Blazingly Simple, Must-Have Portfolio

[kyounge1956]

This is inspired by Meadbh's post in the Inflation Hedge thread, and the linked article:

Here is one man's approach:

The blazingly simple,' must-have portfolio - The Globe and Mail

“The idea just came to me, and it was blazingly simple,” he said from his Toronto home. “I basically sat down and thought, what is absolutely essential to our society, and who provides those essentials?”

"Mr. Henderson’s focus is on the function of a company, not its size.

The first step in building the portfolio was to set a rule that all stocks had to pay a dividend. As a retiree, dividend income is essential to Mr. Henderson."

"The cumulative average 10-year total return on these stocks (that’s share-price gains plus dividends) was 305 per cent."​

Of course, he should have more diversification. But I think his approach emphasizes predictable growth of value and regular cash flow in companies that provide goods and services that will always be in demand. Middle of the road rental properties share those characteristics, because people have to live somewhere, year round.

Reading the article, I was surprised by the limited scope of what the investor considers "essential". There are only seven stocks, and they are all in either fuel/energy, banking, or transportation. I wonder why there isn't a consumer staples company in the portfolio? People are going to wash their clothes and brush their teeth, no matter what. I am not an individual stock picker so maybe there is an obvious reason. (No dividends, maybe?)

For a U.S. investor, what stocks would you put into a portfolio of providers of the "essentials of life"?

 

[Keim]

In no particular order, stocks in the areas of:
1. Fuel
2. Food
3. Shelter
4. Sex
5. Security

 

[BigNick]

The Essentials Portfolio has been the core of Mr. Henderson’s retirement fund for years, but it’s not all he owns. He’s had some success with income trusts and continues to hold some of those. Also, he has what he calls a “gambling account” where pursues his belief that the energy sector has great potential.

Ah. So in other words, this is just part of his portfolio, and we aren't being told how big a part.

Also, he hasn't given us a convincing reason why stocks of a particular company, no matter how essential its role in the economy, aren't overvalued at any given point. Saying that your national pipeline company is essential is a no-brainer. Saying that it's a good investment kind of depends on whether the price is curerntly $50 or $500.

Bottom line: a standard, feel-good article about post-hoc justification for why this guy had the right strategy all along. He probably did, and avoided getting burned by the .com bubble when companies with 60 employees were big enough by market cap to eget into the S&P, but as a lesson for the future I'm not sure how much value it has.

 

[jayc]

XOM - Exxon, WAG-Walgreen, WMT - Walmart, DUK - Elec, T-Communications, PG - Proctor Gamble, KR- Kroger. I started a portfolio using this concept via DRIP's in the 80's. It is now 3% of my total portfolio. I am still long on 5 of the above. The Electric and Communications dividends cover my electric and phone/internet annual costs.

 

[oneils]

I think this type of portfolio is much easier to set up in Canada. Henderson picked 7 stocks from four sectors: rail; oil and gas, hydro, and financials.

There isn't really a lot of competition in these sectors in Canada. So, I could see how their returns would be pretty stable. I don't know enough about the U.S. to say that this portfolio would be as "simple" to set up.

Also, if you look at the returns chart, you'll notice that they took a bath, along with everything else in 2008. If the investor isn't ready to "buy and hold" this portfolio won't help much. Without any fixed income, I can't see many people weathering that storm.

Sure, they are "dividend payers" but when the share price drops in half, your income has just dropped in half. I can't see many people weathering that storm without some sort of fixed income. The article says Henderson is a retired professor, but I'm willing to bet that his fixed income is part time work at a university.

 

[oneils]

Also, the dividend portfolio is still very popular in Canada. I believe this is the case because:

1. Mutual funds are still very expensive in Canada. MERs of 2-2.5% are common. Only one family of funds, that I know of, has MERs under .5% and they are poorly advertised. The Bank that runs them does not even suggest them to their investors. You have to specifically ask for them.

2. Until recently, about mid 1980s, our tax-deffered accounts had a hard-cap to annual contributions of around 7500 bucks*. So, many people invested their money into dividend stocks to save on taxes.

I'm not an expert on these things, but I think it helps to know why this is a popular strategy with many people in Canada. Different circumstances have kind of lead to different investing strategies.

*just did some google-fu on this, the cap was actually the lesser of 20% of income, or 7500. So people had less tax-advantaged room than I thought.

 

[Koogie]

--- cough --- TDCanadaTrust ? --- cough ---

 

[oneils]

--- cough --- TDCanadaTrust ? --- cough ---

Yes, that is the bank I was talking about. Their e-series funds are becoming more popular as more and more pf bloggers recommend them. What is sad is that the bank itself does not even recommend them. If it weren't for the recent boom in canadian personal finance blogs, many people would not even know that these funds exist.

 

[Koogie]

Are you holding the e-series ? Are you satisfied with the returns versus the initial hassle in setting them up ? I've lazily looked into it but Big Green makes it so hard to buy into them. Plus, well, TD and I are about to have a knockdown, dragout brawl over their fees that might see me take my personal and business accounts elsewhere. Not like there is a lot of choice between banks in Canada anyway though.

 

[haha]

I think this type of portfolio is much easier to set up in Canada. Henderson picked 7 stocks from four sectors: rail; oil and gas, hydro, and financials.

There isn't really a lot of competition in these sectors in Canada. So, I could see how their returns would be pretty stable. I don't know enough about the U.S. to say that this portfolio would be as "simple" to set up.

Also, if you look at the returns chart, you'll notice that they took a bath, along with everything else in 2008. If the investor isn't ready to "buy and hold" this portfolio won't help much. Without any fixed income, I can't see many people weathering that storm.

Sure, they are "dividend payers" but when the share price drops in half, your income has just dropped in half. I can't see many people weathering that storm without some sort of fixed income. The article says Henderson is a retired professor, but I'm willing to bet that his fixed income is part time work at a university.

Your "bet" aside, you have some misunderstandings in your post. In particular what I have bolded. I owned ENB throughout the crash, I bought TRP during this time, and I bought other US stocks in pipelines/electric power transmission and generation. You are correct that the prices went down, but the cash flow was hardly affected, and the dividends in most cases went up rather than stayed stable. So not only did I maintain income, it tended to increase. At the time I had almost no fixed income, and the only selling I did was to accept losses and buy other stocks. I did not sell any of these basics stocks.

As far as differences between the US and Canada, Canadian stocks are available to US investors; I have always held some. Also, things like long-haul n.g. pipelines and railroads and gas and electric distribution companies have relative freedom from competition, since once they are laid the incumbent will always have a cost advantage. And for distribution companies, there is often a governemnt granted territorial monopoly. In particular ENB is a stock for the ages. Excellent conservative management. and pipes bringing Athabascan crude into the US pipline system into various refining centers including the US Gulf Coast. They also bring natural gas to the oil sands for bitumen pretreatment, as well as owning some other pipes and subsidiaries. ENB is however fully priced at present.

I do think that when you follow this sort of plan, you need to think long and hard about what new technologies might make obsolete one of the "necessary" technologies in your portfolio, and you also need to be sure that your investment choices are well financed, as the last recession was finance driven. You need to understand some of the nuts and bolts of the industries and geographic areas that you invest in. It is not a high level, extremely abstract process like fiddling with an asset allocation.

It is a fundamentally different approach from the "buy a little of everything and hope it goes up" approach favored by many.

Ha

 

[Calgary_Girl]

Also, the dividend portfolio is still very popular in Canada. I believe this is the case because:

1. Mutual funds are still very expensive in Canada. MERs of 2-2.5% are common. Only one family of funds, that I know of, has MERs under .5% and they are poorly advertised. The Bank that runs them does not even suggest them to their investors. You have to specifically ask for them.

2. Until recently, about mid 1980s, our tax-deffered accounts had a hard-cap to annual contributions of around 7500 bucks*. So, many people invested their money into dividend stocks to save on taxes.

I'm not an expert on these things, but I think it helps to know why this is a popular strategy with many people in Canada. Different circumstances have kind of lead to different investing strategies.

*just did some google-fu on this, the cap was actually the lesser of 20% of income, or 7500. So people had less tax-advantaged room than I thought.

I think you forgot the most popular reason for owning dividend-paying stocks: the Dividend Tax Credit.

 

[clifp]

I think you forgot the most popular reason for owning dividend-paying stocks: the Dividend Tax Credit.

What does that consist of for Canadians?

 

[Calgary_Girl]

What does that consist of for Canadians?

Basically, in a nutshell: The Dividend Tax Credit provides preferential tax treatment for individuals with dividend income from Canadian corporations. Taxable dividends received by Canadian residents from Canadian companies are taxed at lower rates than other forms of income.


Tax free dividends: One of Canada

 

[oneils]

Are you holding the e-series ? Are you satisfied with the returns versus the initial hassle in setting them up ? I've lazily looked into it but Big Green makes it so hard to buy into them. Plus, well, TD and I are about to have a knockdown, dragout brawl over their fees that might see me take my personal and business accounts elsewhere. Not like there is a lot of choice between banks in Canada anyway though.

Hey Koogie, this year I opened a Self-Directed RSP with TD to buy e-series funds. But I found out that they charge an annual fee for this account. In order for them to waive this annual fee, I need an "e-series" account. I'm in the process of converting the SDRSP account to an e-series account, now. When that is done I will be purchasing some e-series funds. So, like you said, TD couldn't have made the process more complicated! lol.

...You are correct that the prices went down, but the cash flow was hardly affected, and the dividends in most cases went up rather than stayed stable. So not only did I maintain income, it tended to increase. At the time I had almost no fixed income, and the only selling I did was to accept losses and buy other stocks. I did not sell any of these basics stocks.

That is pretty cool. So the company actually increased their yield because they were able to maintain their cash flow, while the price was depressed? That's awesome.

... I do think that when you follow this sort of plan, you need to think long and hard about what new technologies might make obsolete one of the "necessary" technologies in your portfolio, and you also need to be sure that your investment choices are well financed, as the last recession was finance driven. You need to understand some of the nuts and bolts of the industries and geographic areas that you invest in. It is not a high level, extremely abstract process like fiddling with an asset allocation.

It is a fundamentally different approach from the "buy a little of everything and hope it goes up" approach favored by many.

Ha

It is a very different approach, and I don't have any issues with it, other than those mentioned in the article. I can't ever see myself not having anything in fixed income. However, there is nothing preventing anyone from building a portfolio of dividend stock in their taxable accounts and bonds in their tax-deferred accounts.

I think that would be a great approach if you are prepared to do the research. Myself, I'm way too much of a wuss to try this approach. I think I will be building a portfolio of index funds as I really don't think I'm prepared to do the analysis to pick the stocks that are right for me. At least, not now.

I think you forgot the most popular reason for owning dividend-paying stocks: the Dividend Tax Credit.

Yes, that is another advantage for holding dividend stock in taxable accounts. You would have to do the analysis to see if it makes sense on whether or not it is best for your situation. Here is a great post from milliondollarjourney on this: How to Optimize Dividend Income Tax! | Million Dollar Journey

This post is three years old, and was updated in August, 2009. I don't know if the DTC rules have changed since August, 2009.

 

[traineeinvestor]

I have serious issues with this approach.

Financials: there were a lot of good dividend paying financials around the world pre-GFC: Citibank, BoA, RBS etc. Before that there was the S&L crisis in the US and even the French have forgotten how many times the taxpayers have had to bail out their banks. Sure, financials can make great investments but ....

Rail: there have been plenty of awful investments in railways. RailTrack (UK) and NZR (New Zealand) were disasters for investors

Food: definitely not bullet proof. A tainted food scandal (Menginu in China if you want a recent example), over supply (kiwi fruit, grapes, apples come to mind), margin pressure (wine and beer), bad harvests can all wreck havoc on companies in this industry

Shelter: home builders, building products suppliers and direct investment in residential real estate have all had their ups and downs

Energy: traditional energy firms have done weel recently - but did poorly in the 1990s. Alternative energy/clean-tech has been a very mixed bag for investors

Yes you can do very well with companies in these industries (and I own a few) but Building a portfolio based exclusively on them or believing that they do not experience business and economic cycles is madness.

 

[haha]

Yes, it does take judgment.