How to get your Minions working for you – Part 1

I like to think of my working capitol as my little minions. A dedicated army of invested dollars working hard to recruit more minions to work for me. Okay some people call it reinvested dividend income – I know boring huh. I like my minions!

Lately with the market up 20% year to date this year and bouncing around all time highs has made it difficult to put my minions to work at a good price. Ideally we would like to purchase quality stocks at 20% below fair value for what Benjamin Graham called a margin of safety. But, you don’t want your minions sitting on the sidelines too long not working for you either. So what is an investor to do? First we need to follow our long-term core investment strategy, which is to:

• Contribute to a tax advantaged account (Roth IRA) every year
• Invest in companies with strong competitive advantages, that
• Have a long history of increasing their dividend payment every year
• Build a diversified portfolio of 20-30 stocks that averages 3.5% initial dividend yield and a 10% dividend growth rate
• Buy them when they are selling at a discount to fair value (ideally 20%), and
• Reinvest the dividends

Second we need to develop our own buying strategy. Everyone is different when it comes to risk tolerance, so this is where things get a little tricky. The primary reason we ideally would like to purchase stock at a 20% discount to fair value is to help protect the investor from themselves! What? Yes you heard me right. “We have met the enemy, and it is us.” The investors worst enemy is our own emotions of greed and fear. There are other secondary benefits to buying on sale below fair value (higher initial yield, more shares, capital gain). However, the main reason is to keep our greed in check, by not overpaying and acting as a safe guard to not panic when the market turns south.

Just how does that work? Well let’s say you buy a quality dividend growth stock when it’s 20% below fair value, and during the course of the year your stock goes up 5% from your purchase price. If the the overall stock market were to retreat 25% your stock being undervalued would not pull back as much (maybe 15%) since you were already up 5% you are only down 10%. On the other hand if you purchased a stock that was 20% overvalued, and it went up 5% during the year. It may very well tank 30%, putting you down 25% where your emotions of fear may cause you to panic and sell at the worst time.  Now here’s the kicker everybody is different and until you go through a bear market cycle or a large sell off you really don’t know how you are going to feel and if those fearful feelings will push you to act on them. That said, the logical risk mitigation for the less experienced investor would naturally be to buy closer to the full margin of safety.

In part 2 I’ll discuss some of the other Dividend Geek investing principles that lower risk and how they tie into your personal buying strategy. Also, I’ll present the pros and cons of three prospective buying strategies for your consideration.

Filed in: Dividend Growth Investing