Compounders And Dividends: Trading Boats For Trains

In the comments section of my previous article, I compared the difficulty of trying to change the top positions of your portfolio through savings and dividend reinvestments akin to turning a boat. It is both a blessing and a curse when your portfolio begins to grow through years of savings and compounding where it becomes very difficult to drastically change your top positions since the amount of money contributed via monthly savings becomes a smaller (and at some point mere basis point(s) percentage of the total portfolio.

Therefore, there are two ways to drastically change the allocation of the top of your portfolio:

• Deposit a material amount of money (maybe a bonus or a portion of your savings account) or;

• Sell a position

As a buy-and-hold investor, I try to never sell a position if I can help it. I’m currently not lucky enough to have a significant amount of money ready to drop into the portfolio and, if I did, I would have already done it. The cash I keep on hand is for family/personal emergencies. Maybe I’ll write an article on the handling of my family’s personal finances. The basic idea is to avoid a situation where we ever need to raise money from my portfolio to meet an unexpected expense. This requires us carrying a good chunk of cash on the balance sheet. While I’d love to deploy that money, it’s irresponsible to my family. My wife also likes to have a good cash buffer in the account. Personal finances are more personal than actual finance, whatever works best for you. It’s mathematically wrong to pay off your house early (maybe not at 7% interest rates, but that’s a different story) over investing that cash into the market. But, if your mortgage keeps you up at night, then paying that off early is the right personal financial decision.

Back to the portfolio.

I have a rule where I don’t sell covered calls on any positions within my stock portfolio. I installed this rule for a number of reasons. The one that likely comes to mind for others who wish to compound capital over the long term is the fear of getting those blue chip shares called away at prices that would make you vomit 10 years from now. I don’t believe attempting to juice a few hundred basis points of yield is adequately rewarded when you lose a position you love. You’re then forced to either sit on the cash (which is difficult for me to do) or trying to run the calculus of replacing the lost yield and finding a company of enough quality as a replacement.

The other reason I choose not to sell covered calls on my stock portfolio is because it forces me to think short-term, which doesn’t align with my long-term bias. I hate looking at option chains and guessing where the stock price will be weeks from now in hopes I’ll keep to get some premium.

Do covered calls have a place in others’ portfolios? Absolutely. This goes back to the personal portion of personal finances. Covered calls (or other options) may be right for you, but I don’t believe they are right for me at this stage of my life with this portfolio.

Now, after all of that, I will note that I have sold covered calls a number of times this year on an international ETF. I’ve been doing this for a number of reasons. It’s been a position I’ve owned for several years, and even with this big downturn, I’m sitting on large unrealized gains. I determined earlier this year that I wanted to eventually divest this position to reallocate to individual securities. In preparation, I began selling covered calls to juice some yield and explore a possible exit price, exactly what I wouldn’t do in my individual stock portfolio. Would I have been better off selling it nearly every time I sold a call? Yep, which is another reason I shouldn’t sell options. Between the premiums and my long-term holding, I still did very well. Mistakes will happen in investing, I’m just glad this one didn’t crush me.

While the ETF position was smaller than my total portfolio, it was significant enough to allow me to make a real move in my portfolio. Since international ETFs have a decent dividend yield, the first thing I had to do was to make up the lost income. Since I am not focused on the short term, this trade will negatively impact the total portfolio’s 2022 dividend. While I was projected to have a low-double-digit increase from last year, this move reduces my dividend income so that I’m now looking at high-single-digit growth compared to last year. That’s fine with me. I’m not going to buy stocks because I’m trying to harvest dividends by the end of the year. I’m much more focused on my dividend income moving forward. My moves already have us sitting on low-double-digit gains for 2023. With that in mind, here is how I first allocated the capital:

High Yielders

For as many positions as I have in my portfolio, I’m arguably under-diversified in my high yielders. I first added shares of Realty Income (O) and Altria (MO) at $57.49 and $43.78, respectively. I decided to use this time to pick up another high yielder which would allow me to cover another good portion of the income. I narrowed it down to a few positions, including AT&T (T), Simon Property Group (SPG), Enbridge (ENB) and Verizon (VZ). I excluded Enterprise Products Partners L.P. (EPD) and Magellan Midstream Partners (MMP) since this is in a traditional IRA.

I ended up initiating a position in Verizon (VZ) at $36.85 per share. I ruled out ENB because I’m not looking for more energy exposure. I’ve said in previous postings that I’m very happy with my two current energy holdings (EOG and COP) and will add there when I want more exposure. If I wanted to consolidate those holdings, I’d shoot for a supermajor like XOM or CVX before going into a pipeline. In 15-20 years? Yes, I’ll likely own a basket of midstream companies to juice more yield out of the portfolio. Until then, I’ll stay with my two variable payers.

I think SPG is a fine REIT, and I read a number of SA articles and dug into the financials a bit more to get up to speed when I saw it was at a 7%+ yield. One of the big issues for me (and this was true for T) was the recent history of cutting the dividend. Was SPG right to cut the dividend? Absolutely, but at this stage when I’m somewhat looking for yield to replace some lost income, I didn’t feel comfortable adding SPG (or T) as the third company in my high-yield basket. I could see either being added down the line when I’m trying to position my portfolio to have a nice spread of the S&P 500’s dividend yield

VZ ended up being the pick. At a 7%+ yield (higher now after I purchased it) and decade-low, I felt like I was initiating a position at a good time. The yearly 2% raise is perfectly fine with me when I’m getting a 7% yield with no recent history of a cut or pause (VZ did pause their dividend in the early aughts).

Core Dividend Growth

After allocating to the high-yielders, I wanted to add more money to my core dividend growth positions. Anyone who read my September 2022 update knows I reinvested some of my dividends into Comcast (CMCSA). I went ahead and used some proceeds to fill out my CMCSA position. I think CMCSA is incredibly attractive right now, and I was happy to add shares at $30.29 yielding ~3.5%.

In addition to CMCSA, I added two new positions, BlackRock (BLK) and Union Pacific (UNP) (which is where the “trains” portion of the headline comes from). BLK is a company I’ve long admired. I couldn’t pass up the 3.3%+ yield which helped make up the rest of the dividends I lost from the ETF sale. I’m sure I’ll talk more about this position moving forward. I felt it necessary to make this a large position and allow it to sit and compound. BLK shares were purchased at $570.14, not at the bottom, but near.

For anyone who paid close attention to the hint I dropped in my top 10 articles and cross-referenced it against my watchlist article, you could have guessed this would happen. I love the tier 1 railroads, and I finally feel my position has the right companies with Canadian National (CNI), Canadian Pacific (CP) and UNP leading the way. It is my hope that these three rails will combine to be my top position at some point. While there still may be some carnage for these cyclical names, I’m happy to initiate positions and accumulate into weakness for a few years. The rails will cannibalize their share counts which will be set up for future success in capital gains and double-digit dividend increases. I purchased a very small starter position in UNP on Monday AM at $192.85. Expect to see me add often and aggressively.

High Dividend Growth

I put the rest of the capital to work to add shares of American Tower (AMT) at $187.04, Texas Instruments (TXN) at $153.18 and Mastercard (MA) at $303.89. The big purchase here is TXN. I was able to catapult TXN into my top ten finally! As noted above, trying to get TXN into my top 10 through savings and reinvestments is like turning a boat, you have to prepare long in advance. My planned purchases/reinvestments would get TXN there sometime next year. This allowed me to get TXN there much earlier. The reason I didn’t dump more is because I plan to continue to add through reinvestments and didn’t want to get to the point where TXN got too big too quickly. AMT and MA companies I want to own more of, and I recently added to these via dividend reinvestments last month.

Conclusion

I’m very happy with this mix of stocks. The high yielders, core dividend growth, and high dividend growth companies give me a higher forward income with higher growth prospects than if I kept the ETF in the portfolio. Moving forward, I have two more large (much larger) ETF positions that I’ll look to divest at some point, but since they are US-focused ETFs, I’m in no rush to let them go. I have no plans to sell any covered calls on these and will likely sell once they’ve received more dividends and I can rotate into some beaten-down stocks with higher yields.

What I hope readers take from this is the need to have a long-term vision to where you want your portfolio to be. I encourage everyone to sit down and look at your portfolio and figure out what positions you want in your top three or five and make a road map to get there. Then be OK when that doesn’t happen when some other company takes off. Have a plan and stick to it and be thoughtful and deliberate with your capital.