Monday, July 8, 2013

July 2013 Portfolio Review

My wife rolled her 401(k) into an IRA in July 2011 and in September 2012 I took over management. Between September and June 2013, I pulled together the rules and goals of the portfolio and put them in writing in this blog. Years from now I’ll have a record of my thoughts and decisions and which of those were successful and which were total failures.

This is my first formal portfolio review and I hope to do one of these twice a year - in January and July.

Managing a portfolio is similar to managing a business. I am investing in companies that will provide me with dividend income during retirement and I expect every stock to pull its own weight. If not, I’ll sell it and buy into a better company.

(1) I’m looking for companies that will double their earnings every 5 to 10 years. Steadily increasing earnings per share (EPS) is often followed by steadily increasing share prices and dividend payments. Using the Rule of 72 as a rough guide for estimating an investment’s doubling time, 72 / 10 years = a minimum EPS growth rate target of 7.2%. The companies in my portfolio have future EPS growth rate estimates of 9% to 16%. The weighted portfolio average is 12% estimated annual EPS growth. No portfolio problems here.

(2) I’m looking for a combination of Yield and Dividend Growth Rate (DGR) that will provide a 10% yield on cost in about 10 years. If a starting yield is 2.5% on the day I buy a stock, then the dividend will need to double to 5% in 5 years and double again to 10% in 5 more years. Using the Rule of 72 as a guide, 72 divided by 5 years tells me I need to look for a minimum DGR of 15%. The weighted portfolio DGR is 16.8% and the Yield on Cost is 2.68%. This combination of yield and dividend growth rate will get me to a 10% yield on cost in about 10 years.

(3) I’m looking for companies with fairly low debt and low dividend payout ratios. This gives some indication of the stability of the dividend payment. The portfolio average for Debt to Capital is 40% while the average dividend payout is 36%. I own one company well outside these bounds. LO has a debt/cap ratio of 238% and a dividend payout ratio of 71%. I’ll keep a watchful eye on LO but, I have no plans on selling the stock at this time.

(4) I’m looking for a certain level of diversification. I plan to own about 20 stocks with no more than 15% of the portfolio in any one company. My wife’s IRA has 12 stocks and one, AAPL, makes up 17% of the portfolio value. I’m not going to sell AAPL at this time though. However, all 12 stocks are Large Caps. I will look to add Mid or Small Cap stocks during future purchases.




June 2013 Holdings


Monthly Income

I will use this graph to illustrate my rising dividend income. The graph looks more impressive now than it will in the future. That’s because the sharp rise from $200 to $800 is due to my transition from non-dividend paying ETF’s to dividend paying individual stocks. By this time next year I will have all of the ETF’s converted and the light blue income trend line will flatten out.



Monday, July 1, 2013

Doubling Income Every 5 Years, My 10x10 Plan

The portfolio I will be documenting is my wife’s IRA. She spent 24 years (1987-2011) with a major bank before leaving to stay home with the kids. She spent most of those years contributing to a 401(k) and when she left, we rolled $211,281 into an IRA. This number will become important in just a few minutes.

To some people that amount seems like a fortune. To others, it’s pocket change. To an average, middle class man like me, nearly 50 years old, it’s no where near enough to retire on. But, I have a plan.

Managing a portfolio is similar to managing a business.

One business model, used by many money managers guiding you along the 401(k) path, is to build up wealth during your working years and spend it down to zero in your retirement years.

My method is a bit more old fashioned. I’m using the model my grandfather, Howard Counts, tried to instill in his children and grandchildren. He bought shares of high quality companies and lived on the dividend income.

The model is called Dividend Growth Investing and the idea is to grow dividends for income instead of selling off shares.

Thousands of companies pay regular dividends but, only about 500 of them have a historical record of increasing their dividend payment each and every year. After all, it’s important in retirement that the income stream, no matter what method you use, increases each year to keep up with inflation.

My goal is much more aggressive than just keeping up with inflation. Instead, it's to reach a 10% yield on cost in 10 years. My 10x10 plan.

Almost everyone knows what a dividend yield is. Apple (AAPL) recently started paying one. They pay an annual dividend of $12.20 per share. Their current share price is $402.63. $12.20 / 402.63 = 3.03% dividend yield.

Apple has increased their dividend once so far. Let’s suppose they increase (hypothetically) their dividend about 15% every year. In about 5 years their dividend would double to $25 per share. If I had bought a share at the original $402.63 price then my yield on the original cost would be $25 / $402.63 = 6.21%.

If the same trend continued, then in 10 years the dividend would grow to $50 per share and the yield on my original cost would be over 12%, well ahead of my 10% goal.
401kcalculator.org


That, briefly, is my plan. To invest in companies that grow their dividend about 15% every year, doubling my dividend income every 5 years.

A plan is no good without starting points and end points. Without end points, how will we know when reached our goal?

Mentioned earlier, my starting portfolio amount is $211,281 but, my starting dividend payment is zero. The bank, like many 401(k) plan providers, didn’t allow investment in individual stocks so I’m selling shares of mutual funds and replacing them with dividend paying stocks. My starting dividend income will be about $5000 once I’ve completed the transition.

The starting date is the date we rolled the 401(k) into an IRA - July 2011.

The target dividend income is 10% yield on cost. The cost is $211,281 and so a 10% yield (or income) will be $21,128.

The target date is 10 years from the start date - July 2021.

So, my goal is to build $21,128 of dividend income by July 2021.

Put another way, the average yield for high quality companies is 2.5%. 2.5% of $211,281 is $5,282. In 5 years, I will need to double that amount to $10,500 and in 5 more years double it again to $21,128.

The project doesn’t end there. In 5 more years, $21k doubles to $42k. It doubles again to $84k 5 years after that. By July of 2031, when I’m well into retirement, this little IRA nest egg could be returning $84,000 a year in dividend income!

It’s exciting having a well laid out plan but, I kick myself for not figuring this out 20 years ago! My grandfather certainly knew the power of compounding interest. I was too stubborn to listen though. Perhaps my kids will pick up a few nuggets from this blog and learn from my mistakes!

Monday, June 24, 2013

Moving to Dividend Growth Investing

In 2011, my wife left her job to stay home with the kids. We transferred her 401(k) into a professionally managed IRA at the bank where she had worked. I wasn’t confident enough to manage it myself and needed some time reading and learning and understanding how a dividend based portfolio should be managed.

I really enjoy the articles at Seeking Alpha and that website has become my primary source of investor education. By September of 2012, I felt ready enough to transfer her IRA from the bank to TD Ameritrade. The bank’s philosophy was to invest the monies into 12-18 different ETF’s. That’s a very safe model but, too diversified for my goals.

http://www.401kcalculator.org/401k-images/
401kcalculator.org
I’ve decided to use the Dividend Growth investment model instead. It’s a model my grandparents used and one I understand and feel comfortable with. The idea is to build retirement income from companies paying ever increasing dividends. During the accumulation years, while I’m working and saving for retirement, the dividends will be reinvested into the companies. The dividends buy more shares, which in turns yields higher dividend payments. Higher dividend payments buy even more shares.

Lot’s of companies pay dividends but, I’m not interested in just any dividend paying company. I’m looking for those companies that increase their dividend payouts year after year. This provides sort of a double compounding effect. Not only are my shares providing income but, the company is increasing the income every year.

Before retirement, this annual increase in income will be rolled back into more shares. After retirement, when I need the income to pay bills, the annual increase ensures our income stays ahead of inflation.

There are nearly 500 companies that have increased their dividend payments every year. Many have a short record of 5 to 10 years but, a little over 100 companies have increased their dividend payments annually for 25 years or more. Companies such as 3M, Colgate-Palmolive, Coca-Cola and Johnson & Johnson have records of 50+ years of ever increasing dividend payments.

It’s this list of nearly 500 companies where I’ll start my search. The list, called US Dividend Champions, is updated monthly and can be found here.

Monday, June 17, 2013

Introduction to Dividend Paying Stocks

I began individual investing at possibly the worst time in recent history. My daughter was born in 1998 - the same time the dot com bubble was beginning. The birth of a couple's first child gets them thinking about saving for the future like no other event.

Everyone was buying tech stocks, me included. I was buying anything and everything and it was going up. People were quitting their jobs to become day traders. I was reading books about it and seriously thinking about leaving my job too. I was cocky and thought I knew what I was doing. That is until the bubble burst in 2000. The high flying stocks crashed to the ground, hard. People lost money in a big way. I had to write off an investment or two but, nothing too serious.  Boy, did I have a lot to learn.

Over the next 10 years I meandered from one stock to another. I made a few mistakes but, nothing too terrible. I was treading water and not making real progress towards our retirement goals. 


Interest rates were high enough that I was earning 4.5% on savings accounts. I was feeling comfortably safe. That is until 2008 when the economy collapsed again, this time thanks to sub-prime mortgage crisis. Now, when a bank advertises a "high yielding CD", odds are good that the "high" interest rate is well below 1% .

That's about the time I started paying attention to dividend paying companies and their 2% to 3% yields.