11/2/08

Buy and Hold Forever Dividend Stock Portfolio

This year's market turbulence has many investors calling the buy and hold strategy dead. Let's prove them wrong. My musings (here and here) on holding dividend paying stocks forever have inspired me to make a new, all dividend paying stock model portfolio.

It's composed of 43 stocks and one ETF, and is based on minimal research (more research is always better, but the goal here is to show how it doesn't take an investing maven to succeed with a relatively diversified dividend stock portfolio). Almost all the stocks were selected because they're household names that pay dividends. The other criterion was to take a couple of companies from every industry that came to mind, so that they wouldn't be clustered in one area, as most dividend ETFs are. As far as energy pipeline companies go, I took the two that I've been hearing the most about. As REITs are not really household names, the portfolio will have a REIT ETF instead of separate stocks.

Here's a list of companies by type (note that some companies may be classified in a number of ways that aren't shown here, and I might be leaving out a few--they're all in the spreadsheet though):

Aerospace/Defense
Boeing (BA)
United Technologies (UTX)

Alcohol
Anheuser Busch (BUD)
Diageo (DEO)

Banks/Credit Cards
American Express (AXP)
General Electric (GE)
US Bancorp (USB)
Wells Fargo (WFC)

Beverage/Snacks
Coca Cola (KO)
Pepsi (PEP)

Chemicals
Du Pont (DD)
Dow Chemical (DOW)

Communications
AT&T (T)
Verizon (VZ)

Diversified
3M (MMM)
General Electric (GE)
Siemens (SI)

Food
Campbell Soup (CPB)
Kraft (KFT)
McDonald's (MCD)
Yum! Brands (YUM)

Healthcare
Johnson & Johnson (JNJ)
Pfizer (PFE)
Sanofi-Aventis (SNY)

Household Goods
Church & Dwight (CHD)
Johnson & Johnson (JNJ)
Procter & Gamble (PG)

Insurance
AFLAC (AFL)
China Life Insurance (LFC)

Oil
Chevron (CVX)
Exxon Mobile (XOM)

Pipelines/Energy Transport
Enbridge (ENB)
Frontline (FRO)
Oneok Partners (OKS)
Overseas Shipholding (OSG)

Railroads
Burlington Northern (BNI)
Union Pacific (UNP)

Real Estate
Vanguard REIT Index (VNQ)

Retail/Consumer
3M (MMM)
Target (TGT)
Walmart (WMT)

Technology
Intel (INTC)
Microsoft (MSFT)

Tobacco
Altria (MO)
Philip Morris International (PM)

Utility
Con Ed (ED)
Duke Energy (DUK)

The portfolio will work as follows. Three hundred fifty dollars worth of each stock was purchased at the close on Friday 10/31/08. Fractional shares were purchased, as can be done with discount brokers like SogoTrade (for $3.00 a trade), with the commission of $3.50 a trade. So, this portfolio starts out with around $15,400 worth of stock, and a loss of $154 for the 44 trades.

As this is a buy and hold forever portfolio, no position will be sold, even if it stops paying dividends. If there is a spinoff (e.g., Target spins off a REIT or Procter & Gamble gives some shares of Smuckers as a dividend) any new stock will be added to the portfolio's holdings and the cost basis of the original stock will be reduced by the amount of the dividend (for example, when Altria spun off Philip Morris International, the spin off was worth $51.06 a share. Had this portfolio existed then, Philip Morris International would be added, and the cost basis of Altria would be reduced by $51.06 a share). If one of the stocks is bought out for cash (e.g., BUD), that cash will count as a dividend (even though it's a capital gain). That's the only way a stock can be sold in this portfolio. If a company in the portfolio is bought with stock, or if there is a merger, the new entity will replace the old in the portfolio. The idea is, buy the stocks and leave them alone. Just get the dividend checks.

Although I think all the stocks in the portfolio are good for the long haul (or else I wouldn't pick them), no doubt some of them (hopefully only a few) will go out of business, decrease, or suspend their dividends in the next few decades (a decrease at GE and probably PFE will come soon, but I think both companies will do well over the long term). Others, I'm sure, will do very well. Although I believe reinvesting dividends regularly boosts returns (e.g., just have your broker buy you more shares for free when the dividend comes in), for sake of ease dividends here will be reinvested once a year--or when the portfolio accumulates $353.50, whichever is later. Dividends will be reinvested in the companies either with the lowest payout ratios or the lowest yields (depending on how lazy I am).

Since I'm taking the minimal research approach, such a simple rule would work better than trying to decide which stock to reinvest in by doing research. Lowest payout ratio seems to be the better approach, but it involves more mouse clicks. Lower yields are easier to find out, but reinvesting in these stocks might make me buy them when they're too expensive. Higher dividend yields mean lower investor confidence, so it's best (not necessarily for capital gains purposes) to add new money to the stocks that are in the best shape. (This approach is the opposite of one I'd take with a diversified portfolio of index funds. It makes sense to add new money to the fund performing the worst, as this enables you to buy more shares when they're cheap and avoid buying shares of the funds that are doing better while they may be too expensive. As index funds are baskets of stocks and their composition changes over time, unless the financial system collapses these funds will not go to zero. Underperforming individual stocks can go to zero, however, so I'd like to avoid throwing new money at them.) Dividend reinvestment will not alter the cost basis.

Total return (capital gains + dividends) is always important. But because nothing will be sold in this portfolio, what I'm calling "Dividend Return" (dividends received divided by total invested and expressed as a percentage) will be the better measure. The portfolio will start out with a negative 1% return (that's the $154 spent on commissions).

The portfolio will be tracked in the spreadsheet below (also available for easier viewing here). The dividends received will be updated at the end of every month (probably over the weekend) here. For sake of ease, the ex-dividend dates will be used rather than the dates dividends are paid. Should a dividend not be paid after an ex-date, it will be subtracted from the portfolio.

Since all things are relative, the portfolio will be measured for total and dividend returns against the S&P 500, represented by the ETF SPY. Since buying SPY involves only $3.50 in commissions, it starts out with only a negative 0.02% return. Its dividends will be reinvested annually. When I get around to it, I might add the total bond ETF BND as a measure. Note that if the portfolio or SPY do reasonably well (at least 8% annualized total return) compared to CD rates, buy and hold is not dead. If the portfolio and SPY grow less than rates offered on CDs, (the highest 5 year CD rate I could find is 5.25%--I'll track these as time goes by), then I'll concede that buy and hold is dead.

Of course, this will take a few years.



Disclaimer: The above is for educational and entertainment purposes only. Do your homework before investing.

Disclosure: At the time of writing, I owned JNJ, PG, and PM. Some may ask, if all the above stocks are so great and you believe in buy and hold, why don't you own all of them? The bulk of my investments are in a target allocation mutual fund to which I contribute regularly without looking at the statement (that's so I don't stop contributing). Individual stocks are for play.

Update 11/3/08: I made an error with the ticker for American Express. I had AXM (America Movil) instead of AXP for some reason (carelessness). This has now been corrected.