Other Voices: Managing Risk In A Frothy Market

Income expert Tim Plaehn details how is managing risk in his income portfolio in a frothy market

By Tim Plaehn,

This instablog post comes from Tim Plaehn, expert on income investing and a friend & colleague of mine at Investors Alley as well as a contributor here on SeekingAlpha. Tim runs the Dividend Hunter newsletter which offers a solid & diverse selection of attractive high yield plays. The service now has over 7,500 active subscribers and can be had HERE for the rock bottom price of $49 (It usually is $99) for the first year. There are few better bargains around for those looking for solid income plays to balance their high beta holdings especially when equities get volatile!

When it comes to planning the management of your portfolio of high yield stocks, I constantly strive to make Dividend Hunter a more useful service. Many of the same techniques can be applied to your own income portfolio, even if you’re not a Dividend Hunter reader.

The stocks on the Dividend Hunter recommendations list come with a wide range of potential rewards and risks. With dividend stocks, the rewards—dividend payments providing an attractive yield—are easy to see as long as you’re tracking them. The risks—primarily coming in the form of possible dividend reductions—are much harder to envision or predict.

The number of dividend increases since I launched Dividend Hunter in 2014 from companies on the recommendations list number in the dozens, pushing triple digits. However, these increases are incremental, while the handful of dividend cuts have been deeper and more dramatic.

I watch company financial results closely, with a focus on cash flow generation to cover the dividends. However, these are high-yield stocks, where most of the free cash flow is paid out to investors. An unexpected business disruption can and sometimes does lead to a dividend cut.

To minimize the effects of dividend cuts, and to reap the benefits of dividend increases, I have long recommended the following simple portfolio management strategies:

  1. Strive to own a balanced dollar amount of all the recommended Dividend Hunter stocks.
  2. Track your dividend income as the primary metric of income focused investment success.
  3. Reinvest at least a portion of your dividend income to build a growing income stream and to buy shares when they go on sale.

For 2019, I have been providing more detailed portfolio management strategies to my Dividend Hunter readers. The goal is to provide more tools to help build an income focused portfolio with a stronger understanding of the risk level of investment decisions.

My first step was to divide the recommendations list into three categories:

  • Conservative Dividend Stocks: These have higher levels of safety for the dividend payments and good potential for dividend growth.
  • Aggressive High Yield Stocks: These are the stocks with very high current yields, but a greater risk of dividend reductions.
  • Fixed Income Investments: These are preferred stock and bond investments where the yields are determined by market interest rates and not business results.

The next step is yours.

First, try putting each of your holdings into one of the three categories above.

Second, determine how you want to allocate your investment portfolio, with a focus on the level of risk you can live with. For example, for some investors a conservative approach would be 50% into Conservative Dividend Stocks, and remainder (25% each) into the Aggressive High Yield Stocks and the Fixed Income Investments.

Your risk tolerance and investing timeline may be different and therefore your allocations may vary from the above example.

My goal is to have you understand that the stocks on your Aggressive High Yield list are the ones where any future dividend reductions will likely occur. If you put the bulk of your money into these stocks to chase the attractive double digit yields, you need to understand the potential for negative outcomes – i.e. dividend reductions.

If your goal is to have a portfolio that generates an attractive, sustainable income, think about going for a more balanced approach. The Aggressive stocks add some nice extra income spice to a portfolio, but the Conservative stocks already yield an attractive 7% (at least those in my Dividend Hunter portfolio) and will produce a growing income stream.

The Fixed Income group is the most conservative and the recommendations that I view as the “rainy day fund” portion of the portfolio.

You can set your portfolio percentage now and either sell and buy shares to get to those percentage, or you can go with a longer term approach, by reinvesting dividends to get to your target percentages.

Comments


Bret Jensen
EditorBret Jensen
Bret Jensen
EditorBret Jensen
Bret Jensen
EditorBret Jensen
New Comment
Bret Jensen
EditorBret Jensen
New Comment
Bret Jensen
EditorBret Jensen
New Comment
alexandra
Editoralexandra
New Comment
1
Bret Jensen
EditorBret Jensen
New Comment
1
alexandra
Editoralexandra
New Comment