Currently, I have a tripartite investment strategy intended to both produce income (dividends) and capital gains (price appreciation). Below is a brief outline of what I invest in and why.
Go check out the portfolio at any time to see how I am applying the strategies discussed below.
Dividend Growth Stocks (~80% of portfolio) - This group includes stocks that have a consistent record of increasing dividend payments. Usually, I like to see at least 10 years of consistent dividend increases before I consider buying. But I will make occasional exceptions. Ideally, dividend growth stocks both produce income in the form of dividends and capital gains in the form of rising stock prices. Win-win, just how I like it.
Some people may label these as conservative, boring investments. Made even more conservative and boring by the fact that my ideal holding period is forever. But I don’t really care, because my objective is to use my investments to generate consistent and predictable income streams and these stocks fit that objective.
High Yield Dividend Stocks (~10% of portfolio) - This group includes more exotic assets such as master limited partnerships (MLPs), real estate investment trusts (REITs), business development companies (BDCs), high yield stocks, and closed end funds (CEFs). The primary purpose of this group of securities is to generate ~10% or greater yield. As much as I would like to see asset appreciation from these securities, it’s not expected. When possible, I try to select securities that have some history of increasing dividends, but finding 10-plus years of consistent increases is hard, so sometimes I lower my standards.
Unfortunately high yields like these come with risks. There is the risk of a dividend reduction or elimination. There is the risk of devaluation as the company sells more shares to gain capital. There is often, but not always, a lack of capital appreciation.
Overall, I’m still not sold on this strategy as I’ve experienced some winners and some losers. I’m not going to give up on this strategy, but I’m not going to get too crazy chasing yields. That’s why these types of securities are limited to 10% of my portfolio.
Long-Term Cash-Secured Put Options (~10% of portfolio) - Selling cash-secured puts can be a great strategy to generate quick cash in one of two situations.
- You’d like to buy a stock at a given price and are willing to wait some period of time in order for the stock to hit your target price. Does this sound familiar? It should, it’s basically a limit order, except that you’re getting paid to wait. (If I want to buy a stock, I may sell short-term cash-secured puts – I’m not going to wait forever)
- You think a stock is likely to appreciate in price and are willing to bet on it. The word “bet” probably makes this sound a bit like gambling. But I’m not one for gambling, so I ONLY use solid dividend growth stocks as the underlying securities for long-term puts. And I ONLY sell these puts when the stock is near it’s 52 week low. Near being a relative term. Since this is a bet, let’s lay out the winning conditions. Heads I win - The stock goes up in price, the option expires, my secured cash is freed up, and I get to keep the money I made from the sale of the put option. Or tails I win - The stock goes down in price and I am forced to buy a quality dividend growth stock that I might have bought anyway. And I get to keep the money I made from the sale of the option. (If I want to make a bet, I sell long-term cash-secured puts, the focus of this section of my portfolio – the longer I wait, the better chance that the stock will be above the strike price and that I’ll “win” the bet.)
Unfortunately, put options have a down side. They have to be cash-secured, which means that the cost of the underlying security is locked up while the option is in effect. And each option controls a standard lot (100 shares) of underlying stock, so you have to have enough free cash to buy a full lot of the underlying security in order to sell a put option.
Readers: How do you divide your investment portfolios? Do you think that there are any other asset classes that I should be including?