This is the seventh in a series of articles elaborating on the 9 Steps To Build and Manage a Dividend Portfolio.
The previous step was about starting small. For long-term investors, rather than jumping completely into an investment with a large single trade, it’s wise to build positions over time, depending on the amount of capital employed. This step is the longer-term extrapolation of this method, and covers two sorts of commitments: commitment of confidence to core holdings, and commitment of continued capital input.
There are different ideas out there about the optimal position size. Warren Buffett has suggested that 6-7 positions is optimal for a personal investor. Some people suggest 10 or so positions, and others suggest 20+ or 30+ positions. The fewer positions, perhaps the closer you can pay attention and get to know your investments, but the more concentrated the risk is. You’re more prone to outright outperform or underperform the market. The larger number of positions, the harder it is to pay attention to, and really get to know, your investments. It becomes more of an index fund of companies that will likely more closely match the market.
I don’t put forth a claim on what the optimal number of positions is. It likely depends on personal preference, tolerance to risk, portfolio size, life goals, whether you use index funds and how much of your portfolio they make up, and financial obligations and responsibilities.
But I do think it’s worthwhile to really commit meaningful capital to investments that we believe are great choices. When you’ve analyzed an investment to the best of your ability, when you’ve sought out trusted opinions on the company, when you’ve invested in the company and built your position over time, and when you’ve revisited your investment thesis multiple times from different angles with the same conclusion, it can be a good idea to establish “core holdings”. That is, a set of strong companies with large moats that act as foundations for your portfolio that you have high certainty for. It’s a choice that, if your investment thesis is correct, can give your portfolio very meaningful growth and stability. Companies with extremely strong financial positions, a history of strong dividend growth, and that are operating in an industry that won’t be going away any time soon are often good choices for a core holding. The ideal balance is such that if one of your top investment decisions were to be wrong, it wouldn’t devastate your portfolio, but if it were to be right, would give your portfolio a worthwhile boost.
I don’t particularly advocate extremely broad diversification. Apart from diluting core holdings, it makes it significantly harder to consistently vote in shareholder elections, which is something I really suggest doing. It’s good to have diversification, and the level of diversification will vary depending on personal differences, but it makes sense to commit meaningful capital to, and be confident in, your top investment decisions. My personal strategy of dividend investing is to have several (five to ten) primary holdings, and another 10 or so lesser holdings to round out diversification and volatility, plus of course other asset classes such as bonds.
Commitment of Continued Capital Input
Regardless of your chosen position size and level of diversification, the most important aspect of building wealth is to stick with it. A lot of us may know a certain type of guy- the guy at work or the neighbor that “dabbles” in investing. He plays around with a taxable investment account. He may enjoy talking about what positions he is holding lately, how they are doing, etc. He may even do well- making more money than he loses. But as the years go by, he’s still just playing games. He may have a few thousand dollars in there, which he manages to compound a bit from time to time, but doesn’t view it as a consistent wealth-building path and doesn’t diligently add fresh capital to it.
A committed wealth-builder, on the other hand, has the focus on long term wealth accumulation rather than just a few hundred bucks in occasional stock gains. She or he consistently adds money to the portfolio, maybe every month or every other month, like clockwork. This is where the psychological edge of dividend growth investing comes in handy. The focus of this investor is constantly on growth of the passive income stream and on growth of the total portfolio wealth, rather than short term fluctuations. The investor is familiar enough with her financial position, her income, and her investment strategy to make fairly accurate long-term goals of how much passive income she wants by a certain date (five year goals, ten year goals, etc), and then hopes to meet or exceed those goals.
The most important aspects of investing are asset allocation and the discipline to consistently add capital. Individual investment decisions are secondary. To build wealth, one must be the wealth builder rather than the “dabbler”- consistently add money to your portfolio, ensure you have adequate asset allocation and diversification, and think strategically far ahead.