Have Capital? Thoughts on Building Your Dividend Growth Portfolio

A Dividend Geek member recently asked me: “I have a 401K account that I am rolling over to a self-directed retirement account. My question to you, if you have $100,000 to invest immediately, how much would you put in each stock that meets the 20% below fair market value.”  I have been asked similar questions of how to build a dividend growth portfolio when you are not just starting your  accumulation phase, but rather already have capital to invest.

Before I describe a capital allocation strategy for you to consider (always do your own homework and make sure it’s right for you). I have a related story… One that dramatically altered the course of personal stewardship over my money.

School of hard knocks

It is very painful for me to dig this up out of my past, but if it helps you in any way it will be worth digging it up for a few minutes. Leading up to the year 2000 during the runaway tech bubble in the market, I had a similar situation of having a large sum of money to invest and manage. I had been investing on my own with smaller amounts for five years and felt good about my investment knowledge and skill, but this was more than I had managed before. At the time I was more of a traditional value investor, and had not yet discovered dividend growth stock investing.

After a lot of thought and encouragement from others we decided to use a professional investment manager who came highly recommended. His fee structure was 1.5% annual commission based on assets under management – standard stuff. During our discussions I clearly stated that I believed the market was over valued and wanted our capital to be invested over time, with a percentage of it invested every 3-4 months to dollar-cost average the capital in over the next year; and since he would be investing in mutual funds, I explained that I wanted no-load funds. He explained that he had access to all types of mutual funds, which was one of the advantages of using his services.

Three months later…

At our first quarterly account review meeting (during which time the market had plummeted) I found out that he had invested the entire sum of our account within the first week of our initial meeting. I was furious that he had not followed my instructions, but with my wife there I managed to keep my composure.  Yep it took every ounce of me not to verbally let him have it. When I asked about what happened to my dollar cost averaging the capital in over a year, he told me that studies show long-term you are better off deploying all your capital up front. I thought, well even if that’s true he didn’t follow my instructions and he didn’t bother to lift a finger to consult with me.

Now I was fighting my emotions on two fronts, the market and him! I knew the market would eventually recover, but now I had no cash to invest on the pull back. I also, knew that I couldn’t trust this guy another minute with my money. What would you have done? Well, I didn’t want anything to do with this guy and his mutual funds, so I had him sell them, close the account and took my money.

Just when you thought it was over

Here’s the kicker… after I closed the account I researched the mutual funds he had invested our money in. Yep you may have guessed it. Every mutual fund had a 6% front and 6% back end commission load! That means that after splitting the commission with the primary broker he likely got a 3% commission when he bought the mutual funds and another 3% when we told him to sell them. He had his butt covered coming and going and all at our expense, probably enough to buy a car in just three months – and after I told him to invest in no load mutual funds.

Well I had better stop here. I’m sure there are good, honest money managers. But for me this was a painful lesson to learn. The good news is that since that day I have studied to become a successful investor, and enjoy helping others along the way. In fact, it really is a journey as I continue to learn and improve how to manage and invest my money.

Know that no one is going to care more about your money than you. Do yourself a favor and take some time to learn to take care of it and to do it well. That is one of the reasons why I started Dividend Geek to help people learn how to become successful investors.

Phew. I survived that – let’s move on to the better stuff.

One capital deployment strategy to consider is a balanced approach where you invest over time. Investing 25% – 33% now to start generating dividend income as well as taking advantage of growth if the market continues to trudge upward, and then slowly invest the remaining 75%-66% over time as quality stocks rotate back out of favor into better discount to fair value prices. This allows you to buy at lower prices (and higher dividend yields) when a stock or the market itself pulls back, or goes off on an 18 month bear cycle. It’s a bit of a balancing act. You don’t want to be all in if the market is topped out and then pulls back; likewise, you don’t want to be out of the market missing out on dividend income and market growth.

It’s not so much market timing, because no one knows where the market is going. But rather it allows you to both participate in flat or up markets and still take advantage of better opportunities when they present themselves. It also reduces the human emotional risks of fear and greed. Patience and sticking to your plan is required.

For good diversification consider purchasing stocks in 5% ($5K) amounts, so that when you finally have all $100K of your capital deployed (fully invested) you would have 20 great companies, with a 5% weighting for each company. For sector balance you’ll want your portfolio to eventually have 2 companies from each sector for a 10% weighting for each sector.

High Quality is King!

I would target the highest quality dividend stocks (2 from each sector). The trick (or problem) is that the highest quality stocks rarely trade at 20%+ discounts to fair value. If you’ll remember, Benjamin Graham’s extensive research enabled him to find small lesser known companies trading below book value to get his margin of safety. That’s rare with the high quality companies that raise their dividends every year that I follow and are used in this compounding system. That said, I never purchase a company when it is over valued (highlighted in red on Dividend Geek), but I’m willing to purchase some high quality companies at smaller discounts to fair value say in the 8% to 12% below fair value range.

There’s one more thing to consider for your dividend growth portfolio. There are two types of dividend growths stocks. For lack of better terms I call them conservative and aggressive dividend growth stocks (DGS’s).

Conservative vs Aggressive Dividend Growth Stocks

Conservative DGS’s are older cash cow type of companies with strong competitive advantages (think PG, JNJ, MCD), with longer consecutive years of dividend increases. They have higher initial dividend yields (3%-5%) and lower dividend growth rates (6%-10%).

More aggressive DGS’s are pretty much the opposite. They are less mature companies still in their growing phase with medium strong competitive advantages. They generally have fewer years of consecutive dividend increases and lower initial dividend yields (2%-3%), but higher dividend growth rates (11%-15%).

Generally speaking dividend reinvesting (compounding), dividend growth (rate of dividend increases) and initial dividend yield favor conservative DGSs for under 15 years of compounding, and favor aggressive DGSs over 15 years. So you want to have a mix of both conservative and aggressive in your portfolio to maximize your potential retirement principle and income. The mix percentage (conservative vs aggressive) depends on how long you intend to hold and compound this portfolio during its accumulation phase (before retirement or reaching financial independence when you switch over to the distribution phase and take the income in cash to replace your earned income.

What’s the % mix?

Running the numbers produced the following best results:

15 years = 100% Conservative / 0% Aggressive

20 years = 70% Conservative / 30% Aggressive

25 years = 50% Conservative / 50% Aggressive

30 years = 30% Conservative / 70% Aggressive

Okay I hope that all makes sense. It is a lot to take in.

Here is an example of 20 high quality dividend growth stocks 2 from each sector and their DG type (Conservative or Aggressive).

Note: regardless of the conservative or aggressive dividend growth type; all of these are great high quality DG companies with competitive advantages and long histories of consecutive annual dividend increases that a long-term investor would want to be a partner in their ownership for income and long-term growth.

Sector	Stocks	Dividend Growth Type
Consumer Discretionary	MCD JW-A	Conservative Aggressive
Consumer Staple	PG CL	Conservative Aggressive
Energy	COP OXY	Conservative Aggressive
Financial	CB AFL	Conservative Aggressive
Healthcare	JNJ MDT	Conservative Aggressive
Industrial	ITW NSC	Conservative Aggressive
Materials	CMP APD	Conservative Aggressive
REIT or Utility	O WEC	Conservative Aggressive
Retail	WMT LOW	Conservative Aggressive
Technology	ADP TXN	Conservative Aggressive

These stocks do not take into consideration current valuation. You’ll need to look them up to see if and when they are undervalued or overvalued. I hope this helps you on your path to improve your investing skills as well as avoiding potential pitfalls.

Disclaimer: I am not a professional financial planner or broker so these are not recommendations. Your personal situation may differ, so do your own homework on everything I have said here to make your own best decision for your situation.

Full Disclosure: I have long positions in: ADP, AFL, APD, CL, CMP, COP, ITW, JNJ, LOW, MCD, MDT, NSC O, OXY, PG.

All the best!

Filed in: Dividend Growth Investing • Investment Principles