New stock purchasing rules

simple landscape representing simple new stock purchasing rulesIn March this year I changed my stock purchasing rules for individual stocks (yes, again). Here are the new rules and the reasoning behind them.

Please keep in mind my individual stocks are restricted to being about 10% of my Income Fund. So this is a fairly small component of the overall holdings and won’t have a major impact.

The individual stocks I own are income-focused, although they tend towards lower (and hopefully more sustainable) dividend yields rather than high yields. This isn’t an especially efficient approach – arguably while accumulating wealth before retirement it’s better to focus on total return instead of income.

The New Rules: Individual Stock Portfolio

Portfolio Weighting

Since the individual stocks are aimed at producing income, I’m going to weight the stocks by their projected dividend income with the goal of equalizing the income from each position.

RULE 1: No single position in the Portfolio should pay more than 5% of total projected dividends.

As an example, suppose I held stocks in ten different companies which paid a total projected annual dividend of $100. This rule says that no single holding should pay dividends totaling more than $5. In other words, there should be at least twenty holdings in the portfolio, assuming an equal yield.

This rule exists to reduce the impact of a company cutting or cancelling its dividend. Because the individual stocks are about 10% of my Income Fund, this means each individual stock contributes about 0.5% dividends on average.

What this rule also implies is that a stock paying a 1% dividend will end up being a position five times larger compared to a stock paying a 5% dividend. I’m okay with this too since the higher yielding dividend stock is likely slower growth and more at risk to cut its dividend than a lower yielding stock.

What to Buy

RULE 2: If adding to an existing position, buy more of the holding with the lowest projected dividend income.

This rule is to simplify managing the stocks. I’m not going to spend a lot of time researching the best price to buy a stock. I’m just going to buy more of the lowest weighted position at the time I have money to invest.

It really comes back to mitigating the impact of dividend cuts, rather than worrying about trying to maximize income or total return. Since most of the stock market gains are because of a few top performing companies, there’s a good probability the stock you’re about to buy isn’t one of those.

RULE 3: If adding a new holding to the Portfolio, it must meet the following

  1. Market Cap > $250 Million
  2. Dividend between 1% and 6%
  3. Sector: Any except Real Estate and Basic Materials
  4. Company has strong brand or market advantage

I favor large cap companies for higher stability and dividend payments. High dividend yields aren’t sustainable in the long term and should be avoided. Overly small yields will also mean too much ownership in one company and it’ll be quiet boring buying the same company each month when adding funds.

While the Real Estate sector is good for producing income, it’s quite tax inefficient so I’m going to skip it. Basic Materials is not a great dividend paying sector either.

As for a strong brand or market advantage, this is all entirely subjective. It includes companies I consider to have a wide “moat“.

When to sell

RULE 4: Consider to sell a holding only if there’s a significant change to the business operation such as cancellation of dividend or merger and acquisition.

This is a buy and hold portfolio so I rarely sell stocks. But since it’s a dividend paying portfolio, if a company stopped paying dividends then I’d look at replacing it. I’m not as worried about dividend cuts or holding the dividend steady.

The main test is that if I wouldn’t buy more of the position, then it’s time to sell.

Selling for tax loss harvesting is potentially okay however as long as the position is held through ex-dividend dates. There needs to be a fairly large percentage drop in the price for this to be worthwhile though.

Outlook

As of March 2019, I own 28 individual stocks. I’m planning to increase that number to 32 over the next several months. Because 32 is a nice round number after all.

Why change?

It wasn’t that long ago when I last updated my stock purchasing rules. Most of the changes at that time were to relax the rules a bit since the index funds I own provided most of the stock market exposure.

I honestly don’t think the rules matter that much since this is a limited portion of my income fund. By far the biggest driver in increasing wealth is to save as much as as you can for as long as you can.

Really these changes are just to make it simpler how I manage my individual stocks since most of the new money I add to my Income Fund goes to index funds anyway.

I’ve updated my IPS with my new stock purchasing rules.

Quote of the Day

It is not death that a man should fear, but he should fear never beginning to live.

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