Re-Introducing My Dividend Growth Portfolio

I created my public Dividend Growth Portfolio (DGP) almost 10 years ago to demonstrate real dividend growth investing.

As it nears its 10th birthday, I want to re-introduce the DGP to Daily Trade Alert readers.

I originally intended to terminate the portfolio after 10 years, at the end of May 2018.

However, Daily Trade Alert and I have agreed to keep the portfolio going, because it has turned out to be a great teaching and learning tool.

I update the portfolio every month. You can quickly access the latest update by hovering over the Dividend Growth Investing dropdown menu at the top of every page. Click on “Dave Van Knapp’s Dividend Growth Portfolio” (circled in white below), and you will immediately link to the latest monthly update.

Beneath the monthly update, you will find a list of articles I have published on Daily Trade Alert about the portfolio. Those articles provide historical information about the DGP, most importantly about how I have reinvested dividends along the way.

Real Time, Real Money

My Dividend Growth Portfolio is not a hypothetical back-test or so-called model portfolio.

The DGP is a real-time, real-money portfolio.

• I funded it with my own money.

• All decisions about it –what to buy, hold, or sell – have been and continue to be made in real time. That’s real-life investing: No 20-20 hindsight.

The DGP’s inception date was June 1, 2008. It is not a huge portfolio, but it is large enough to demonstrate basic dividend growth investing principles. Those principles operate the same at any portfolio size.

At inception, the DGP’s dollar value was $46,783. By the end of 2017, it grew to $110,946.

No new outside money has been added since creation. Of course, “organic” money has flowed into the portfolio from dividends collected.

The reason that I call that money organic is because dividends are produced by the portfolio itself. Generating dividends is the exact point of dividend growth investing!

Goal 1: Optimize Income

In my opinion, all investing should start with your goals.

Investment goals are personal: They vary from investor to investor. Goals are important, because they flow down to determine the strategies, tactics, and individual decisions you will make to reach your goals.

Many times in investing, it is assumed that amassing the most wealth or beating the market are everyone’s goals. But you should think about what your goals really are.

My principal goal for the DGP is not to maximize wealth, but rather to optimize income for eventual use in retirement.

That shift in goal-setting leads to a variety of financial and psychological differences that influence areas like what stocks to select and how to react to price drops.

At some point in the future, I will use this portfolio’s income to help fund my retirement.

When that time comes, I want it to generate enough income – combined with other sources of income – that I don’t need to sell a single share of anything.

Other ways to look at this goal would be to say that it is about income replacement or expense coverage in retirement.

Here is the way the DGP’s goal is stated in its new Business Plan:

Build a reliable, steadily increasing stream of dividends over many years that can eventually be used as income for retirement.

Here are the key elements of that goal:

1. The income builds up over a period of time. The portfolio’s annual cash flow after 10 years of investing is much larger than it was at the beginning. It will continue to grow moving forward.

2. The income should be reliable, with little negative volatility from year to year.

3. The income should be generally increasing, with a growth rate that surpasses inflation.

4. The income should be of a sufficient amount that it fills the gap between other sources of income (like Social Security or a pension) and the total amount needed in retirement.

As a result of the income-centric focus of the DGP, important decisions about whether to buy, hold, or sell a particular stock are driven principally by what will optimize the income over a long time rather than by what will maximize wealth.

In running the DGP, my outlook is very long term, measured in years or decades rather than weeks or months. There is relatively little trading. The intent when buying a stock is to hold it for years. Some stocks in the DGP have been there since 2008.

Optimizing income is not always the same as maximizing it. That’s because investment decisions need to account not only for the immediate income amount, but also for reliability, safety, and long-term growth.

Why Does Dividend Income Grow over Time?

There are 3 main reasons why a dividend growth portfolio’s cashflow rises as the years pass:

Companies increase their dividends. As a basic ground rule, I only select stocks for the DGP if they have already compiled a 5-year streak of increasing their dividends. (See Dividend Growth Investing Lesson 3: The 5-Year Rule.) Some stocks have streaks of over 40 or 50 years.

Dividends are reinvested to buy more shares. Additional shares pay dividends themselves, thus compounding the speed at which dividends increase. (See Dividend Growth Investing Lesson 5: The Power of Reinvesting Dividends.)

Occasional portfolio changes may increase the income. For example, trimming a highly valued, low-yield stock and purchasing a higher-yielding stock in its place will cause the portfolio’s income stream to rise.

Here is the dividend record of the DGP since its inception in 2008 through the end of 2017.

Ignoring 2008 (because it was a partial year), the compound annual growth rate (CAGR) of the dividends from 2009-2017 was about 11% per year. (For a definition of CAGR, see DGI Lesson 5: The Power of Reinvesting Dividends.)

That growth rate has been well above the level of inflation. Going forward, I am expecting annual dividend growth in the 6%-8% range per year.

Goal 2: Achieve Competitive Total Returns

The DGP has a secondary goal, which is to achieve competitive total returns. By that, I mean that I want the DGP to produce returns that are roughly in line, over time, with the S&P 500.

I use the ETF SPY for the comparison. SPY tracks the S&P 500 index.

Since I reinvest dividends in the DGP, I compare my results to SPY with its dividends reinvested.

Below are the results through 2017. As you can see, total returns have been quite similar.

I should point out, in keeping with my income focus, that the DGP’s yield is generally about twice that of the S&P 500. As of this writing, the DGP’s current yield is 3.7%, compared to the index’s yield of 1.8%.

Stock Selection

The DGP’s stock selection is driven by these considerations.

1. Protection from inflation. I want the income from this portfolio to go up faster than inflation.

2. Income sufficiency. When I began the portfolio, I aimed for approximately a 4% current yield. I made the assumption that when I used the portfolio for retirement, my needs would be about 4% of the portfolio’s value. Now, after nearly 10 years, the actual yield is usually about 3.5%. Partly that’s because the value of the portfolio has risen so high during the 2009-2017 bull market: All else equal, a portfolio’s yield and value move in opposite directions.

3. Dividend safety. I want reliable dividends that go up each year. Obviously, no one can guarantee that any company will maintain annual dividend increases forever, but a well-diversified portfolio, filled with quality companies that have shown the ability and willingness to increase their dividends, has a decent shot at achieving that goal across the whole portfolio.

I don’t buy stocks in the hopes of giant price increases. I buy them for good, reliable dividends that I expect will be increased every year.

Over the years I have developed processes for scoring stocks on a variety of quality, financial, and valuation factors. I use those factors to try to select the best stocks for the portfolio.

I won’t go into the details here. If you want to dig deeper, the scoring factors can be seen in action in these two series of articles:

Dividend Growth Stock of the Month
Valuation Zone

And the factors are explicitly laid out in these two Dividend Growth Investing Lessons:

• Lesson 11: Valuation
• Lesson 19: Grading Dividend Growth Stocks to Find the Best Ones

Reinvesting Dividends

One element in how I manage the DGP deserves special attention: Dividend reinvestment.

I accumulate incoming dividends in cash until they reach $1000. Then I make a purchase.

Through the end of 2017, more than $24,000 had been reinvested. That’s more than half the value of the original portfolio. (Dividends do pile up over the years.)

When I reinvest dividends, I might buy more of a stock that I already own. Or I might buy a wholly new stock. Overall, I want the portfolio to hold 20-30 positions. It has 22 now.

Portfolio Management

This is mainly a buy-and-hold portfolio. There are only a few transactions every year.

Most of the transactions are dividend reinvestments. At the current rate that the portfolio is producing dividends, there are 4 reinvestments per year of about $1000 each.

Occasionally, I trim or swap out stocks to improve the portfolio.

For example, I don’t want any position to exceed 10% of the portfolio’s total value. Thus in 2017, I trimmed McDonald’s (MCD), because it had grown to more than 12% of the portfolio. I used the proceeds from selling some McDonald’s shares to buy shares in two other stocks.

The dividend growth strategy is generally not for traders, and it doesn’t usually reward impatience. Rather, it is for long-term investors who want to make steady progress toward a goal.

No one bats 100% in investing. Some of the stocks in the portfolio have cut their dividends over the years. When that has happened, I have usually replaced them with other, hopefully better companies.

What’s Changed from the Original Dividend Growth Portfolio?

I am treating the extension of the DGP beyond its original 10-year term as a chance to re-introduce the portfolio for the benefit of readers who haven’t followed it before.

The fundamental purpose of the DGP remains intact: To illustrate dividend growth investing in real time using real money.

There are a few changes from the original DGP worth mentioning.

• The former numerical target of achieving 10% yield on cost in 10 years has been dropped. For the record, the DGP won’t hit that target by the end of May, 2018. The yield on cost will be about 8.1%. I will continue to track yield on cost but won’t be aiming for a particular target.

• The removal of the yield on cost target may lead to the future addition of more low-yielding but faster-growing dividend growth stocks that may have been bypassed previously.

• The phrase “over many years” has been added to the main goal to emphasize the long-term nature of this endeavor.

• The anticipated characteristics of an overall 3.5% yield and 6%-8% per year in dividend growth have been added. They help illustrate the straightforward nature of the portfolio. It’s not meant to be either a high-yield or superfast-growth portfolio. It has elements across the spectrum. Hopefully, most dividend growth investors can find something of educational value in the DGP.

• The maximum size of the portfolio has been increased to 30 stocks.

• The explicit exclusion of ETFs has been dropped. I may add an ETF or two to the portfolio at some future time for educational value.

How to Use the Portfolio

I suggest that you use my Dividend Growth Portfolio as a learning tool.

Learn from my sources and methods. Learn from my failures and successes.

The DGP is an illustration of real-life investing. I do not hold it out as a model or best-of-type, but rather as a real-time, real-money, sensible demonstration of what an investor can achieve by following a dividend growth strategy.

Use it for ideas. While obviously the specific stocks it holds may be ideas for yourself, so are the methods used to pick them. Learn about investigating companies and the principles of valuation.

The Business Plan may inspire you to write your own plan, which I would recommend to all investors. Maybe you want to tilt your portfolio to fast growers or high yielders. Whatever your personal situation, write your goals and strategies down.

My DGP is meant to be a general-purpose illustration. It contains a mixture of stocks drawn from the whole spectrum of dividend growth stocks. It is diversified across sectors, industries, yields, and growth rates.

Obviously, since I am reinvesting the dividends, the DGP is managed as one would manage a portfolio when they are in the “accumulation” stage of life. Later on, in retirement, the dividends would be taken as cash income, to be spent on living life.

Dividend growth investing is a collection strategy: You collect stocks, and you collect dividends.

I have observed that dividend growth investing often has an interesting effect on investors. Their attention swings away from the frenetic daily media coverage of price movements to the more relaxed (and reliable) production of dividends.

Many dividend growth investors report that instead of panicking, they often see market drops as buying opportunities rather than fearsome events. They learn patience.

I like to say that stock prices are like dogs on a leash: They run forward and then they run back, but generally they move along with the growth of the dividends in a portfolio like the DGP. When prices fall, you are still collecting dividends while you wait for prices to rise back up.

And historically, they always have risen back up. In the meantime, if you have money to invest, you get to enjoy buying shares at depressed prices to add to your collection.

Dave Van Knapp