Yesterday I posted Taking a Look at Canadian Stock Pickers Who Choose Dividend Growth. By no surprise many investors who create their own stock portfolio insist on dividend paying companies and usually dividend growth. It was the advice of Benjamin Graham, Warren Buffet’s teacher, that the defensive investor (kind words to mean more unsophisticated investors) should insist on at least a 20-year history of dividend payments. If a company is paying a dividend that almost exclusively means that they are profitable. The dividend and a meaningful dividend growth history can work as a divining rod that finds successful companies.
Buying successful companies, market leading companies, is the essential approach of core index investing. Insisting on dividends and dividend growth is an attempt to increase the odds of success.
It takes a special kind of investor to hold a stock portfolio.
Humans make for terrible investors for the most part. Let’s be honest about that out of the gate. Most investors will take on too much risk, or they simply start ‘doing stuff’ that they don’t understand. Even index investing by way of ETFs can be a challenge. Again, we have to understand stock market history and stock market volatility and we have to be prepared to watch our portfolio value bounce up and down like a yo-yo.
Investing can be very simple and very successful, but we do need to invest within our risk tolerance level. And of course that usually means holding enough of those bonds that act as the adult in the room to keep an eye on those unruly stocks.
Holding stocks brings additional risks compared to holding ETFs. When you hold an ETF all of your stocks are bundled together and you likely don’t know what’s going on under the hood. But if you start to hold 20 or 25 individual stocks, all of a sudden you might take a real interest in the latest news and headlines on each stock. You might actually care that Royal Bank missed their earning estimates by a penny a share, oh no! Or you might worry that Enbridge had to close a pipeline for two weeks. Financial headlines and stock ‘gurus’ will be screaming at you every time you open your laptop or turn on the TV. It is more difficult to remain passive.
In my opinion when you hold enough market leading companies, you don’t have to watch – you don’t have to be active. Buy. Hold. Add. Patience is still key.
How many stocks is enough?
There are studies that show holding just 12 companies does most of the heavy lifting.
In their book Investment Analysis and Portfolio Management, Frank Reilly and Keith Brown reported that in one set of studies for randomly selected stocks, “…about 90% of the maximum benefit of diversification was derived from portfolios of 12 to 18 stocks.” In other words, if you own about 12 to 18 stocks, you have obtained more than 90% of the benefits of diversification, assuming you own an equally weighted portfolio.
That said, after reading way too much on the subject and studying ‘how many is enough’ for a few decades, I’d suggest that you likely want to hold 20 or more companies to own a market. That 20 number is offered by Larry Bates in his best-selling book, Beat The Bank.
For our US stock holdings we own 15 of the largest cap companies skimmed from the Dividend Achievers Index, ticker VIG. Here’s how they track the total index from purchase in 2015.
The chart is courtesy of portfoliovisualizer.com
Portfolio 1 is our 15 individual stocks from the index
Portfolio 2 is the total Dividend Appreciation ETF VIG
We can see that the 15 stocks has offered periods of out performance but it is essentially tracking the total index that holds 180 companies.
For the Canadian market the top holdings with a dividend approach would look like this. Here are the top 10 holdings of Vanguard’s High Dividend Yield ETF VDY.
We can see that because the fund is cap weighted, the top 10 holdings captures 76% of the total index. The next 5 holdings of National Bank, Fortis, BCE, Thomson Reuters and Shaw Communications would grab another 9% of the index. In its brief history from 2012 VDY outperforms the broad market TSX XIC by almost 1% annual.
While I hold VDY for my wife’s portfolios, I skimmed a few of the top holdings of popular Canadian dividend indices. My simple mix of Canadian stocks has offered some lower volatility and greater total returns compared to total market funds. And of course, that’s why one will choose to create a stock portfolio; it offers the ability to potentially shape the risk and returns.
Many investors will seek help with the evaluation of companies. In Canada, Dividend Stocks Rock (aka The Dividend Guy) offers various levels of portfolio ideas and ongoing research. And you’ll find writers such as John Heinzl at the Globe and Norm Rothery on MoneySense who offer up strategies and lists. Mr. Rothery’s top picks have a very impressive market beat from the last recession to present.
There is a dividend sweet spot in the Canadian market. Have a read of this Tangerine Dividend Portfolio review.
Why Dividend Investing Can Work
Even many of the Dividend Deniers will offer that investing in Dividend Growth Stocks can lead to better investor behaviour. While in the end it is about the total returns, the dividends and dividend growth can be a useful distraction. It can help an investor focus on the growing dividend stream instead of fluctuating stock prices. There is a more immediate reward when we receive those generous dividends. Almost exclusively the most successful investors that I’ve come across have been dividend investors.
There are many ways to build a simple and successful portfolio. Add a Dividend Growth Stock Portfolio to the list.
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