that at a minimum there would always be 20 to 25 companies performing as per my initial expectation. These will continue to provide growing dividends over time. I also expect that they will continue to increase their value.
• The remaining ones may or may not perform. I will have to continue to make changes such as adding to existing ones, removing, and adding newer ones.
• In addition, I also understand my limitation of not being able to keep track of more companies.

At present, I continue to hold approximately 27 companies. One of the benefit of long term buy and hold investing is that you do not need to keep following the market daily or monthly; all of the companies that I select are not going to vanish or crash in such short period of time. Sure, some small number will have problems like 2008/2009, but I do not expect to have all of them in a same crashing bucket. If it does happen, then it was likely due to improper portfolio management process.

It is that time of the year when many of us reflect back on the year and start thinking about how we would re-balance our portfolios. We always read about re-balancing our portfolio on various blogs or investment wisdom. Almost all of these sources show us that we should have diversified asset allocation. Now, when it comes to actually doing re balancing, that’s where, I find such resources fall short of a methodology. If I am reading any literature from investment advisory houses or brokerage firms, then I find a fixed template, which ironically remains same for everybody (albeit with some minor tweaks). I have asked few certified financial planners or advisers and almost everybody just repeats the same tape of diversification but misses on how it should be done. There is a school of thought that says sell good ones that have increased value, and buy ones that have reduced in value. Now, why should I sell something when it is consistently giving me returns (and I expect it to continue), or why should I buy something that has reduced in value. The reduced value should be an indication that something is not working, right?

In my view, the process of re-balancing is an ongoing effort. It should be always be part of investor’s ongoing buy and sell decision making process. Depending upon your investment goals and risk profile, individuals should have a set of predetermined criteria which should guide them in making buy/sell decision. This way they are proactively managing their asset allocation.

As a dividend growth investor, I have a decided a set of constraints for myself. I am a buy and hold investor as long as any given company keeps performing to my objectives. The set of constraints that I use on an ongoing basis are as follows:

1. Continuity of meeting my buying objective: Here, my attempt is to make sure that my stocks portfolio continue to meet my buying objective of dividend growth, or continued value preposition, or index exposure. Whenever, I a buy a stock, I make sure why I am buying it and how it will help my portfolio. For example, when a company cuts dividends, I sell it if it was bought for dividend growth.
2. Maintaining asset class allocation: This is related to my overall assets, ideally, which are supposed to be not related. But I always wonder in the inter-related global world, is there anything that is not related? My attempt here is to make sure, I do not over expose myself of any particular class, like REITs, emerging equity, or commodity related stocks.
3. Maintaining diversification: As a dividend investor, I believe this is a very important aspect for diversified asset allocation. Like in any other style of investing, dividends have appear to be favorable in few industry sectors such as REITs, CONROYS, consumer staples, large caps, etc. Until last year, financial sector was a darling of dividend investors. I try to limit myself up to 10% allocation in any given sector.
4. Dividends from a single stock should not exceed 5% of total dividends: 100% investing success is an illusion. Similarly, a dividends will never be cut is also a mirage. Last two years have shown us that dividends will be cut, no matter how great the company is. The only way to reduce the impact is makes sure dividends from a single company does not exceed 5% of your portfolio dividends.

It may seem that using these criteria is a cumber process. It may feel like overwhelming or over engineering. But in reality it is not so. When your buying and selling frequency is less than 24 times a year, it does not feel as a tedious process. I have discussed my risk analysis to show how a quarter reviews helps maintain a diversified allocation. It is my hope that it will minimize the down side risk in long term.

How do you perform your portfolio re-balancing?

(Photo Credit)

Last week, I presented an update on the monthly progress of my dividend portfolio. In this post, I am discussing the quarterly risk analysis. My objective here to make sure I am continuing to following my risk management process.

1. Maintain pre-determined asset class allocation;
2. Maintain pre-determined diversification (any sector should not exceed 10%); and
3. Dividends from a single stock should not exceed 5% of total dividends.

My dividend portfolio holdings can be referenced in My Portfolio menu at top of this page.

Maintaining Asset Allocation

Chart 1 shows the asset class allocation along with my maximum target limits. In general, I am continuing to meet (or much closer) to my pre-defined target levels. During 3Q09, I did not make any contribution to the emerging markets index funds such as VWO and EPI. This was because I believe they rose too quickly to my comfort level. I am still tad lower than my maximum limit for emerging markets.

Dividend Portfolio : 3Q09 Asset Allocation

Maintaining Diversification

For industry sectors, I have a pre-defined maximum limit of 10% for each sector. Chart 2 shows that I have higher exposure (relative to my limit) in financial derivates and consumer sector. Energy sector is almost equal to my max limit.

• Financial derivatives is a sector including dividend CEFs and REITs and hence it has higher percentage. Since this includes two sub sectors, I am comfortable with this exposure.
• The consumer sector allocation increased significantly because of my recent purchases. I took the opportunity of lower valuations and initiated position within the same quarter. This resulted in higher allocation. My future purchases will likely to be limited in this sector.

For morningstar style classification, I do not have any pre-defined allocation limits. Chart 2 also shows that my portfolio is concentrated around large cap stocks (more so on value and growth). Intuitively that seems to be correct because majority of the dividend-growth stocks are stable and mature companies. I add two mid cap dividend growth stocks in last few months. I will continue to look for small cap dividend growth stocks. Another option is to invests in a broad small cap index ETF.

Dividend Portfolio : 3Q09 Diversification

Criteria of Maximum Dividend per Stock

My objective here is to make sure that dividends from any given company do not exceed 5% limit. This limit allows me to reduce the impact of dividend cuts on passive cash flow. The chart shows that O (~7%), AOD (~14%) exceeds my pre-defined limit. I will not be making any changes any of the individual positions. I do not expect to see dividend cut in O. My capital allocation to AOD is very low and even if the dividend is cut in half, my yield will still be more than 5% and dividend contribution be still above 5% of total dividends cash flow. However, I will not be making any future purchases. Therefore, my allocation will automatically come down.

Dividend Tree : 3Q09 Max Dividend Criteria

The quarterly update shows what action I took during 3Q09.  I hope with this approach to risk-based allocation, I will reduce my risk to dividend cash flow and continue to maintain potential for capital appreciation.

Economy, Finance, Investing.…..

• ETF marketing hurting investors
  
• What’s wrong with P&G?
• Stock picking with Diversification
  
• The Div Guy’s Top 20 Holding
• Record level of cash for S&P Industrial
• The curious investor’s economic forecast
  
• Portfolio Update
  
• Riding this bull market
• Dividend Growth and Yield
  

These are some diverse set of articles from fellow bloggers and business magazines. I hope you enjoy reading all or some of these interesting posts.