Tweaking my dividend growth strategy in my taxable account

 

I’ve been making a few changes in the overall structuring of my investments recently. Not dramatic changes, but more a change of emphasis in relative weightings. My taxable account strategy has been something that I’ve been mulling over the last few weeks. I think I’ve further solidified my approach going forward. 

 

Current Investment Strategy 

Regular readers who have been familiar with the Integrator $50k fund and my interest in getting to an annual dividend income stream of $50k by 2018 know that dividend investing has been my strategy of choice for many years. Dividend investing provides both income and wealth. The mechanics of ever increasing dividends, progressively higher yields and stock price appreciation provides a pathway for sustained long term stock price appreciation.

Dividend investing has worked pretty well for me over the years. It’s allowed me to comfortably outperform my benchmark index. I’ve determined that I generated a total return of close to 12.5%  over my decade long period of investing in dividend stocks.

My progress toward $50k/ yr in dividends is making good progress. The portfolio is on track to throw off $27k annually in dividends in 2013. Natural growth in dividend increases plus some net new investments in dividend generating stocks from surplus income will see this progressively tick higher over the coming years

So if things have been working so well, is there really a need to tweak my strategy and consider changes?

Recent Changes in thinking and approach

I’ve come to realize that dividend investing is one arrow in my quiver on the path to financial independence. Without doubt it’s my dominant approach and my main pathway to financial independence. It’s been increasingly occurring to me that there are a multiple set of asset classes and financial factors that impact overall my overall financial health.

Low cost index investing in my 401k

Our tax expense is a big factor, no doubt about it. In general, I don’t think we spend enough time planning around taxation and the impacts that it has on our after tax situation. I also realized recently that a more tax effective approach to investing could increase our asset position by almost $500,000 by the time we come to tap into the assets needed to support a financially independent lifestyle.

It was on this basis that I decided that we will be maxing out our 401k’s and contributing in excess of our contribution to get the company match. The net result will be investing almost $35k annually in our low cost US large cap index fund.

The same reasons that I’ve enjoyed investing in Dividend Classic payers is the same reason I’m looking to have my 401k money directed into Large Cap stocks that mirror the S&P 500 index. These companies provide steady earnings growth, generally have strong economic moats and are fairly stable. Sure my 401k index fund isn’t as attractive as holding dividend classic payers. But it’s low cost (I pay something like $0.21 in fees for every $1000 in balance) and helps shield my tax expense.

A new rental property

My wife and I have decided that we will try our hands at being landlords!

This is going to happen as a result of us looking to upgrade our existing place to a large house and retain our current condo which we’ll basically own outright sometime next year. In general, I’m not in love with the idea of being a landlord. It requires a lot of work, and careful screening of tenants.

Property repairs can be a money pit if you have a particularly old place. Our condo is almost brand new. We bought it close to 3 years ago. Given this, we feel that running repairs should be pretty minimal for at least the next 4-5 years. We’ll keep the rental till for a 4-5 yr period, use the cashflow to accelerate repayments of the mortgage on our yet to be purchased new place, and likely sell it off after 4-5 years.

Venture Fund Activity

As some of you may also recall, I’ve started up my own venture fund. The Venture Fund is my attempt to look at some very early stage plays that have good prospects for considerable wealth accumulation and disruption.

Given these investments are very early stage and inherently risk, I’ve got a total cap of about 3-5% of my total portfolio in this asset class. My Venture Fund is currently fully invested. I’m looking forward to seeing how the investments in the fund play out over time.

So you can see, I’m planning to have a few bows in my quiver to strike my goal of financial independence. In spite of all of the above initiatives. my wife and I expect we’ll still have some surplus capital left over that will make it’s way into my taxable account.

What’s my taxable account strategy going forward ?

Undervalued large cap dividend payers

My dividend strategy has been pretty successful thus far, and I don’t see any material reason to change it. A good chunk of my excess cash flow is going to continue to make it’s way into dividend paying stocks in my taxable account.

While I may not be able to be as aggressive on my path to $50k/yr in dividends by 2018, my aim is to still try and get there, even if it takes a few extra years.  I won’t be making any significant changes in my Australian taxable dividend portfolio. That will continue to run on autopilot mode.

I’m going to continue with my existing large cap divided paying stocks in my US portfolio. Purchases will continue to be of the same vein that I’ve been making, such as recent purchases in Coca Cola and McDonalds. The main difference will be that I’ll only be adding materially undervalued large cap dividend payers, rather than accumulating large caps at a fair price.

This will probably mean more purchases like my recent large buy of BP, rather than accumulating more Coca Cola and McDonalds at current prices. This is primarily because I’ll be acquiring these large cap payors indirectly through my US large cap index fund anyway.

Given elevated market pricing, it’s possible that there may not be many major large cap dividend purchases over the next few months, but I’ll be actively on the lookout for anything that can be added. Cisco is a company that is active on my current watchlist.

Emphasis toward mid cap and small cap dividend accumulation

This has been a area of active interest for me in my Australian taxable dividend portfolio, but I now want to make this an area of explicit focus in my US taxable account. The great thing about having a very strong core is some freedom to experiment in the periphery.

Having a Venture Fund is only possible because I have a core backbone of high quality large caps that are stable, predictable growers. I’d like to be able to unearth more small cap and mid cap dividend payers of the likes of Female Health Company and United Guardian. While I had some modest luck trying to unearth promising small cap dividend payers for my US portfolio, there are a number of promising mid cap dividend payers in the $1-$10B range such as Resmed that I’m going to spend more time discovering and investing in over time

Aggressive Growth Positions with smaller yields or no dividends

The strong revenue and earnings growth of companies such as Medidata Solutions (MDSO) in my portfolio have got me thinking  more seriously about making investments in strongly growing mid cap stocks with rapid earnings growth. The reality is that some of these positions won’t be paying dividends given the stage of growth that they are in.

They are too busy reinvesting their earnings back into their business, where they will experience much higher returns on capital, rather than paying them out to shareholders. Even though the companies are small, they are still carving out defensible competitive positions or first mover advantages in high growth niches. Mercadolibre is another example of a business that I like that fits into this category (albeit that it pays a small dividend).

Takeaways

As I mentioned, there are a variety of pathways to look at getting to financial independence. They are all like different arrows in your quiver of which can all help  to strike FI.

Some pathways may be more consistent, some may be more volatile, but pursuing different options gives you a greater likelihhod of achieving the end goal.

I’m not planning major wholesale changes to what’s currently in my US taxable account, but I expect that the range of investments and what’s in there will broaden out over time, more so than what’s been seen to date. I’ll be using my taxable account more effectively as another arrow in my quiver to achieve early financial independence.

 

Comments

  1. Looks pretty good and gave me a few thoughts/ideas:

    1) Love the idea of using the condo as a rental property for generating some additional cash flow while continuing to pay down your two mortgages.
    2) Interesting you made the BP reference as an undervalued position (in addition to CSCO) as you just trimmed your position recently.
    3) I think given the size of your core portfolio and existing dividend generation, diversifying into the VC fund, small and mid-cap dividend stocks, as well as a sprinkling of growth positions is a great idea for you and your family. A couple of big wins in these smaller companies can really accelerate the rate of return of the overall portfolio.

    Hope all is well Integrator!

    • Integrator says:

      Thanks for the comment W2R.

      I still believe BP is pretty undervalued. I made the comment more as an indication of the type of large cap plays that i’d likely chase going forward. I won’t be looking to add to my BP stake any further at this stage (particularly after having just recently trimmed it), It’s close to one of the largest current positions in my portfolio, but if I could find “another BP” in the large caps I’d likely want to add this to the portfolio. I just don’t see many of these type of candidates right now.

  2. I’d been thinking about starting to add in some growth stocks as well but doing like you and limiting it to a small total position. It’s not exactly the worst thing to have a few companies that you get to root for. It’s kind of like being a fan of the New York Yankees (KO, PG, JNJ…) in the late 1990′s (well do we win the world series or make the world series) rather than the Florida Marlins around 2000 (lowest payroll, no expectations and BAM! win the World Series). I can tell you one is more fun than the other. Is there a chance you can bring on a property manager for the condo or are you wanting to make sure the new house is paid off before eventually calling it quits?

    • Integrator says:

      I came to the realization that my ultimate goal was to get to FI as soon as possible. Dividends have been my chosen path thus far, but that’s not to say other pathways couldn’t play a role. I think if anything, small and mid size companies are probably the most likely to help get there. I do see some promising mid caps, they don’t pay dividends, but generate tremendous value and returns, and share price appreciation. I think I definitely need to be a bit more proactive about selectively adding them into my taxable account and seeing how they perform. Being conscious of their risk and setting portfolio limits is a good way to limit downside exposure. Btw, your analogy kinda reminded me of the book/movie “Moneyball”. I think it’s very true though, potentially low undiscovered companies flying under the rader with 2-3x return compared to their more fancy large cap counterparts!

      On the property, I’d be open to having a property manager manage the place.. I think they take about 5-6% of gross rent per month. We’d have to carefully run the numbers, but it may be worth it to avoid the disturbances that we’d have otherwise.

  3. Moneycone says:

    Just like dividends have a snowballing effect, taxes have a snowballing effect too – that’s how I think of dividend paying stocks in taxable accounts! Unfortunately, we only have limited space in retirement accounts and have to manage as best we can in taxable accounts. Optimizing investments in taxable accounts is just prudent.

    I enjoyed the post.

    • Integrator says:

      It can be hard to see the tax leakage because it’s not something that most of us consciously focus on. Tally it up over a lifetime, with some assumptions on how you may have otherwise been able to grow that money and it’s a big, big deal.

  4. If there is one piece of advice I can give for being a landlord….
    Get a property manager.
    I have a great one that charges 10%. Its a no brainer imo to pay someone that much to make all the problems go away.
    No 1:00 AM calls about a broken and leaking water heater.
    No calls about something wrong when you are on vacation.
    No hassle with late rent
    No background checks and finding a new tenant.

    • Integrator says:

      I do like the simplicity of being able to work through a property manager, particularly to deal with all the administrative hassles that will undoubtedly come up from time to time. Making sure the tenant can pay the bills on time and doing the background reference checks right would be well worth the money invested.

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