How to Quickly Manage Your Diversification

The following is an excerpt from Dividend Growth: Freedom Through Passive Income.

Dividend investing can be appealing as it doesn’t require you to check your portfolio every week. However, the trick is that you still need to manage your portfolio once it is built and make sure that you are not over- exposing your investments to specific risks.

In order to do so, I would suggest you use a sector distribution list to ensure that you don’t spend too much time on diversification so you don’t put yourself at risk.

One of the most important reasons why you should have bought this book is because you don’t have enough time to properly manage an active portfolio. Dividend investing can be appealing as it doesn’t require you to check your portfolio every week; however, the trick is that you still need to manage your portfolio once it is built and make sure that you are not over- exposing your investments to specific risks.

In order to do so, I would suggest you use two methods to ensure that you don’t spend too much time on diversification and don’t put yourself at risk.

Make a Sector Distribution List

The first thing to do before building your portfolio is to identify the sector that you want to invest in. I’ve showed you how to determine great stocks regardless of their industry, now you will do the opposite: you will look at all of the sectors and then select the one you want in your portfolio. Then, you will be able to go back to your stocks on the radar list and pick the one that fit your sector needs.

Think of selecting sectors that should do well in the future and pick strong dividend payers in each of them. This way, although you might be wrong on the sector, you will own the “best” stocks in each industry. Concentrating on one sector (such as energy, financials or telecoms) will create greater fluctuations in your portfolio. Depending on what you are looking for (growth, steady income, etc.), you may classify your sector like this. Growth sectors will offer greater capital gains potential, but you will have to be ready to ride higher fluctuations as well. Steady income sectors will provide a nice steady dividend, but might not be the sexiest investment options. Here’s a quick review of each US sector (I used sector description from Bloomberg).

• Basic Materials: If you are looking for dividend-payers, you might forget about basic materials right away. Historically, those companies don’t pay much dividends since they need their cash flow to invest in new mines and productions. Only a few stocks pay over 3% in dividend in this sector. Among them, you find Southern Copper (SCCO), Du Pont (DD) and Nucor (NUE).


• Communications: The telecoms and internet providers are among the most generous dividend-payers. You just have to think of both giants AT&T (T) and Verizon (VZ) paying over 5% in dividend yield. This is a sector where you can find huge companies that are well-established and decide to distribute a generous dividend. Across all sectors, they are part of the top three in highest dividend yield.


• Consumer, Cyclical: Considering we’ve had such a volatile economy I’m not sure I would invest a lot of money into cyclical industries. They are generally not super generous in term of dividend yield either. However, a few interesting stocks are worth mentioning: Wal-Mart (WMT) with a low dividend yield but always increasing, Hasbro (HAS), and Darden’s Restaurants (DRI) are also interesting.


• Consumer, Non-cyclical: Often seen as one of the ultimate defensive sectors, consumer non-cyclical stocks are usually showing lower dividend yield (such as KO, CL, DPS, TAP), but great and diversified companies. You also find the high dividend-paying, but controversial tobacco companies. You shouldn’t expect much growth form this sector, but it’s a great place to pick a few solid stocks.


• Energy: The energy sector in US is not known for high-paying dividend stocks. Once you have looked at a few exceptions (such as CVX& COP), you are down to pick stocks giving 1% or 2% dividend. This is definitely a sector where you would gain to look north of the border and get a few Canadian companies.


• Financials: After everything that happened in 2008, several investors are having cold feet before buying financials. As you can see in the previous quadrant analysis, AFL and BLK are showing strong metrics too. Dividend metrics are not at their best yet, but there is still room here. REITs might be an interesting sector too along with… Canadian Banks! Obviously.


• Industrial: There are a lot of huge companies that are spread around the world in this category (such as MMM and CAT). Defense and Aerospace (LMT & GD for example) offer great dividend yields as well. Mind you, industrial sector will follow major economic trends as most companies don’t upgrade their equipment during recessions.


• Technology: This is definitely one of my favorite sectors. Recently in 2012, companies such as Apple started paying dividends. They could become an interesting addition to a great pool of stocks already (INTC, HRS, GMRN, STX, MSFT, etc). While technology evolves very fast, there are a lot of companies that kept huge liquidity in money market funds. They represent one of the most sustainable dividend sectors in the overall market.


• Utilities: This is the realm of steady and high dividend yields. In this sector, it’s not hard to find a 4% dividend stock (there are also a few great 5% stocks too!). The utility sector is known to maintain dividend payout ratio around 50% (electricity) and 60%-70% (water) and it is useful to follow those guidelines. This sector will bring stability and push your overall portfolio dividend yield higher.

How Can You Manage Portfolio Diversification Efficiently

There are several tools to help you manage your portfolio efficiently without losing too much time on diversification. For example, you can calculate and manage the beta of your portfolio. To learn more, check out Dividend Growth: Freedom Through Passive Income.

Comments

[Old Limey]

Diversification is essential which is why I gave up buying individual stocks very early in my investing life. A managed mutual fund typically owns hundreds of companies and has a team of analysts that do all the research needed to zero in on the best companies to buy.

However, my investment success did not come from buying and holding an assortment of mutual funds representing a broad base of many of the available sectors.

Instead I used ranking software to purchase 4 or 5 funds that represented the sectors that were currently the best performers based upon several short term time periods. I would then follow those funds on a daily basis and when a fund violated the parameters of indicators that I was using, I would immediately sell it and do a search for a replacement. In my early days of investing I used the Fidlity Selects which is a 42 fund family where each fund holds a selection of companies in a particular sector. During the dot.com bubble it was even easier, I just chose 4 or 5 funds that were great performers and held emerging growth companies that were prospering in the emergence of the Internet. It was quite rare for me to hold a fund for as long as 6 months.

I also used to do a post-mortem on each trade that I made. It helped me later on to refine my ranking and fund selection techniques.