Follow the dividend investment decisions of a person who has no background in financial investment and wishes to take control of their financial future.

Risk Part 2 – Equity Diversity - 20 Sep 2013 21:20

Tags: diverse diversity risk

A fact with Dividend Growth Investing is that it is 100% invested in stock equities. Though historical stock performance can provide some patterns it cannot accurately predict the future on how stock markets perform. The lack of uncertainty exposes you to some level of risk if stocks perform poorly.

Some might argue that while investment cost is a concern it is not the top priority for DGI. As long as a portfolio continues to receive income and income growth through dividends the downward stock prices are not a major impact. Or more simply…”Why do I care if equity prices rise or fall as long as I keep getting my dividend checks?” While this may be a valid statement it does not address unforeseen risks.

No one has a crystal ball and there are too many external factors that can influence the stock market. For example, what if a drastically higher corporate tax is applied by the I.R.S? The increased tax expense may require companies to decrease dividend payments and invest the capital back into the company to sustain growth and compensate for the excessive taxation. Of course this is not a real scenario but only one of many what-if topics that could derail your investments and DGI strategy.

As much as I enjoy, support, and strongly believe in the benefits of DGI I would be wrong to say that it should be your only investment. Much like stocks, you should diversify your equity investments to reduce risk and preserve equity. Of course if you are a young investor starting out this probably is not feasible as you have limited financial savings but equity preservation should be a part of your long term investing plan.

Examples of some investments you can use to diversify your equity:

Cash

  • Bank Savings Account
  • Bank Certificate of Deposit
  • Money Market Account

Bonds

  • U.S. Government Debt
  • Foreign Government Debt
  • U.S. Corporate Debt
  • Foreign Corporate Debt
  • Municipal Bonds

Hard Investments

  • Real Estate / Rental Property
  • Precious Metals

Other Investments

  • Annuities
  • Preferred Stocks

I do not recommend investing in all the items above but simply listed potential alternatives. Never invest blindly, if you wish to diversify then investigate each one and become well versed on the good & bad or talk to a financial analyst if you do not have the time.

The next question is if you diversify how much? I do not believe there is one single answer to this question. It depends on your personal situation. The best I can share is my situation where I have 7% in cash, 78% in stocks and 15% in bonds. Since I am in my mid-forties I believe I can withstand a decent level of exposure to risk and still have enough time to recover. My current house has 90% equity and should be paid off in 3 years so I see no reason to add rental property. Additionally, I am one of the lucky few who will receive a small pension which provides further security in later years so I feel extremely comfortable maintaining my 78% stock exposure up to retirement. - Comments: 0

Risk Part 1 – Stock Diversity - 19 Sep 2013 21:08

Tags: diversification diversity risk

(This post is the first of a 2 part blog to identify potential risks in your portfolio.)

As a DGI investor it is easy to get caught up in the wrong numbers. In a constant pursuit to find the best combination of dividend yield and growth it is not hard falling into the trap of continually buying the same stock or set of stocks in the same sector placing a large percentage of your investment into one basket.

Exposing most of your portfolio to a single stock, sector or industry is one of the most risky items you can financially take on. All of the modern stock market crashes had specific sectors or industries at their core.

  • 1987 – Banking Industry
  • 2001 – Technology Sector
  • 2008 – Financial Sector

If your portfolio was heavily weighted during any of the crashes your portfolio would have been in ruins. Of course some would argue that the overall markets dropped like a rock in each of these incidents but it was worse for these specific stocks as you not only lost equity value but also income as they slashed or eliminated dividend payments during that time.

Need another example? You do not need a stock market crash to be exposed to loss. In 2012 the S&P 500 gained 13.4%, a good year by any means. But, there was one sector that was suffering…basic materials. As China went through its massive growth cycle basic material stocks were booming, especially those involved with coal, iron, steel, and other base metals. These stocks were sporting high yields & fantastic dividend & earnings growth rates. Once China growth had slowed the basic materials sector was hit hard in late 2012 and most of 2013. Companies such as Cliff’s Natural Resources dropped their dividend 76% and all the while their stock price dropped like a rock.

As a DGI investor you need to be diligent in balancing of your portfolio weighting in relation to individual stocks, industries, or sectors. I have yet to figure out if there is a magic weighting but for now I have the following plan but as my portfolio grows in size I’m sure these numbers will decrease:

  1. No more than 15% of my portfolio weighted to an individual sector
  2. No more than 10% of my portfolio to one industry
  3. No more than 7% of my portfolio to one stock

Of course if you are a new investor just starting out this is most likely not feasible but you should have a plan that with each investment you build the diversification. That is why in my watch list I always use a target weighting to determine how much I want to spend and to place me on track for a diversified portfolio. - Comments: 0


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