Monday, April 25, 2016

How To Manage Your Dividend Portfolio In A Downturn

The recent (albeit short-lived) turbulence in the market has provided dividend growth investors first hand experience in managing their dividend growth portfolio in a declining market. How did you reacted to this downturn? Did it been a source of despair and gloom, or was it been a source of excitement?

Here are some things that will help you succeed and thrive when the bear puts his paw print on the market:

I. Remember Why You Are A Dividend Growth Investor

The goals of an income portfolio are different than those of a capital-appreciation-based portfolio. The good news is an income portfolio consisting of dividend stocks can not only succeed, but excel during a down market.

The goal of dividend investors is to build a steady stream of rising income from solid companies. While everyone else is panicked about their portfolio’s decline, income investors see the downturn as an incredible buying opportunity.

II. When The Chips Are Down, Go For The Blue Ones

When it seems to be a perpetually declining market, one of the true bright spots is the ability to strategically pickup some bargains in the bluest of blue chip stocks. Normally, these stocks are difficult to buy due to a built in “safety” premium for times like these.

Over-allocate safe stocks and save the risker investments for when they are needed (more later). Here are some traditional low risk dividend stocks that with a RQ rating of A3 or better trading below their calculated fair value:

Aflac Incorporated (AFL) provides supplemental health and life insurance in Japan and the U.S. Products are marketed at work sites and help fill gaps in primary coverage. The company has paid a cash dividend to shareholders every year since 1973 and has increased its dividend payments for 33 consecutive years. Yield: 2.5%

Genuine Parts Co. (GPC) is a leading wholesale distributor of automotive replacement parts, industrial parts and supplies, and office products. The company has paid a cash dividend to shareholders every year since 1973 and has increased its dividend payments for 33 consecutive years. Yield: 2.7%

Johnson & Johnson (JNJ) is a leader in the pharmaceutical, medical device and consumer products industries. The company has paid a cash dividend to shareholders every year since 1944 and has increased its dividend payments for 53 consecutive years. Yield: 2.7%

Cincinnati Financial Corp. (CINF) is an insurance holding company that primarily markets property and casualty coverage. It also conducts life insurance and asset management operations. The company has paid a cash dividend to shareholders every year since 1954 and has increased its dividend payments for 56 consecutive years. Yield: 2.9%

Wal-Mart Stores, Inc. (WMT) is the largest retailer in the world, operating a chain of over 10,000 discount department stores, wholesale clubs, supermarkets and supercenters. The company has paid a cash dividend to shareholders every year since 1973 and has increased its dividend payments for 41 consecutive years. Yield: 2.9%

III. Sometimes You Will Misfire

As hard as we may try to pick all winners, sometimes a good stock will go bad, cut its dividend, and we’ll have to sell it. Often it is one of our higher yielding stocks, leaving a large void in our annual dividend income. How do we manage this? Here is what I do:

1. First, when you suspect a stock might cut its dividend put it “On the Shelf” and don’t make any future purchases, until you are convinced the dividend will not be cut.

2. Manage the risk of a dividend cut by limiting your allocation to any single stock to a maximum of 5%.

3. Keep some high risk/high yield allocation in reserve. As mentioned above, when the market goes south, we need to under-allocate high risk/high yield stocks. This will allow room in our allocation to selectively purchase these types of stocks when we choose to sell a past performer that is no longer meeting our expectations.

As your income portfolio grows, you will not always be able to replace the lost income, but the above principles will help you minimize the decline.

IV. Don’t Let Fear Derail Your Long-Term Plan

Someone once said, ‘Your emotions are the best inverse indicator of what you should be doing in the market’. In a declining market many people will sell it all and walk away from the market. They’ll be back though – when the market is reaching all time highs, only to get out when it falls with no end in sight. This is a long-term recipe for disaster. For those of us who still have time before retirement, be ready for when the market presents us with a golden opportunity; what will we going to do with it?

Full Disclosure: Long AFL, GPC, JNJ, CINF, WMT, in my Dividend Growth Portfolio. See a list of all my Dividend Growth Portfolio holdings here.

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