My Dividend Portfolio Allocation Strategy

I view dividend stock investing as something similar to growing a tree: you initially plant a seedling and do your part by providing it with a lot of care and nourishment. With time and patience, this little seedling will grow into a enormous tree that will eventually pay you back by providing fruits, flowers and also shade. Similarly, with dividend stocks, you simply need to invest in high-quality companies consistently and patiently and with time, through reinvested dividends and also dividend growth, the resulting compounding will blossom into a cash-generating machine that will serve you well for decades to follow.

In one of my earlier posts, I briefly touched upon entry criteria for selecting such companies. But how does one construct a dividend portfolio of such companies? That is the subject that I shall delve into in this post.

Before getting started though, I would like to state a few important background notes regarding my personal situation:

  • My dividend portfolio only represents a certain percentage of my overall investment portfolio (which also includes things such as my retirement accounts like 401(k), Roth IRAs and a HSA).
  • My general strategy is to max out contributions to my retirement accounts. Following that, I will use any remaining funds to invest in my dividend portfolio.
  • I follow a process of hybrid investing: wherein I stick to a mix of investing in low-cost index funds, low-cost ETFs in my retirement accounts and invest in individual dividend paying stocks in my taxable account.
  • I also have a very small percentage of my overall portfolio allocated to growth stocks.
  • For the purposes of reducing my overall taxes, I invest in REITs in only the tax-advantaged accounts (currently Roth IRA and HSA).

With all that out of the way, let me get into the crux of my allocation strategy for my dividend portfolio.

The general idea behind my allocation strategy is two-fold:

  1. Have enough upside such that when the broader market gains, my portfolio not just gains but beats the overall market.
  2. Have enough risk-tolerance such that when the broader market dips, my portfolio does not dip as much.

I attempt to achieve this through categorization based on certain aspects.

Categorization based on My Investment thesis

My general rule of thumb is that for every stock I own, I will have a brief one-pager document explaining the reason why I hold the stock and the associated risks. I refer to this as my investment thesis for the stock. With this in mind, I have categorized my allocation into four broad buckets:

  1. Core stocks: These are my sleep well at night stocks and represent the foundation of my portfolio. These are the classic blue-chip companies that have been around for decades and withstood several economic downturns and come out on top. These holdings offer a decent starting dividend yield but are not going to grow rapidly for the coming decades. However, they are still in the process of innovation and I am very confident that they will remain relevant during my lifetime.
  2. Growth-like stocks: These stocks are in a phase of aggressive growth at this stage. They are relatively younger in their dividend history in comparison to the Core stocks. Their starting yields might be much lower but they have substantially higher dividend growth rates and a lot of runway (in terms of dividend payout ratio) to increase their dividends.
  3. Bond-like stocks: I do not own bonds in this portfolio, but when it comes to de-risking my portfolio, I rely on these type of stocks. Some of these offer a relatively high-starting yield but they are very slow growers.
  4. Speculative stocks: These are the stocks that I have the least confidence in. This is either because of the nature of the sector they are in or because of mixed signals from the management about the commitment to long-term shareholders. I would generally have this as the smallest allocation in my portfolio.

In my view, this categorization provides long-term stability and future growth while also safeguarding against risk during an economic downturn. Each stock has a specific role to play and in conjunction with the other stocks in the portfolio, they form a team to play offense/defense whenever necessary.

Nothing about this categorization is set in stone as such and I may choose to move stocks from one category to another depending on changing trends. In general though, I will skew towards keeping the allocations for the first two buckets (Core and Growth-like) a lot more higher than the last two categories.

Categorization based on Sector

I have split up my allocation across different sectors in the following manner.

The allocation is a reflection of my investment style : very conservative/defensive with a low risk tolerance. I have the highest allocation towards the Consumer Staples & Retail sectors followed by Healthcare. This is mostly with the understanding that regardless of what happen in the stock market, the average consumer is still going to shop daily for consumer products that he/she will use on a day-to-day basis.

Likewise, the healthcare sector is always going to be forced to innovate to remain competitive. A crazy year when the world was grappling with the COVID-19 pandemic has been a testament to that theory. Furthermore, my wife is an engineer with a background in biotechnology, thus bringing this sector in her circle of competence. I have a sizeable allocation the Tech sector since I work as an engineer in the semiconductor industry and understand its intricacies fairly well. This follows my advice from one of my previous posts about investing in what you know.

The least allocation is towards the Energy sector which is mostly composed of Big Oil. While I think the oil industry is going to remain relevant for the remainder of my lifetime, I am also cognizant that there will be a greater push towards use of cleaner sources of energy for large scale infrastructure projects.

As stated before, I do not own REITs in this portfolio to save on taxes (since distributions from REITs are taxed as ordinary income per IRS regulations here in the US). Instead, I own REITs in my tax-advantaged retirement accounts. I will cover my REIT allocations in a future post.

Capital Allocation Strategy

My primary focus is to max out contributions to my retirement accounts for the calendar year. Once I have achieved this, I allocate a fixed amount for contribution towards my dividend portfolio each month. The broker I use (M1 Finance) does not have a traditional DRIP feature, where dividends can be reinvested back into the same stock. Instead, it provides an “auto-deposit” feature which can be used to purchase stocks automatically: generally M1’s algorithm attempts to buy stocks that are currently underweight in your portfolio based on your target allocation. I have mostly not used this feature since I want to be in complete control of what buy orders I am placing rather than rely on any algorithm.

I pool all the dividends that I have received along with any remaining capital and buy stocks that I think are the best value at any given moment. Also, to remove any emotion out of the picture and to ensure that I am consistently dollar-cost averaging into all my holdings, I have a spreadsheet setup that tells me the number of days (configurable for each category of holding) that have elapsed since my last purchase on any given stock. I call these as “staying in the game” purchases, as these purchases are typically for a small dollar amount where the valuation of the stock is not as important.

Dividend Portfolio Revealed

At the time of writing this post, my dividend portfolio contains the following holdings.

Here is an alternative view of the portfolio in a treemap format.

At the time of writing this post, there are reports that AT&T will be cutting their dividend following a spin-off of WarnerMedia and merging it with Discovery. I am planning to continue holding my AT&T shares for now but this reinforces my original thesis of why I put this holding in the “speculative” bucket. Thankfully, I have enough safeguards in my portfolio due to diversification to protect myself against this news.

I am fairly happy with the number of holdings I have in my portfolio (31 at present). Generally, I am not as much focused on this number itself. But I would like to keep this to a manageable number since it would be very difficult to track several companies and periodically research them.

In some future posts, I will dive into the reasons why I hold each of the above stocks.

Summary

So there you go! That is my portfolio allocation strategy and my portfolio. I would love to hear your thoughts on this subject. How have you constructed your portfolio? Do you diversify across sectors like I do? Please let me know in your comments below.

Happy Investing!

2 thoughts on “My Dividend Portfolio Allocation Strategy

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