Wednesday, December 26, 2012

Dividend/Growth Investing

I started reading personal finance blogs in early 2008, when my wife and I were beginning our mortgage payoff project.  At first I followed blogs focused on debt reduction and mortgage elimination, but over time I branched out to general personal finance topics.  I found a subset of blogs discussing "early retirement" and "financial independence" (FI).  I was immediately hooked.  Even though I didn't have a term for it, in my own mind I had been dreaming of financial independence for years.

After finding the "FI" blogs I started following closely-related Dividend Growth investing blogs, especially as we were nearing the end of our mortgage and were looking forward to saving and investing for the future.  The Dividend Growth (DG) strategy appeals to me on a number of levels, including its simplicity (easy to understand and implement) and its focus on income from dividends (sustainability) rather than capital gains (speculation).  This style of investing has become increasingly popular in recent years, especially within the FI crowd.

Although I appreciate a lot of what the DG strategy has to offer, I don't see myself committing to the most strict DG guidelines when building our own portfolio.  I like the idea of buying stocks that pay dividends, but I don't want to arbitrarily limit investments to a certain minimum (or maximum) dividend yield, or to a certain string of uninterrupted historical dividend increases.  Admittedly, my investing strategy is evolving over time, and I've only been investing in individual securities for about six months now, so this is subject to change.  But at the moment I plan to favor a more personalized, hybrid approach.

At the core of our portfolio I hope to have a foundation of traditional DG favorites, which are blue chips with a solid dividend and a history of commitment to dividends.  I'd like to see about 50% of our portfolio fall into this category, across a wide range of market sectors.  Examples would be JNJ, KO, PG, SYY, and MCD.  Our current portfolio is light in this category because valuations have seemed high to me over the past six months.

Within a number of market sectors, I'd like to complement these DG core holdings with a blue chip competitor exhibiting characteristics more closely associated with a "growth" company, but which I expect to develop into a future DG core holding (based on a developing large moat, a short but robust history of increased dividends, and solid brand).  For example, MCD could be paired with SBUX*.  INTC could be paired with QCOM.  PG could be paired with CHD.  I expect these more growth-oriented holdings to make up another 25% of our portfolio.

* In the first example, I fully expect that in another 10-20 years, SBUX will be as ubiquitous worldwide as MCD is today.  After their growth phase ends and the company matures, I anticipate SBUX will use more of their free cash flow to pay a healthy dividend to their shareholders.  At the same time I expect that MCD will remain a solid investment, but if it falters, I could shift some funds from the old guard (MCD) to the new (SBUX) and not lose an investment in that sector of the market.  If I was limiting myself to classic DG investing entry criteria like a minimum yield (for example 2.5%) or a minimum number of years of dividend increases (for example 10) I wouldn't be able to buy SBUX until some point in the future.  And although we have no idea what the market will do from one year to the next, the general idea behind DG investing is that the market will rise over the long run, successful companies included.  So if I expect SBUX to perform for the long run, why not invest in it today, to take advantage of some capital growth to go along with its dividend growth?

With the remainder of our portfolio (the last 25%), I'd like to focus on high current yield.  This will be a mixed bag, but I expect to see some utilities here, along with REITs and BDCs and more speculative, out-of-favor dividend payers.  This is somewhat over-represented in our current portfolio (AGNC, CLF, EXC, PBI, SNH) but I expect it to become a smaller slice as we continue to add capital and make investments in the other categories.  The goal of this high current yield is to help offset the low yields of the growth holdings.  With the dividend payouts from this group, we'll have additional capital available to reinvest in our overall portfolio, wherever the best current opportunities happen to be.  I am willing to sacrifice some opportunity cost from the slow-growers (like utilities) and the occasional capital loss from some of the more speculative deep value names in order to bring up the average yield of our overall portfolio.

This is still a work in progress, and I may decide to make further revisions to this strategy as time goes by.  I'm also open to any input from my wife as she's been taking a greater interest in the nuts and bolts of our finances and investments.  But for now I'll be working under the guidelines of what I'll call "Dividend/Growth" (D/G) investing -- our personalized version of the classic "Dividend Growth" investing strategy.


  1. For high yielders you could go with MO, T, VZ as companies with above average yield and very good dividend growth rates as well. MAIN is a good BDC with a great reputation that has done well this last year or so. It yields over 6%. Utilities are another great option for dividend investors, solid businesses, protected by the government, basically mini-monopolies in their respective markets, etc etc. Having one or two utilities in a portfolio is never a bad thing.
    MCD and SBUX and any brick and mortar retailer scare me a little, because who knows what the retail sector will look like five years from now. The same with technology companies. I would be more inlined to buy MCD then SBUX, mostly bc I am not a coffee drinker, and my suspicion is as the economy gets worse, people will start cutting back which would be a smart move for them to make. I need international exposure, but since you mention VOD, I feel like it might be better to buy into an international dividend ETF because I know nothing about foreign companies. Also, a lot of big US companies like MCD for instance are just as huge overseas, so you aready have exposure there to a certain extent. As for your philosophy, I have several stocks in my portfolio that dont fit the DGI 'handbook' but those are just guidelines. The only hard and fast rule I follow with every purchase is to insist on a dividend. You absolutely have to tailor your portfolio to your own needs, and dont try to shoehorn it into someone else's plan. And grats on paying off the house again, must be sweet knowing you actually own your place.

  2. Thanks! I agree with you regarding physical retailers for the most part, but I can't imagine restaurants will suffer the same fate as bookstores or electronics stores. With a hot meal or beverage, there is a freshness and warmth to the meal that doesn't translate well to an online transaction. You don't want to come home to a box on the front porch containing fries or a hot coffee beverage.

  3. I like the approach you're taking here. I think it's well thought out and it sounds like it fits your style. You'll have a lot of companies to choose from, which is always good. Hopefully a few of them will be the next MCD or JNJ. If not, you can still collect the income!

    I personally only look for stocks that should increase distributions over time (and it doesn't have to be every year) because if the dividend stays flat I might as well just own bonds or preferred stock. I'm first and foremost an income investor. I'm heavy on equities right now because interest rates are low. I would rather be 25-40% bonds/fixed income, but I'm currently 90% stocks which is pretty aggressive.

    I think too many FI bloggers ignore the fixed income component, but they can get away with it for the time being with today's rates.

    1. Our fixed income is currently held in tax-advantaged accounts like 401k/IRA which I don't consider part of our FI portfolio (since we can't touch them until we are almost 60), so I don't mention them in this blog. However I may consider adding a muni component to the FI portfolio at some point. Do you invest directly in individual bonds or do you go through funds/ETFs?

  4. I like your way of looking at it. I'm not sure that I agree with the dividend growth investing strategy - it was far too sector specific and not very diversified. It also seems somewhat short-term, when stock investing is meant to be long-term, so I like your idea of looking for potential future dividend stocks. I definitely don't think Starbucks is going anywhere either!

    1. DG is meant to be straightforward and somewhat conservative. I guess my risk tolerance is a bit higher than the classic DG strategy supports. Still, at its core I believe there are some solid concepts.