If you haven’t read Parts 1 and 2 yet, then scroll back down my Blog Page a tiny bit and you should find them very easily.
Features of an ideal Dividend Stock
There are many aspects and features that make a particular Stock suitable for an Income Portfolio - the following spring to mind as things to consider:
On the ‘Funds’ page of this Website you can find some text explaining the differences between various Fund type Investments like Investment Trusts, Unit Trusts, ETFs, Tracker Funds etc. An Investment Trust is a Company that can be bought and sold just like any other Company that is Listed on the Stockmarket (in other words, there is no difference in the mechanism of buying an Investment Trust like European Assets Trust EAT or buying Shares in a ‘normal’ Company like Tesco PLC TSCO), but with the difference that it is in effect a Company that Invests in other Companies - i.e. it is a sort of Fund.
I do not currently hold any Investment Trusts in my own Income Portfolio but I think it would be perfectly good sense for someone to create an Income Portfolio which held some Investment Trusts. Theoretically it would be possible and quite straightforward to construct an Income Portfolio entirely from Investment Trusts and you could diversify along the Lines of Sector exposure, Geography, Investment Manager expertise, etc. Having said that, if you are aiming for an Income Portfolio with 12 Positions, then perhaps having 1 or 2 as Investment Trusts would make sense and something like the Edinburgh Investment Trust EDIN run by Mark Barnett (he also runs Neil Woodford’s old Unit Trust at InvescoPerpetual) would perhaps make a good ‘Core Holding’ kind of Bedrock thing.
Many Investment Trusts pay Dividend Yields up around 4% or so at the moment and I think adding something like this to an Income Portfolio would perhaps lower Risk and add to the Diversity - although obviously a lot of care needs to be taken in selecting the appropriate Stock (an Investment Trust is just another type of ‘Stock’). Perhaps a good idea is to buy an Investment Trust which invests in Bonds as it would be a completely different Asset Class - I am sure there are a few of these around.
Note John Baron who writes in Investors Chronicle (he is also a Tory MP but don’t let that put you off !!) runs several Portfolios made up from Investment Trusts - if you check out his writings you might get some good ideas from him. His Website is here although sadly much of it is Subscription Only (although the Investment Trusts he uses get listed in Investors Chronicle most weeks):
A critical thing to understand on Investment Trusts is their Discount or Premium to the Net Asset Value (NAV) of their Underlying Assets - ideally you want to buy when they are on a sizeable Discount but as always care is needed (and obviously when the Discount is wider the Dividend Yield will be higher as the Share Price will most likely have fallen). See my ‘Funds’ page for more details about this.
As mentioned in the ‘Investment Trusts’ bit above, if you look at the ‘Funds’ page on this Website you should get more idea of what the differences between the various types of ‘Funds’ you can buy actually are. When compared to Investment Trusts, I just see Unit Trusts as generally inferior (and in the cases where a direct comparison can be made because there is a Unit Trust and an Investment Trust run along similar lines by the same Fund Manager, it is usually the case that the Investment Trust outperforms), and my limited understanding is that the kind of Dealing Platforms through which you are able to Buy and Sell Unit Trusts tend to have much higher charges than the Platforms which are purely for dealing with Companies (remember, an Investment Trust is a type of Company). I may not be entirely correct on this so I suggest that any Readers looking to buy Unit Trusts investigate this thoroughly.
In some cases an Investor has no option - only a Unit Trust is available. For example, this is the case with Mark Slater’s Growth and Income Funds which are both very good performers (although not necessarily ideal for an Income Portfolio). Having said that, if you want 1 or 2 Unit Trusts you don’t necessarily have to hold them on a ‘Platform’ as such I believe - in fact (although this might be a historic thing) I hold a Tech Unit Trust and a Health Unit Trust outside of any kind of Platform or ‘Wrapper’ - and to Sell chunks of them I just phone up the Fund Management Company. Of course I am liable for CGT and/or Income Tax on these so I need to manage my Sells carefully.
With the above in mind, I would suggest that if you are tempted to buy a Unit Trust for your Income Portfolio, you make sure that you cannot buy a ‘sister’ Fund as an Investment Trust instead - it is probably the more effective way.
I see these things as very similar to Unit Trusts but in this case they do not have an ‘Active’ Manager as such but they are in effect copies of an Index (for example, like the FTSE100 or S&P500 etc.) and are created to ‘mirror’ the actual Index with regards to the Stocks included and their individual Weightings within that Index. I have a fairly limited understanding (in simple terms this is because I have little interest in them !!) but I think they need to be Bought and Sold like a Unit Trust and require the same sort of Platforms/Wrappers to use them.
I am unsure about these with regards to suitability for an Income Portfolio. My gut reaction and personal bias is that I wouldn’t have one myself, but maybe within a collection of 12 to 18 Assets, the odd Tracker wouldn’t hurt. The obvious benefit of these things is that they are very low cost but the disadvantage is that they do what it says on the Tin - in other words, it is marvellous when they Track a Bull Market to ever new Heights, but extremely unpleasant when they Track a Bear Market downwards with immense velocity !!
Perhaps is you are a particularly adept ‘Trader’ and ‘Timer’ of Markets, then you could Sell your Tracker Fund before the drop but of course this sort of defeats the ‘do as little as possible’ aspect of a Low Effort Income Portfolio and if you are out of the Market you will not be benefiting from any Dividend Payments - this could be really problematic if you rely on the Income to eat and drink Beer (or Wine, Gin, Fevertree, etc. for you posh types). And of course if you try to time the Markets and get it wrong (it is almost guaranteed that you will) then you will be missing out there as well.
My thinking is that if you use Trackers (or anything which ‘Tracks’ a Market) then you are sort of ensuring that you will suffer the Bad Times quite hard. I take the view that with careful Stock Selection and a focus on Diversity and Defensives, it is possible to create a Low Risk and Low Effort Portfolio which will perhaps perform slightly better than ‘The Market’ in Bear periods - this makes sense because it is likely that Cyclicals get really beat up and the type of boring stuff in an Income Portfolio will fare better. However, sadly I think it is impossible to create an Equity-based Income Portfolio which is totally immune from Bear Markets - you will take some sort of hit but as I mentioned in an earlier Part, if you have a Diverse collection of Decent Stocks then they should recover in time.
Exchange Traded Funds (ETFs)
If you look on my ‘Funds’ page I have written a bit about these and in particular it is important to understand the difference between ‘Physical’ and ‘Synthetic’ replication which I have explained there.
As I see it ETFs are just in effect another form of ‘Tracker Fund’ and the comments I made in the Section just above on Trackers largely applies to these. I am not totally averse to the use of maybe 1 or 2 ETFs within an Income Portfolio but I think care must be taken to ensure you are not taking on a ‘Market Risk’ that perhaps is avoidable by diversifying across Stocks with some sort of defensive nature. The big advantage of ETFs over Trackers is that they can be Bought and Sold via a ‘normal’ Share Dealing Platform and are treated in effect like Companies (similar to Investment Trusts if you like). ETFs also tend to be very Low Cost which is always a good thing.
A recent trend is the proliferation of ‘Smart Beta’ ETFs - these are special and complex ETFs that instead of merely Tracking an Index or whatever, they try to give the Performance of particular Sub-Divisions of the Market. For example, a Smart ETF might in effect track all the Stocks in the FTSE350 which have a Dividend Yield over 3.5%, or perhaps one might track the Return of Stocks which would qualify as being something Warren Buffett might invest in - you get the idea (hopefully).
I am really unsure about these ‘Smart’ ETFs (it often seems to be the case that such complex and artificial ‘Products’ turn out to be very ‘Dumb’ for Investors) and my gut instinct would be to leave well alone. As with any of these things, if you are tempted then I suggest doing really thorough research and before rushing into buying one for your Income Portfolio, think carefully about the Alternatives and whether or not the potential Smart ETF actually brings anything to the Diversification Party which should make up your Portfolio. Rather than these kind of things, I would probably stick to Investment Trusts myself.
That’s it for Part 3, now I need to crack on with writing Part 4 !!
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