My dividend portfolio sector allocation

A while back now, I looked at US stock sectors and the number of dividend champions they produced to see if there were any dividend-champion friendly sectors. I’ve used this train of thought to overhaul how I am weighting my stock portfolio. Are you sitting comfortably? Then I’ll begin…

What’s gone before

Previously in Dividend Life, I weighted my portfolio fairly equally across all 10 market sectors, as opposed to how the S&P Index is weighted. My thinking here was that if one sector in my portfolio lagged behind the others, then it must contain relatively cheaper stocks so I should add to that sector and get some relative bargains. In reality, because the new capital was significantly larger than market variation, the new purchase disturbed the results so I would end up cycling through each sector with little variation between the sequence. This effect would be less pronounced the larger the portfolio when the market price is more of a factor than new capital added.

Going forward

I already have one self-weighting rule in my Charter that I really like:

Never let any single stock contribute more than 5% of my annually projected dividend income.

This is simple risk management – if one of the stocks in my portfolio melts down and cancels its dividend then I lose no more than 5% income. This rule can’t be achieved if you own only a few stocks, so it inherently forces diversification which is a good thing – the 5% number itself is entirely arbitrary.

I’ve decided to take a step further and weight my portfolio based on dividend income percentages rather than market capitalization dollars. This has several impacts which I’ll eventually get to further below.

New dividend portfolio sector allocation

The sectors I use are those defined at Morningstar and they match those used in the US Dividend Champions List (although with slightly different names). Category is a higher level grouping also from Morningstar which groups stocks into one of three ‘super-sectors’: Defensive, Sensitive and Cyclical.

I started out with an base allocation for each sector based on their category, added a relative weight within that category and total the amounts to get the following.

Sector Category Base %  Adjustment Final %
Utilities Defensive 12 +1  13
Consumer Defensive Defensive 12 0  12
Healthcare Defensive 12 -1  11
Communication Services Sensitive 10 +1  11
Energy Sensitive 10 +1  11
Industrials Sensitive 10 -1  9
Technology Sensitive 10 -1  9
Consumer Cyclical Cyclical 8 +1  9
Basic Materials Cyclical 8 0  8
Financial Services Cyclical 8 -1  7

Comparison to dividend champions per sector

These weightings match reasonably well to the percentage of dividend champions per market sector that I reviewed previously. I didn’t try to match the exact percentages but I did use the order of the previous ranking to help guide my decision. The table below compares them.

New % Ratio of Champions per sector %
1. Utilities 13 1. Utilities 17
2. Consumer Defensive 12 2. Consumer Defensive 14
3. Healthcare 11 3. Communication Services 12
4. Communication Services 11 4. Energy 12
5. Energy 11 5. Healthcare 9
6. Industrials 9 6. Consumer Cyclical 8
7. Technology 9 7. Basic Materials 8
8. Consumer Cyclical 9 8. Industrials 8
9. Basic Materials 8 9. Financial Services 7
10. Financial Services 7 10. Technology 6

I favor the Healthcare and Technology sectors more and have reduced Basic Materials allocation compared the dividend champions percentage values.

Using the weightings

Using these values is quite simple – I’ll use the percentages here to stop purchases stocks in a sector if the annualized dividends from that sector exceed the target percentage plus one percent. Here’s my current portfolio allocation comparing the actual and target values.

Current dividend portfolio sector allocation
My current dividend portfolio sector allocation as of 07-March-15

So I won’t be buying Communication stocks for a while, but as I add stocks from other sectors the over-allocated sectors will decrease and eventually balance out in one big happy portfolio.

And just for fun…

Here’s the comparison between my dividend portfolio sector allocation based on dividend percentages and the allocation based on market capitalization.

Comparison to dividend percentage allocation vs market value allocation
Dividend portfolio sector allocation two ways: Dividend percentage allocation vs. market value allocation

The main factor here is dividend yield which links market capitalization (share price) and dividend income (dividend per share). High yield stocks such as those in the Communications sector do not need as much market value to contribute a higher percentage of dividend income. And conversely, a larger amount of lower yielding stocks are needed to contribute the same overall income percentage than higher yielding stocks.

Summary

Based on the market capitalization above, I shouldn’t expect my portfolio to beat the S&P 500 in terms of total return since it’s oriented towards defensive, lower growth stocks. I should expect higher dividend income however which is what this is all about. Because I’m planning to use only dividend income from this portfolio in retirement and not sell the stocks I’m not particularly worried about total return or capital gains.

The goal of this allocation is to try to mitigate risk of reduction in dividend income by favoring market sectors that are more reliable for long term dividend growth and to limit the dividend income from each sector. Only time will tell if this allocation is successful or not!

 

Quote of the day

Wide diversification is only required when investors do not understand what they are doing.

0 thoughts on “My dividend portfolio sector allocation”

    1. Hi DFG,

      I’m only rebalancing by buying other sectors. I’m adding enough new investments each that the Comms sector reduces about 1% per month or so. I have mostly T and some VZ in this sector – T’s dividend growth rate is very small, so the other stocks are gaining ground on their own.

      Best wishes,
      -DL

    1. Hi Dividend Drive,

      It’s not a very traditional method but since my goal for this portfolio is focused on dividend income, it makes sense to me. I use a more typical asset allocation in my retirement account for total return.

      UK stocks seem to have a much more fine-grained classification of industry / segments than the 10 or so commonly used in the US. I like 10 as I don’t run out of fingers when I’m counting!

      Best wishes,
      -DL

      1. No it is certainly not traditional. I like the idea though.

        There is such a degree of variability with classification systems. I recently, in fact, changed how I classified my holdings after the previous system did not quite do what I was expecting it to.

        I very rarely come across a consistent use of one across the board! I am currently using the Industry Classification Benchmark (ICB) to get in line with the site I use to analyse stocks.

        All very confusing!

        1. Hi Dividend Drive,

          In my mind it’s like coming up with a classification of music genres that everyone can agree on. It’s a very subjective thing and not likely to succeed. The classifications that Apple uses on its store may not match those that Amazon use. But if you’re an Apple iTunes user, you probably won’t look too much at what Amazon use.

          I guess it’s the same with sector classifications too – people will tend to use what their broker uses or what’s convenient to them. Although if you’ve a number of different investment accounts across different brokers it’s definitely useful to normalize them somehow.

          For the UK Dividend Champions List I’m using the sector definitions from LondonStockExchange.com – I think this is probably the same as the ICB you mention but I’ve not checked that.

          For my personal US investments I go with whatever Morningstar use.

          It’s definitely a confusing subject though!

          Best wishes,
          -DL

          1. It is not clear what the LSE use, to be honest! It may be the ICB.

            As you say, it largely according to what is most convenient and largely depends on how much you want to drill down into the details. Some are so vague they are almost useless!

          2. Hi Dividend Drive,
            Yes, I like to use the higher level categories as lower levels is too granular for me. After some more searching it looks like the LSE does use the ICB which is used by the Dow Jones and FSTE indexes.
            In the US, Morningstar uses the S&P standard known as GICS.

            The links above are actually quite useful in that they show the breakdown / rollup of the categories.

            Best wishes,
            -DL

  1. people can try to beat the S&P, but it is quite hard. Like at the end of August, September, Mr. WRI (who’s 100% cash) was happy because he beats the S&P while my account was suffering 10%. Anyhow, now the S&P has rebounded, people who had the cash to deployed, didn’t, they’d miss out the biggest gain of the year.

    It’s better to be in the market 🙂

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