Dividend growth investing is a fantastic way to build a large chunk of your portfolio. During this bull market, many investors have fared well by owning dividend stocks which got bid up due to low interest rates. However, with valuations very high, and risk rising, it is time for people to look more deeply at the guts of their investment approach.
Asset Allocation Will Control Your Risk
This article is not about asset allocation, but I think it’s important to start out with a brief word on the topic. Studies have shown that asset allocation will be the key determinant of the volatility in your portfolio.
We have all heard that asset allocation affects 93% of your portfolio. Many investors assume that means the returns in their portfolio. That’s not true. The study that refers to 93% has to do with portfolio volatility.
Carefully considering your asset allocation in order to reduce volatility has more impact on how well you sleep than anything. Wildly volatile portfolios can be (but generally aren’t) very profitable, but, if wild volatility gives you sleepless nights and a heart attack, future gains probably don’t matter much.
The chart below, pulled straight off of NASDAQ’s website, shows that diversification, an outgrowth of asset allocation, requires only small basket of stocks to be diversified. The caveat is that you can’t have all of your money in correlated sectors or categories.
In a special report I provided to Margin of Safety Investing (MOSI) members titled “Intelligent Asset Allocation: Better Returns & Lower Risk,” I cover the idea of effective asset allocation. That report is available to you just for taking a free two-week trial.
The key takeaway of “Intelligent Asset Allocation” is that having stocks in at least five sectors of the economy is vital, but so is having assets that are far less correlated to the stock market, like cash, real estate, private equity, currencies, commodities or other alternatives.
For the average investor, many “alternatives” come in the flavor of equities, such as REITs or listed private equity shares. Keep in mind what your money is truly correlated to in order to maintain an effective asset allocation. Being too much in any asset class not only increases your volatility, but also your risk of suffering from a correlated correction. This applies to dividend growth investing too.
For many, having a quarter or half of your money in dividend growth stocks can make a lot of sense, but going much beyond half runs…