Every investor wants to make money—that’s why we’re here. But Cabot subscribers know that there’s more than one way to achieve that goal: that’s why we offer 10 different premium advisories. Cabot Dividend Investor is designed for the investor whose priorities include some combination of three things: regular income, long-term capital appreciation and peace of mind.
I created Cabot Dividend Investor’s three-tiered portfolio to address the needs of the widest possible variety of investors with some combination of these goals. But this variety means that you need to figure out how to mix and match my recommendations to best fit your goals. A subscriber recently emailed with just this question. He wrote:
“Are you able to suggest any allocation percentages of the companies or ETFs you suggest? I’d like a mix of high yield tier, safe income and dividend growth tiers. But what percentage of each would you suggest? 20%, 60%, and 20%? 25%, 50%, 25%? Some other combination?”
Obviously if I could give one answer that was right for him and everyone else, I would simply make those exact recommendations in the advisory. But in today’s Dividend School, I’ll try to give you some guidelines for figuring out what mix of my recommendations might work best for you.
Figuring Out Your Goals
While generating income is the defining goal of income investing, you most likely have other goals for your portfolio as well.
Many investors’ first or second priority is capital preservation, or safety. When we surveyed a large group of income investors in 2013, 49% ranked Safety (protection of capital) as their number one priority, above Income and Growth (capital appreciation). However, 65% of the same group of respondents classified their risk tolerance as “Medium,” defined as being “OK with occasional 10%–20% losses.”
Growth was also an important goal. Most investors want or need to see the overall value of their portfolio increase over time. In Cabot Dividend Investor, we focus on a very long, multi-year time horizon for making that happen.
Then there’s income: getting regular income from your portfolio allows you to fund ordinary expenses with your investments, without having to sell holdings when you need cash. I keep two types of income in mind when choosing recommendations: current income and future income. High yielding investments generate the best current income, while investments with the highest Dividend Growth scores should grow to become your biggest income generators in the future.
Knowing your risk tolerance, your growth expectations and your current and future income needs and wants is the first step to creating an income portfolio that works for you.
I can’t tell you what those are; you have to figure it out for yourself. Some of the answers will be defined by your gut feeling: how do you feel when you lose 20% on a position that makes up 5% of your portfolio? What if you lose 5% on a position that makes up 10% of your portfolio? Also try to go beyond your feelings and ask yourself how various types of losses would actually affect your current living situation, investing situation and income.
Other answers will be defined by your circumstances. How many other sources of income do you have or expect to have when you retire? What are your living expenses? Do you expect them to increase or decrease in the future?
You might be tempted to stretch for the maximum amount of everything—the safest, highest-yielding, highest growth potential investment!—but trying to excel in all areas at once is likely to lead to mediocre performance.
Putting It All Together
Once you’ve figured out your priorities, you can start crafting a portfolio that meets your goals.
Yield is an easy number to use to figure out if your portfolio will meet your income needs. If you know you need to draw 4% of your principal for ordinary expenses every year, try to find a combination of investments that generates a yield on cost of 4% or greater. That could mean focusing on investments that yield between 3% and 5%, or balancing some of the safer, lower-yielding investments in the Safe Income tier with a couple of higher-risk double-digit yielding investments from the High Yield tier.
If future income is important to you as well, either because you’re anticipating retirement or simply because you expect your demands on your investment income to be higher in the future, then you should focus on securing a growing income stream now by buying recommendations with the highest Dividend Growth ratings. These can be in any tier of our portfolio, but all the Dividend Growth tier recommendations are good candidates. If you focus on investments with the highest Dividend Growth ratings, your current yield may not be as high, but you’ll reap the benefits down the road.
I don’t provide numerical ratings for growth potential or risk, but you can assess both by reading my recommendations. Keep the big picture in mind when assessing risk and growth potential. An investment that is too risky to make up a large portion of your portfolio might be okay as a half position with a stop loss. Likewise, you will probably want a mix of stable, low-beta investments and higher-growth-potential investments to create the best balance of risk and reward—just be sure to monitor and adjust the overall mix if necessary. If you sell a boring utility, don’t replace it with an exciting tech company, unless you’re prepared to make your portfolio more aggressive overall.
And remember, you can always email me with questions.