Welcome to our weekly passive-income portfolio (PIP) update—#13 in the series! Before we get to the update, I wanted to take a moment discuss portfolio allocation management and how we grow our dividend-growth portfolio.
Setting the question of investing strategy to the side, portfolio management—specifically allocation management—is probably the next most controversial investing topic out there. Just like strategy, when it comes to allocation, the spectrum of available options is as wide and diverse as investors are themselves.
To build a portfolio, you have to grow your positions. But how do you determine which positions to add to and when?
Some folks take a very rigid, technical approach that seeks out the efficient frontier or risk parity, while others develop their own process.
I recently published a great article on this topic and encourage you to read it (The Efficient Frontier: Should Dividend-Growth Investors Chase It?). In it, I provide an actual real-world example from our site’s portfolio.
In this week’s portfolio update, I wanted to take just a few moments to share how we approach our portfolio allocation management because I think it’s critically important for investors—both beginners and experienced alike.
How you allocate your portfolio and the process you employ to build it over time is a foundational component to investing—one that will have a direct and significant impact on, among other things, your portfolio’s expected return and volatility (risk).
As I noted above, lots of investors utilize some degree of modern portfolio theory to manage their allocations. This may involve seeking the efficient frontier through minimum-variance optimization (MVO) or a risk-parity approach.
I personally do not feel these approaches provide a great fit for dividend-growth investing—for a host of reasons outlined in my article.
To introduce you to our approach, it is important to begin with allocation variables—meaning those things that we specifically want to manage our allocations for. After all, what you base your allocations on is as important—if not more so—than how you allocate them.
You can allocate based on any variable. For example, you could allocate your portfolio based on the alphabet (e.g., the first letter of ticker symbols)—though I think we would all agree this would not be a great idea!
Why? Because that variable has no correlation to important portfolio metrics, such as expected return or risk (volatility). In other words, the first letter of ticker symbols is not a driver of portfolio behavior.
For our Wicked Capital passive-income portfolio, we have identified three (3) primary variables and two (2) secondary ones that we want to manage our portfolio allocations around.
Our primary allocation variables are:
We have identified size (market capitalization) as being an investment factor that is important to us—we want exposure to micro and smallcaps. We believe exposure to this factor has been demonstrated to be a statistically-supported alpha producer.
Asset type is an interesting variable. This variable can be defined anyway one chooses to! Thus, we use this variable to define what types of market exposure we want to manage. For example, we have chosen to classify our holdings as BDCs (business development companies), MBSs (mortgage-backed security companies), CLOs (collateralized-loan obligation companies), REITs (real estate investment trusts), MLPs (master limited partnerships), and regular stocks.
Finally, we allocate by sector and industry to capitalize on opportunities provided by sector rotation.
Our secondary allocation variables are:
In terms of secondary variables, we want to manage our position sizes and yield.
Yield is an interesting variable as well. This is where we manage our yield mix. In other words, our mix of current income (high-yield/low-growth) positions verses future potential income (lower-yield/higher-growth) positions.
Having defined the variables around which we manage our portfolio allocations, it is important to share how we use them.
We view these allocations as soft targets—or general guides. In other words, they provide us with some broad parameters that we want to keep our portfolio allocated within.
They are not hard targets that must be perfectly maintained! As we will see next, our process defines our specific allocations—not the other way around.
Determining what position to add to and when to do so is all about your investing process.
You have to start with your investing goal. Our overarching goal for this portfolio is passive income.
Next, you have to determine your strategy for achieving your goal. For our portfolio, we are going to achieve passive income by using three-tier strategy: dividend-growth within a value framework.
This strategy then shapes our investing process: a value dividend-growth investing (VDGI) process or approach.
So, how does this impact how we build our portfolio and manage our allocations?
We do not buy based on our soft allocation guidelines.
Rather, we buy based on opportunities identified by our process!
Our process focuses on value. Thus, I am always looking to add to my portfolio of quality companies when they present the best relative value within my portfolio—period.
This is not a growth portfolio and I do not chase price for the sake of a hard allocation. In other words, I almost never add to a position when it will decrease my yield-on-cost (YOC).
Again, I add to those positions that provide the greatest relative value opportunity within my portfolio.
My portfolio is not filled with high-flying growth stocks… eventually there will be a short-run catalyst for each of my holdings that the market will overreact to—providing me with a value opportunity to add to the position.
This takes patience. But that’s my process—one I fully understand and stick with.
I wait for price to come to me. That’s my investing edge (time arbitrage).
This means that our allocations will inherently vary—dependent on current opportunities. Again, as long as I stay within my broad allocation guides, I’m comfortable with that. I’m not trying to hit an arbitrary allocation mix—I’m trying to deploy my capital as efficiently as possible. There’s a BIG difference.
To identify relative value opportunities, I use my process. I rank all my holdings by a number of key value metrics. I then utilize a formula to combine these rankings into a final score.
I then add to my positions that are at the top of the list—representing the greatest current value opportunities.
For example, here is a distribution of our portfolio holdings by yield variance margin [(YOC – Current Yield) / YOC].
This is just one metric we rank our positions by; however, it shows how we can easily identify the best positions to build–positions that provide us with the most capital efficiency.
This upcoming week, we will be adding to these 10 high-opportunity positions, as well as 10 out of the next (secondary) group of opportunities (i.e., those with variances margins between -8% and -1%).
Furthermore, if I feel my portfolio allocations are getting stretched (i.e., exceeding a particular allocation variable guideline), I can simply filter my list by that variable and add to holdings that provide the best value opportunity there.
For example, if I feel my allocation to smallcaps is getting too low, I simply filter my list by smallcap holdings and identify the best opportunities within them to add to.
It’s that simple! I’m not chasing the efficient frontier or risk parity, nor am I handcuffed by a “hard” or “rigid” allocation mixes. I let current value opportunities dictate where the portfolio grows—predicated on the notion that expected return will follow the efficient deployment of capital (value opportunity).
Now let’s get our weekly passive-income portfolio update!
As we close out the week (our 25th since portfolio inception), we currently have a portfolio value of $3,724.28—up from our starting value of $500 on March 13th.
In terms of market performance, we are down -5.6% since inception, down -3.1% over the past quarter, and up +0.1% over the past month.
We have earned $62.42 in dividends since inception, $48.87 over the past quarter, and $17.14 during the past month.
We officially closed the month of August with $29.49 in dividends paid.
Dividends continue to trend in the right direction with basically 27% of our earned dividends coming in the last month (representing 16% of the portfolio’s lifespan).
Our yield-on-cost (YOC) has risen to 8.1% and our current yield is 8.5%. Again, as I noted above, we are seeing lots of opportunity and plan to continue deploying capital to build our YOC.
Per our discussion above, it is worth noting that as we deploy capital into positions with the most value opportunity, our allocations will be skewed in the short-run. However, over time, we will naturally back-fill to rebalance as value opportunities shift.
Below is a graph of our YOC and current yield since inception. From a portfolio-level perspective, anytime YOC is below the current yield, it’s a targeted buy zone—there is opportunity to increase our capital efficiency (i.e., raise our YOC).
As you can see, our YOC is trending up and chasing current yield as we deploy additional capital into specific opportunities. We’ve actually gained about 0.6% in yield-on-cost across the portfolio over the past two months—thanks to an effective process that efficiently deploys our capital.
To wrap up, here are our current allocations by capitalization, asset type, and sector:
We hope you’ve enjoyed this week’s update on our public-view dividend growth portfolio and my always-opinionated (but usually valid and hopefully beneficial) discussion.
You can always view our Wicked Capital dividend growth portfolio at https://m1.finance/1zUclN2JL
If you’re interested in starting an M1 Finance portfolio, please consider using our referral link https://mbsy.co/sZVS3 and we’ll both get some free cash!
That’s just one more reason to start your dividend growth investing today! It’s never too soon to start working towards your financial freedom!
If you’re interested in dividend growth investing—you’re in the right place! We focus exclusively on helping others be as successful as possible with this approach and we hope you’ll continue to return to our site to learn, grow, sharpen your skills, and find effective and positive ideas and motivation!
Soak it all in, take and use what you want, modify it to fit your unique situation, and keep building that portfolio with a solid process and winning mindset!
Remember, portfolio allocation management is important but…
Your allocation parameters should only be used as a check against the outcome of your process. In other words, process should only be modified when your allocations exceed your maximum limits (high or low).
However, even when they do, you should still apply your process (via filtering) to steer your car (portfolio) back within your soft lines!
One final note: Portfolio diversification is critical. If you have a portfolio of 5 stocks, how each is allocated is far more important. However, if you have sufficient diversification, individual allocations have far less impact across your portfolio—providing you more flexibility to capitalize on the value opportunities the market is offering you at any given moment!
Always remember, investing involves substantial risk of loss and is not suitable for everyone. The valuation of investments may fluctuate, and, as a result, you may lose substantial amounts of money. No one should make any investment decision without first consulting his or her own financial adviser and conducting his or her own research and due diligence.
You should not treat any opinion expressed on the Wicked Capital website as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of opinion for entertainment purposes.
The opinions are based upon information we consider reliable, but neither Wicked Capital nor its affiliates, partners and/or subsidiaries warrant its completeness or accuracy, and it should not be relied upon as such.
Past performance is not indicative of future results. Wicked Capital does not guarantee any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment discussed on this website.
As noted above, strategies or investments discussed may fluctuate in price or value. Investors may get back less than invested.
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