Diversification! Asset Allocation! Risk!
I don’t know about you, but these words get the acid in my tummy tumbling! Finding answers that provide the foundation for a secure portfolio is not easy. MBA’s and PhD’s will have all sorts of warnings and recommendations, but few can offer practical advice on sizing a portfolio. That’s where the Dividend System™ welcomes Occam’s Razor: The simplest answer is usually the right answer.
To get to the right answer for sizing a portfolio depends on these factors:
- The largest amount of gains in your portfolio are from the fewest number of shares
- The amount of time you are willing to devote to stock research
- The amount of risk you are willing to take
As the model dividend investor that you no doubt are, we will get right to the point. You’ve got to minimize the number of shares in your portfolio, limit the amount of your time devoted to research, and minimize your risk of loss. Therefore, here are the recommendations in the chart below:
The minimum number of different stocks you should have is 20, and that’s the absolute minimum. Twenty-five (25) stocks is the ideal, with 30 being the upper most limit should you have more time on your hands to research the particulars of any stock.
To further reduce risk, the Dividend System™ recommends that 50% of your portfolio be devoted to stocks with a record of 25 or more years of paying increasing dividends, commonly called “Aristocrats.” This will reduce the beta of your portfolio, as the Aristocrats typically have betas lower than 1.0.
The Aristocrats tend to be mature companies with wide moats, stable and steadily increasing revenues, but not usually at huge growth rates. So to give the typical portfolio exposure to companies still in a growth phase, the Dividend System assigns 30% of a portfolio to stocks with a record of rising dividend payments for 9 to 24 years; these companies are commonly called “Contenders.” These companies are not yet considered “mature” by dividend investors, as they may still have higher PE’s representing the market’s expectation of further growth. Regardless, their moats may not be as secure, so the Contenders are a bit riskier, have higher betas, and because of the higher risk, it’s wise to limit the amount of Contenders in one’s portfolio. That’s why we have higher requirements for Contenders to be included in Dividend System portfolios.
Finally, depending on one’s age, we still want to have some big growth opportunities in our portfolios, so we allocate 20% to stocks that have increased their dividends for 7-8 years in a row, and these companies are commonly called “Challengers.” These companies are poised to make it from Challenger, through Contender standing, all the way into the Aristocrats. As Challengers carry higher risk due to their short record of dividend payments, these stocks have the highest requirements for entry into our portfolios.
Your portfolio, to resist risk, should have no fewer than 20 different stocks, ideally 25, and up to 30 stocks if you have a lot of time on your hands.
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