Monday, February 24, 2014

13 Dividend Stocks and 3 ETFs To Balance Your Asset Allocation

If you want to lower the risk of your income portfolio and position yourself to increase returns, you can not ignore asset allocation. Many dividend investors loaded up on banks and other high-yield financials, only to see their portfolios collapse along with the financial markets in 2008-2009. So what can you do to protect your portfolio from stock and sector specific declines? Here are some of the steps I take to help protect my portfolio:

The Allocation Dilemma

If your entire portfolio consists of income-based dividend stocks it would be very easy to end up over allocated in certain sectors. Of the 230+ companies that I track, 22% of them are in the Consumer Goods sector. Furthermore, some of most well-known and very best dividend growth stocks are in this sector, including: Colgate-Palmolive (CL), Coca-Cola Company (KO), Pepsico, Inc. (PEP), Procter & Gamble (PG) and Kimberly-Clark Co. (KMB).

The relatively high yields of the Financial Services sector also make it appealing to dividend growth investors. The Financial Services sector is well represented in the stocks that I track, accounting for nearly 14%.With most banks falling out of favor, many higher-yielding insurance companies have filled the void, including: Erie Indemnity Co. (ERIE), Cincinnati Financial Corp. (CINF) and Mercury General Corp. (MCY).

In addition, the Healthcare sector produces several desirable dividend growth stocks. These include: Abbott Laboratories (ABT), Abbvie Inc. (ABBV), Cardinal Health, Inc. (CAH), Johnson & Johnson (JNJ) and Medtronic Inc. (MDT).

Judge Allocation Based On Your Total Portfolio

Instead of trying to preserve my allocation at the individual portfolio level (Income, 401(k), IRA, Dividend Growth Stocks, etc.), I measuring asset allocation across my entire portfolio. You can't truly determine your overall risk, unless you consider your entire portfolio. The first time I calculated my allocation across all my holdings, I was surprised at the outcome. Some of the areas I thought would be over-allocated were not, while other areas came up short.

Needless to say, the first time you look at allocation across your portfolio, there is fair amount of set-up work. I have made available my DFL-Calc-Asset-Allocation.xls Excel spreadsheet to those interested in short-cutting some of the effort.

Set Limits On Individual Holdings

In addition to my overall asset allocation, I have set limits on individual stocks, Exchange-Traded-Funds (ETFs) and Closed-End Funds (CEFs). In setting these limits, you have to ask yourself, 'What is the most I would be willing to lose, if a company went belly-up over night?' For me and my risk tolerance, 5% was the amount I was comfortable with. I doubled the amount to 10% for funds (ETFs and CEFs) since they are invested in many different stocks. I did limit exchange traded notes (ETNs) to 5%, since your risk is effectively in the company issuing the security.

Sector-Basted ETFs

As a result of being over-allocated in some sectors and close on others, I began to investigate how I could target specific sectors where I was significantly under-allocated. I looked at two fund companies that offered sector-based ETFs, iShares and Vanguard. Their offerings were similar, and included: Consumer, Energy, Financial, Healthcare, Industrials, Materials, Real Estate, Technology, Telecomm and Utilities. In many instances the funds tracked the same indexes. As you might suspect, the Vanguard fund expenses are less than the iShares funds. Most of the Vanguard sector ETFs charge less than 0.25% for the management fee.

For some time, I have looked for appropriate income investments in the Utilities and Real Estate sectors. Unfortunately, they have been hard to come by. The Vanguard Sector ETFs are designed to help increase your allocation in a specific sector. Here are three that you may want to consider:
Vanguard Utilities ETF (VPU) | Expenses: 0.14% | Yield: 3.66% : The fund employs a passive management investment approach designed to track the performance of the MSCI U.S. Investable Market Utilities 25/50 index. This index consists of all capitalization companies within the utilities sector. The sector includes electric, gas, and water utility companies, as well as companies that operate as independent producers and/or distributors of power. The sector includes both nuclear and nonnuclear facilities.

Vanguard REIT Index ETF (VNQ) | Expenses: 0.10% | Yield: 4.14% : The fund employs a passive management investment approach designed to track the performance of the MSCI® US REIT index. The index is composed of stocks of publicly traded equity real estate investment trusts (known as REITs).

Vanguard Telecom Services ETF (VOX) | Expenses: 0.14% | Yield: 3.99%: The fund employs a passive management investment approach to track the performance of the MSCI U.S. Investable Market Telecommunication Services 25/50 index. The index is made up of stocks of large, medium-size, and small U.S. companies within the telecommunication services sector. The sector includes companies that provide communication services primarily through fixed-line, cellular, wireless, high-bandwidth, and/or fiber-optic cable networks.
In the past I owned VNQ and VPU in my income portfolio. After a period of time, I determined their erratic dividends were not appropriate for my income portfolio. After a quick look at VOX, I found that their dividends were not consistent and thus also not appropriate for my income portfolio. However, I will continue to give consideration to holding these ETFs outside my income portfolio - not as income investments but for allocation purposes.


Full Disclosure: Long KO, PEP, PG, KMB, CINF, ABBV, JNJ in my Dividend Growth Portfolio, long MCY in my High-Yield portfolio. See a list of all my dividend growth holdings here.

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