Wednesday, April 9, 2014

How to Manage Your Dividend Portfolio

The hardest part about investing is sitting down, and not doing anything. Just monitoring your portfolio even when its quoted value drops by 50% in a given year, is something that only a very small number of investors can achieve. Studies have shown that the most investors usually perform very poorly when making investments. Those that buy and hold on, are a very rare breed. However, these are the types that save a ton in commissions, taxes and have the best chances of generating the most bang for their investment bucks.

Wall Street makes its money if you actively buy and sell stocks. It nickels and dimes you in commissions, bid/ask spreads, annual fees etc. The hedge fund managers and high speed computers are all operating at a day to day or minute to minute time frame. They see orders from small investors as prey. However, as dividend investor, you should not care whether you paid $37 or $37.01/share for Coca-Cola. Your edge lies in the fact that you would hold the stock for as long as it maintains and raises its dividend. This is where your edge against the Wall Street types comes from.

Your other edge as a long-term investor comes from deferring taxes paid to the IRS. If you bought Coca-Cola in 1988 for a split-adjusted $3/share, you are now sitting on an unrealized capital gain of $35 - $36. At 15% in taxes, this is more than what you paid for the stock. Those who buy and sell securities frequently, end up paying a ton to the tax man. Of course, if they are really bad at investing, they can generate a lot of tax deductions for themselves to use for years against taxable incomes.

Your other edge comes from the fact that you should not care how you are doing against a benchmark like S&P 500. Many mutual fund manager are evaluated based on how they did against a benchmark within a 3 month period. This is non-sensical – as quotations in the short run are just noise. You can’t judge the performance of an investment strategy based on short-term period of less than one year. You also have a much better chance of succeeding, if you have a strategy that fits your investment goals and objectives ( see first article in the series). If your goal is to generate a rising stream of income, that would pay for your expenses in retirement, you should not worry that the quoted value of your dividend stocks is down by 50%, as long as the underlying fundamentals are still intact.

What I am trying to show with those examples above is that your portfolio management should be very passive in nature. You should sit tight, and watch your dividends deposited in your accounts.

I usually sell only after a dividend cut. I have modified my criterion of selling if I thought stock was severely overvalued, but so far my results are pretty mixed with that. In retrospect, I would have been slightly worse off sticking with the original investment I sold. Therefore, you should be very careful about selling securities. This is because a factor that might influence you to sell could seem important at the time of sale, but in reality could be just noise in the data. With long term buy and hold investing, you stand the greatest chances of earning the most in dividends and capital gains. The best results are probably still ahead for you. If you think about it, if you focus on strong franchises such as Coca-Cola (KO), Wal- Mart Stores (WMT) and McDonald’s (MCD), chances are that 20 years from now, your investment would likely be worth several times your initial capital outlay. If history is any guide, you can likely expect an annual dividend income stream which is equivalent to approximately 20% yield on cost. Therefore, while your amount at risk is fixed, your upside is virtually unlimited.

There are a few more traps that suck investors into selling their stock prematurely, and therefore not participating fully in any dividend upsides:

- Do not sell simply because you have a huge gain

- Do not sell if your stock trades at a P/E of 23 and replace with a stock with a P/E of 20

- Do not sell because of dividend freeze

- Do not sell because of spin-offs

The most important thing about investing is to be patient. It is true that you won’t make money on all of your stock selections. A portion of the businesses you purchase today would likely be obsolete in 20 -30 years, thus cutting or eliminating distributions, while another portion would likely be mediocre dividend growers. The dividend growth from the remaining winners however would likely more than compensate for the lost dividend income from the losers.

As a result, it is wise to accumulate dividends in cash, and use it to buy the most attractive securities at the time. If a position accounts for more than 5%, do not add to it. Unfortunately, if it becomes 10%, determine if new cash added over next year to other positions can lower positions weight in portfolio. Otherwise, you might need to trim it.

Full Disclosure: Long KO, WMT, MCD,

Relevant Articles:

How to be a successful dividend investor
How to identify your dividend investment goals
Where to search for investment opportunities?
When to buy dividend paying stocks?
- How to analyze investment opportunities

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