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Like so many investors who actively invest in dividend stocks that have a very long track record, I got really burned in the this most recent market downturn. I was lured into the perceived safety of long term dividend growth stocks – especially when it came to financial and banking stocks. For example, at my peak I held shares in the following banks and financial stocks: Citigroup, Bank of America, Royal Bank of Canada, IGM Financial, and U.S. Bancorp. This got me into trouble and highlighted a major problem with dividend investing.[ad#tdg-embedded]
The problem I am speaking about is one that plagues all investors who takes an active approach to their portfolio and invests in individual stocks. The issue is ensuring adequate diversification. Even as an investor who built a core portfolio of index ETFs and then only supplements with dividend stocks, I took on a larger loss than I perhaps should have because my individual stocks were much too concentrated in the banks.
How did I get to have this problem. As I look back on it, it really is quite simple. Some of the longest standing dividend payers and dividend growers were Citigroup and Bank of America and I was buying into that strong yield and strong growth. As a dividend investor, this is what we are really trying to do – achieve that fantastic long term growth that comes from a growing dividend. This lured me into a false sense of security in these securities and I got burned.
I have learned a strong lesson from this. I am still investing in individual dividend growth stocks, however I am ensuring much more diversification. True to my investing code, I sold the stocks that cut their dividends (U.S. Bancorp, Citigroup, Bank of America) and have focused those funds on ensuring overall good diversification in my portfolio. I also pledge to never hold more than 2 stocks of any one industry in my portfolio, much preferring to hold only one. I hope this will help my portfolio grow in the future and will shield me from dramatic problems in one given industry. Time will tell.
No, this is wrong! If they’ve cut their dividends, and you sold afterwards, you already missed your selling chance, and you know this. You bought HIGH, and sold LOW!
Bank of America especially, theirs will come back, the only reason it’s so low is because of TARP requirements. Buying at today’s prices will yield tremendously in the future, and once the market figures it out, you’re going to miss your chance all over again.
What happened with Royal Bank? Did they recently cut the dividend?
I must have missed that one.
It seems like it is a double edged sword though, either you diversify in the same industry or you are more dependent on one stocks fortunes. I think you are likely making a wise choice as long as that means you are more selective and only pick your best companies that you have confidence. I think Buffett said it best;
“I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches – representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all. Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do so much better.”
Though I require good dividend stocks for my portfolio, I never touched financial stocks because I just didn’t trust their numbers, plus I stay away from any company with lots of debt. Sure, banks, etc deal with debt, but is just is not a product which I think is worthy for investment. Take a company like Kimberly Clark (KMB). As long as people pee, poop and sneeze, they will do fine, with leading brands in all those categories. There simply is no reason at all to look at financial companies, with many other stocks available, too, which deal in products, with top notch brands, like PEP, KO, KFT, PG, MMM which I own. I also have SYY and ADP, service companies but tops in their fields, with little debt and sterling balance sheets. Also, I have BMY, about as risky as I want, but with tons of cash and a high dividend.
Actually, having only one stock per industry leaves you at more risk than having three or four. If you get a dividend cut, that leaves you with much more exposure percentage-wise.
Look at it this way: you need 30-40 stocks to be fully diversified. There are six major industries (tech, nat resources, financials, consumer, industrials and health care). Keep 5-7 in each and you’ll get better diversification.
Your big mistake in financials was owning only banks, which are highly correlated. You could have owned a bank, an asset manager, an insurer, etc. to protect yourself.
Thanks for sharing a learning opportunity with us!
Mike
I’m reaching the conclusion that very long term buy and hold is only feasible if investing via broad funds like ETFs, otherwise the chances of particular companies or sectors blowing up is too great.
This doesn’t mean you need to sell every six months or whatever, but I think you do have to review active stock picks regularly.
Re: The financials, did you look at the exposure you were already getting via the ETFs? The UK stock market as a comparison was at one point something like 25% dependent (from memory) on financials for its dividend payout.
Matthew Waterman ,
Why hold on to a dividend cutter? You are HOPING that ONE DAY the dividend cutter MIGHT increase their dividends. When would that day come?
In the case of BAC, if you sold when they first cut their dividend in 2008 at $29-$30, you would have made a pretty smart decision. Financial stocks are full of surprises. I wouldn’t touch them with a ten foot pole. There’s so much preferred shares issued by financial institutions, and so many shares which are going to be issued and would dillute existing shareholders, that reaching the old level at 0.64/share/quarter would take decades..