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They say the hardest lessons in life are learned through experience. Well let’s just say a 38.6% loss in about a month is a lot of “experience”.
On November 6, 2015, and December 1, 2015, I purchased shares of a stock that was yielding 8-9% and was guiding annual dividend growth of 6-10% for the next few years. The company had a wide moat and a long dividend streak.
⭐ Find dividend growth stocks that have survived multiple recessions and increased dividends for 5, 10, 25+ years in a row.
Unlike other companies that typically increase their dividend once a year, they’d started increasing dividends every quarter. I got in after the 7th consecutive quarterly dividend increase.
Sounds like every dividend growth investor’s dream, right?
Not so fast …
A week after my 2nd purchase they cut the dividend 75% and I sold the stock; Kinder Morgan Inc. (NYSE:KMI), for a 38.6% loss.
Source: https://ir.kindermorgan.com/dividend-history
Here are the 6th and 7th lessons I learned in the fourth part of this 5-part series covering the “8 Lessons I Learned from One of My Worst Dividend Growth Investments” …
You can check out the other lessons here:
- Lesson 1 & 2: Maintaining an “Investment Grade” Credit Rating Matters & Financial Strength Should Never Be Overlooked
- Lesson 3 & 4: Don’t Trust Management If the Numbers Don’t Make Sense & Never Ignore the Payout Ratio
- Lesson 5: When the Dividend Yield Gets Really High, It’s A Warning Sign That A Dividend Cut May Be Coming.
- Lesson 8: Know Yourself, Make A Plan and Be Patient
Lesson 6: Diversification & Asset Allocation Matter
The Kinder Morgan shares I purchased represented roughly 2.5% of my portfolio.
By having a diversified portfolio and not putting all my eggs in one basket I was able to avoid a crippling loss. Yes, a 38.6% loss in a month sucks, but it could have been way worse if I had a more concentrated portfolio.
There are some that argue that it’s better to have a concentrated portfolio, but for me, it’s not.
Warren Buffett, one of the most successful investors of all time, said
“Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.”
Here’s the thing … compared to Warren Buffett, I don’t know what I’m doing. And no offence, you probably don’t too.
Warren Buffett is a very smart man who for decades has spent most of his time reading and learning about investing. We’ll never be as knowledgeable or experienced as Warren Buffett.
And even if you do know what you are doing, it doesn’t mean you’ll actually do it.
After all, you are an emotional human being. If you made rational decisions all the time, behavioural finance wouldn’t exist.
Benjamin Graham, who is known as the father of value investing and was one of Warren Buffett’s professors at Columbia Business School, said it best:
“The investor’s chief problem – and even his worst enemy – is likely to be himself”
Source: The Intelligent Investor (AL). Warren Buffett has said that this is “By far the best book on investing ever written.”
So even if you do know what you are doing, odds are you’ll make mistakes along the way. Diversification and asset allocation are a way to protect yourself during these times.
How many stocks should you own?
Somewhere around 30 … but make sure you have a good mix of different companies in different industries.
“The volatility-reduction effect of diversifying a portfolio has been studied by academics. Evans and Archer found that about 90% of the maximum benefit was achieved using a portfolio of twelve to eighteen stocks. That study was undertaken in 1968, when there were far fewer issues. In 1987 Meir Statman published work that indicated that a well-diversified portfolio must contain at least thirty stocks. To some extent the number of stocks you hold will depend on your comfort level and your ability to both find and follow suitable holdings.”
Source: The Single Best Investment: Creating Wealth with Dividend Growth by Lowell Miller (AL. Emphasis added)
Lesson 7: Don’t forget income allocation too!
While it’s important to pay attention to the number of stocks you have, you also want to monitor the amount of income each investment pays.
Let’s look at an example …
You can see that if the stock that eliminated the dividend entirely represented 5% of your portfolio’s income before-hand you still end up with 1% more dividend income at the end of the year. This is because the other stocks in the portfolio increased their dividends enough to offset the 1 stock that eliminated its dividend.
If the one eliminating stock paid 20% of your portfolio’s dividends then you’d suffer a 15% drop in dividend income by the end of the year.
If your goal, like mine, is a reliable and growing stream of dividend income, then don’t forget income allocation.
Odds are that one or more of your stocks will cut or eliminate the dividend at one point. If you limit how much income each stock pays you, then this doesn’t have to have a large impact on an income source that you are relying on.
Summary
The 6th and 7th lessons I learned in this 5-part series covering the “8 Lessons I Learned from One of My Worst Dividend Growth Investments” were …
Lesson 6: Diversification & Asset Allocation Matter
By having a diversified portfolio and not putting all my eggs in one basket I was able to avoid a crippling loss. Yes, a 38.6% loss in a month sucks, but it could have been way worse if I had a more concentrated portfolio.
Even if you do know what you are doing, odds are you’ll make mistakes along the way. Diversification and asset allocation are a way to protect yourself during these times.
Avoid a concentrated portfolio and try to have around 30 stocks in different industries to take advantage of the volatility-reduction effect of a diversified portfolio.
Lesson 7: Don’t forget income allocation too!
While it’s important to pay attention to the number of stocks you have, you also want to monitor the amount of income each investment pays.
Odds are that one or more of your stocks will cut or eliminate the dividend at one point. If you limit how much income each stock pays you, then this doesn’t have to have a large impact on an income source that you are relying on.
For example, if a stock paid 5% of your portfolio income and then eliminated its dividend entirely, you could end up with 1% more dividend income at the end of the year if the other stocks in your portfolio increased their dividend 6%.
The Other Lessons
They say the hardest lessons in life are learned through experience. A 38.6% loss in about a month is a lot of “experience”, and that means a lot of lessons.
In fact, too many for just one article, so you’ll have to check out the other 4 articles in this 5-part series for the rest of the lessons.
- Lesson 1 & 2: Maintaining an “Investment Grade” Credit Rating Matters & Financial Strength Should Never Be Overlooked
- Lesson 3 & 4: Don’t Trust Management If the Numbers Don’t Make Sense & Never Ignore the Payout Ratio
- Lesson 5: When the Dividend Yield Gets Really High, It’s A Warning Sign That A Dividend Cut May Be Coming.
- Lesson 8: Know Yourself, Make A Plan and Be Patient
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