There are different ways to weight a dividend portfolio. I am going to examine the three most popular methods in this article. Then I am going to reflect on the method I use.
The first method is weighting portfolios based on market capitalization, and then adjusting weights based on free floats. The logic is that as a company becomes more valuable, it should have a higher weight in a portfolio, whereas a company that is less prosperous should have lower weights since its capitalization is lower. This method is preferred by many index funds, as it makes it easier to just buy a basket of several hundred or thousand securities, and then passively hold them. It is viewed as a self-cleansing mechanism, where prosperous companies gain higher weightings, while less prosperous companies are eventually flushed out. The dangers behind this method is that a speculative company with no material profits and elevated valuations could get a higher weighting due to stock price being bid up by speculators. This happened with a lot of indexes such as the S&P 500 during the tech boom in the late 1990s, when they added companies like Yahoo! (YHOO) at several hundred times forward earnings. The results were disastrous, and pulled down the expected returns for all index investors. On one side, it is a good idea to give higher weighting to the companies that are prospering. On the other side however, you could end up in a dangerous situation where the most successful companies will get large and command a large piece of the pie. However, these large companies might end up dominating that portfolio. In fact, the 50 largest components of S&P 500 account for 47% of the portfolio. Apple (AAPL) accounts for almost 4% of the portfolio. Through July of 2015, just six companies in the S&P 500 accounted for most of the index gains. I wonder if this is a repeat of 1999 - 2000, or not.
Wednesday, September 30, 2015
Monday, September 28, 2015
Dividend Companies I am Considering in October
The stock market has been showing signs of weakness this quarter. Little did I know that the stock market will go down so quickly after I wrote my article titled " are you ready for the next bear market" back in early August of this year.
For those of us who are in the accumulation stage, this is welcome news, since it means that future dividend income is available at lower cost today. To paraphrase Warren Buffett, whether it comes to socks or stocks, everyone loves a good sale.
For whatever reason, the environment today feels a lot like we are going to see lower prices in the foreseeable future, as long as the S&P 500 stays below 2000 points. After all, the stock market only started going down one or two months ago (though many cyclical companies had been drifting lower before that). It is interesting to note that through July of this year, most of the gains on the S&P 500 came from just six stocks. So we might actually see further weakness in major stock indices from here.
We have all been trained to buy on weakness over the past 6 years. If this doesn’t work for this correction, and it actually does turn into an actual bear market, I wonder how many will abandon stocks altogether
For those of us who are in the accumulation stage, this is welcome news, since it means that future dividend income is available at lower cost today. To paraphrase Warren Buffett, whether it comes to socks or stocks, everyone loves a good sale.
For whatever reason, the environment today feels a lot like we are going to see lower prices in the foreseeable future, as long as the S&P 500 stays below 2000 points. After all, the stock market only started going down one or two months ago (though many cyclical companies had been drifting lower before that). It is interesting to note that through July of this year, most of the gains on the S&P 500 came from just six stocks. So we might actually see further weakness in major stock indices from here.
We have all been trained to buy on weakness over the past 6 years. If this doesn’t work for this correction, and it actually does turn into an actual bear market, I wonder how many will abandon stocks altogether
Friday, September 25, 2015
Does Market Capitalization Matter in dividend investing?
One criticism of Dividend Growth Investing is that it focuses exclusively on large cap stocks. The common complaint is that if you buy a small cap today, it can grow out to be as big as Johnson & Johnson (JNJ), Coca-Cola (KO), Exxon-Mobil (XOM), or Wal-Mart (WMT) etc.
In theory this sounds like a great idea. The problem of course is that this complaint completely ignores reality and facts. The reality is that when each of the companies I mentioned above became dividend achievers ( meaning that they had regularly increased dividends for at least ten consecutive years in a row), they were big companies already. Yet somehow, they managed to grow earnings and dividends for decades. This is the beauty of a stable company which has a successful business model that showers shareholders with cash each year.
In reality, if you were able to buy each of those companies when they just became dividend achievers, you would have banked a boatload of dividends. Plus, there would have been a pretty sizeable growth in share prices over time.
I looked at each company at the time they became dividend achievers. I calculated the returns as of September 21, 2015, assuming that someone put $100 at the end of the year in which they achieved that status. Check the table below. It is interesting that those companies that were already deemed as large-caps at the time delivered phenomenal results to investors. For example, a $100 investment in Exxon at the end of 1992, with dividends reinvested, would have turned to $891.73. That investment would be generating $35.48 in annual dividend income. This means that the investor of 2015 will be getting their original investment in cash every three years.
In theory this sounds like a great idea. The problem of course is that this complaint completely ignores reality and facts. The reality is that when each of the companies I mentioned above became dividend achievers ( meaning that they had regularly increased dividends for at least ten consecutive years in a row), they were big companies already. Yet somehow, they managed to grow earnings and dividends for decades. This is the beauty of a stable company which has a successful business model that showers shareholders with cash each year.
In reality, if you were able to buy each of those companies when they just became dividend achievers, you would have banked a boatload of dividends. Plus, there would have been a pretty sizeable growth in share prices over time.
I looked at each company at the time they became dividend achievers. I calculated the returns as of September 21, 2015, assuming that someone put $100 at the end of the year in which they achieved that status. Check the table below. It is interesting that those companies that were already deemed as large-caps at the time delivered phenomenal results to investors. For example, a $100 investment in Exxon at the end of 1992, with dividends reinvested, would have turned to $891.73. That investment would be generating $35.48 in annual dividend income. This means that the investor of 2015 will be getting their original investment in cash every three years.
Wednesday, September 23, 2015
Financial Independence Is Easier to Model with Dividends
The biggest advantage of dividend growth investing is the ability to set a goal, and track progress towards that goal. This is because dividend income is more stable than stock prices, which makes it easier to check how I am doing relative to my goals. Stock values on the other hand are much more volatile, which makes reliance on them for retirement planning much more speculative in nature. If noone can forecast stock prices accurately, then how can someone rely on stock prices for their retirement planning?
Let’s look at two different scenarios. Imagine, that in the first scenario, the goal is to have $500,000 in 20 years. Based on the 4% rule, you will sell 4% of your assets per year and hope that you will not be retiring at the top of a major bull market ( like the one we had in 1999 - 2000). You save some money every year, and the stock market generally rises. By year 19, your portfolio is worth more than half a million dollars. You decide to wait for another year, in order to beef up your portfolio. Unfortunately, this happens to be the first year of a bear market, where stock prices fall by 30% in the first year, and then 20% in the next one. Are you ready to retire, or not? You seemed ready and above target in year 19, but in year 20 you seem to be behind your goal. You decide to keep on working for an unknown amount of time until the stock market rebounds.
In the second scenario, the goal is to generate an annual income of $20,000 in 20 years. You save the same amount of money, reinvest dividends, and could not care less if markets are up or down. You can afford that, because dividends are more stable than capital gains, and go up almost every year. The only time dividends on the S&P 500 fell significantly over the past 90 years was during the Great Depression of 1929- 1932 and during the Great Recession of 2008. Since 1960, the only significant decrease in annual dividend income was in 2008. That is a success ratio of over 98%. I define significant as any decrease in annual dividend income that is larger than 4%.
Let’s look at two different scenarios. Imagine, that in the first scenario, the goal is to have $500,000 in 20 years. Based on the 4% rule, you will sell 4% of your assets per year and hope that you will not be retiring at the top of a major bull market ( like the one we had in 1999 - 2000). You save some money every year, and the stock market generally rises. By year 19, your portfolio is worth more than half a million dollars. You decide to wait for another year, in order to beef up your portfolio. Unfortunately, this happens to be the first year of a bear market, where stock prices fall by 30% in the first year, and then 20% in the next one. Are you ready to retire, or not? You seemed ready and above target in year 19, but in year 20 you seem to be behind your goal. You decide to keep on working for an unknown amount of time until the stock market rebounds.
In the second scenario, the goal is to generate an annual income of $20,000 in 20 years. You save the same amount of money, reinvest dividends, and could not care less if markets are up or down. You can afford that, because dividends are more stable than capital gains, and go up almost every year. The only time dividends on the S&P 500 fell significantly over the past 90 years was during the Great Depression of 1929- 1932 and during the Great Recession of 2008. Since 1960, the only significant decrease in annual dividend income was in 2008. That is a success ratio of over 98%. I define significant as any decrease in annual dividend income that is larger than 4%.
Monday, September 21, 2015
Dividend Stocks I Purchased In the Past Month
I like to keep my investing simple. I purchase shares in companies I believe to be attractively valued, when I see a track record of raising dividends and having the fundamentals to support further dividend increases. For each dollar that I invest in, I end up earning anywhere between 2 to 4 cents per year in dividend income alone. The initial amount will then grow above the rate of inflation over time. It is that simple – for each dollar I put to work today, I earn an average lifetime income of 3 cents right from the start. To reach financial independence, I need to both cut costs and increase the level of passive dividend income to meet those expenses.
I have been on this journey for eight years now. It is becoming a second nature by now:
1) Earn money,
2) Think of ways to earn more money,
3) Save Money
4) Think of ways to save more/cut expenses
5) Invest those savings wisely
6) Keep thinking how to be a more impactful investor
7) Reinvest dividends during accumulation stage
I have been on this journey for eight years now. It is becoming a second nature by now:
1) Earn money,
2) Think of ways to earn more money,
3) Save Money
4) Think of ways to save more/cut expenses
5) Invest those savings wisely
6) Keep thinking how to be a more impactful investor
7) Reinvest dividends during accumulation stage
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