Saturday, November 1, 2014

9 Steps to Build and Manage a Dividend Portfolio

There are various approaches to designing and managing a personal stock portfolio. Some approaches are more like a science, while others are more like an art.
A portfolio of dividend stocks is more than the sum total of its contents. For most investors, it should have a clear overarching strategy and a certain amount of diversification. In addition, it should be combined with other asset classes for complete diversification, as well as personal finance strategies for building wealth.

Step 1: Determine your Goals

The first thing to do is determine the type of portfolio you want. A common theme that all dividend portfolios share is that they provide passive income, but even among portfolios with a dividend theme, there can be big differences.
Ask yourself:
-What kind of rate of return am I looking for?
-What is my risk tolerance?
-How experienced am I?
-How long until I plan to retire?
-How much time do I want to devote to stock research?

Step 2: Consider a Yield Target

Once your goals are determined, it’s helpful to have an average portfolio dividend yield in mind. The average yield should be substantial enough so that the portfolio truly receives the benefits that dividend-paying companies can provide.
As a general rule, people that plan to currently live off of their dividend income will want to seek higher yields while investors that are primarily focused on earning a good rate of return for several years should focus on achieving a high sum of dividend yield and dividend growth.

Step 3: Identify your Core Competencies

Nobody is an expert on everything, and yet investors should have a reasonably diversified portfolio. Identify a few sectors that you feel you have a solid understanding of, and use those as your primary means of diversification. If all of your stocks are too concentrated in one or two sectors, then a single unexpected macro-economic trend can dominate your portfolio. While I don’t recommend over-diversifying, it’s important to spread risk and reward into a few different sectors while remaining in your circle of competence.

Step 4: Socially Responsible Investing

Before you begin to buy shares of companies, it makes sense to develop a guideline or two about what sort of company you’ll let inside your portfolio. Maybe your view is that anything goes, and you’ll invest without social responsibility in mind. Maybe you’re on the other end of the spectrum, and will only allow companies that meet specific guidelines into your portfolio. Or perhaps you’ll have some sort of middle ground. In order to have peace of mind, it makes sense to develop a simple set of guidelines that are well-reasoned in your view.

Step 5: Research

After you have identified your goals, yield target, and comfortable sectors, it’s time to begin constructing the portfolio. The internet is a valuable tool in identifying worthwhile companies to invest in. Several services, including Google Finance, offer stock screeners that allow an investor to narrow down the search to companies that meet certain criteria such as yield thresholds or P/Es.
In addition, there are specialized sites out there to help you make stock selections. Sites like Morningstar can be of solid assistance to an individual investor. Sites like Seeking Alpha provide a ton of investor commentary and analysis. And of course, sites like this one and others constantly analyze individual stocks for readers. Ultimately, whatever investing decisions you make will be yours, and information from other sources can be helpful but should not be overvalued.

Step 6: Start Small

Once you’ve decided to invest in a company, there are a few ways to do it. Basically, there is a clumsy way and a more elegant way. The clumsy way is to take whatever capital you have available and buy that much worth of stock. The more elegant way is to start small, and enter your position over time. This allows you to average out your buy price over a given time period rather than going all-in on a single day.

Step 7: Finish Big

It’s useful to start small, but it’s important to finish big. What I mean is, once you’ve identified what you believe to be a good investment, and you’ve been buying up more shares, it makes sense to commit. Consider having a set of core holdings that you hold through all market conditions, a set of more cyclical companies, and lastly a set of smaller companies. Core holdings should have a wide economic moat, should exist in an industry that has good long-term prospects, and should have a strong financial position and be fairly resistant against recessions. Cyclical companies may have a lot of those good traits but will likely be more volatile. This volatility can be harnessed as you increase or diminish your position as economic conditions permit. Smaller companies are those that can provide more upside but need a little bit more attention. Become an “expert” on a few small caps that you know extremely well and follow closely.
When you identify what you believe to be an excellent investment, you’ve done your homework, and you have initiated your position over time and continually re-considered your reasoning and outlook for this company, don’t hold back. Make the position a meaningful size so that you can capture some serious value from your wise investment choice. Of course, always diversify, and don’t put all your eggs in one basket, but have some confidence.

Step 8: Prune and Grow

Buying and holding great dividend-paying companies is the path to wealth, but “buy and hold” doesn’t mean “set and forget”. Keep tabs on your stocks. It helps to write your reasons down for buying a stock in the first place, and then regularly check that your companies are still meeting your expectations. Make sure their dividends look as though they can be maintained, that the companies remain at reasonable valuations, and that the financial strength of the business continues to meet your requirements.

Step 9: Allocate Your Assets

In addition to maintaining a solid dividend portfolio, it’s important to complete your diversification by owning other asset classes such as bonds. One can also consider stocks that don’t pay a dividend, real estate, as well as options if that’s of interest to you. Owning investments in a variety of asset classes allows you to take advantage of the fact that different asset classes move inversely to one another, and it reduces your overall portfolio risk.

This article was written by Dividend Monk. If you enjoyed this article, please subscribe to my feed [RSS]

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