When I researched my holdings and dividends for my quarterly review, I noticed something that required further analysis. I put it aside while completing my taxes, but resolved to readdress it. The issue is portfolio balance – or more specifically – being out of balance. I noticed over the past few months that portions of my portfolio were sliding farther from their assigned allocations. I currently rank my holdings by value (price * # shares). I then weight by category. The companies I’ve identified as Anchor positions would comprise a maximum 18% of the total value. Frankly, none of these positions has yet attained the 6% threshold since I only added this category last year. WEC (5.4%), CLX (4.6%) and KMB (3.8%) hold these slots and I haven’t been adding to them this year outside of dividend reinvestment due to valuation. So my ‘heavy hitters’ aren’t out of balance.
Another area causing some portfolio disruption is the amount of M&A activity. This one of those good/bad things with 16.5% of my holdings merging, being acquired, spinning off divisions, being privatized or are subject to rumors thereof. But in deeper analysis, only two of these – PNY (4.4%) and NSC (2.3%) – have a concentration greater than 1%. So I have to conclude that other than limiting my watch list due to overvaluations, the M&A impact is minimal. Perhaps with CP scrapping their NSC bid this week, the NSC value will begin to normalize.
So I finally concluded that just maybe my emphasis on value within a portfolio – over dollars generated – was ill conceived. I didn’t perceive a significant difference between the two methods and assumed it was more about personal preference. But last January, Dividend House published Our Dividend Growth Investing Portfolio Plan on Seeking Alpha which addressed:
- Should each stock be weighted equally? Many folks espouse equal positions (either based on market price or on dividend income) for all of the positions in their portfolio. Others, like myself, take a tiered approach. We have three tiers in our current DGI portfolio … I weight stocks like Johnson & Johnson, Coke, and Procter & Gamble more heavily than stocks like Kraft or Mattel. In other words, I trust JNJ, KO and PG to pay out increasing dividends consistently every year more than I trust KFC and MAT to do so. As a result, a full position for JNJ is larger than a full position in a Mattel.
- Should I weight by market price or income?We weight our stocks by income. This means we end up purchasing more of our higher quality stocks (which typically have lower dividend yields) to provide as much income as a more speculative stock. If you weight by price, you run the risk of overweighting speculative stocks’ impact on your portfolio from an income perspective.
Which is exactly the situation I find myself. I haven’t added to my Comcast position since November 2002. My last purchase of Home Depot was February 2014. Yet both of these stocks have been increasing in value. Not necessarily a bad thing but it sure distorts the intent of the portfolio – particularly when one is no longer in the pure accumulation phase of investing. Mike Nadel, who authored Weighting Portfolios: Equally, Variably Or By Dividends Generated?, added this comment to her article:
As for your ideas, one of my favorite for a DGI is a weighting system that favors income over dollar values. Let’s say I own JNJ and MAIN (and, indeed, I do). Obviously, JNJ is one of the greatest, most stable companies in the world, a decades-long dividend grower. I think MAIN is the creme de la creme of BDCs, but it still is a speculative company that lends money to businesses that have trouble getting loans from banks. Nevertheless, if I invest $10K in each, I’d be counting upon MAIN to provide 2 1/2 times as much dividend income as JNJ. To me, that makes absolutely no sense for a DGI portfolio.
All of which makes perfect sense. With that being said, today I changed how my portfolio is presented. I no longer show the percentage by value but the percentage by dividend payments. Comcast now accounts for 9% and Home Depot 7% of my dividends – but most important trending down as I increase my holdings. And perhaps one day Comcast will provide the desired 1.5% without selling any shares.
Seeking Returns 
Some good points raised, SR.
Looking at market value just gives you a sense of weighting based on the increased or decreased stock price. I also look at the dividend weightage in my portfolio in addition to market value based weightage.
Thanks for bringing this up for discussion. An interesting thought exercise.
R2R
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SR that is great approach! It shows how you are aligning with your long term goals of creating passive income and reducing risk via income diversity. Well done.
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Ken, you highlight the greatest benefit (to me) of this change. Risk diversity was being masked to a degree. Thanks for reading!
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I appreciate the comment, R2R, and you raise a valid point in that both methods have their purpose. As a long-term valuation junkie, I probably have a little bias since the dividends themselves now have a greater importance.
I would assume a leading cause of the imbalance were 1) a stock grant that hit the money prior to expiration (CMCSA) and 2) an IRA contribution plan that was no longer available at the halfway point. But my point was not to examine the root causes but the impact of price appreciation.
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Great points, much more useful to know how big of chunk your income decreases with when dividend cuts occure. I think I will implement that at some point as well 🙂
Best Regards
Dividend Freedom
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Although financials comprise about 20% of the total value of my portfolio, I was completely out of them pre-crisis. I reentered the financials March 2013 – so I dodged that bullet. Never owned KMI or BBL either. The only dividend cut I experienced was BAX and my response was to offset the cut by increasing my BXLT position. But I get your point – what if one of my three 6%ers cut? Now that could be ugly! But in theory diversification would take care of that (hopefully).
Thanks for the comment.
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Great article SR!
The issue of weighing by cost basis vs. weighing by income is one that I’ve pondered for a long time; I was actually planning on writing about it myself.
I too have come to the conclusion that for a dividend investor, it makes way more sense to weigh by income, either equally or using a tiered system where safer/more proven holdings are prioritized.
In the early stages of one’s investing endeavor I can see why weighing equally by cost basis (as I am more or less doing right now) could have merit, as it makes it easier to start achieving some level of diversification when one might not have that much capital to invest every month, but I do feel it is best to start gradually re-balancing one’s portfolio toward an income-based weighing system, especially as one gets closer to depending entirely on dividend income.
When one no longer has any external sources of income beyond dividends, imo it definitely makes sense to lessen the blow of a potential dividend cut by having each holding generating roughly the same amount of income.
Cheers!
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Appreciate the comment! When you look at my tiers, they are structured not only by (perceived) quality but also across quarters and weeks. Meaning – once I get the percentages in sync, with few exceptions I should be generating about the same payout on a weekly basis.
In your article you mentioned concerns with CVX with which I concur. At this point my take has been to end DRIP and place the shares in my brokerage account. Since my issue is on their emphasis on E&P, I’ve decided to offset this a little by adding to my TRP (midstream) and VLO (downstream) positions.
Good investing to you!
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