As a financial planner, I keep talking to my clients about the importance of asset allocation in a portfolio. I think it is very important that all investors understand the benefit of having a well diversified portfolio. Why should you consider asset allocation in a dividend portfolio? Because the stock market reacts like a psychopath… I’ll get back to this later but first:
How can you diversify with less than $1,000 to invest?
Some argued in the first post of this series that you would be better off investing in 2 or 3 dividend stocks with your $1,000 instead of buying an ETF. I disagree with them when we are talking about a young investor with his first $1,000. Why? Because the chances of making a poor investment pick are huge. And because you can’t really diversify your asset allocation effectively within a $1,000 investment portfolio.
What is my choice? Buy 1 or 2 dividend ETFs. 1 US ETF to get access to the most diversified dividend paying portfolio and another one from the North of the border; a Canadian dividend paying ETF. Why choose a Canadian ETF? 1st because I am Canadian ;-), 2nd, Canadian dividend stocks are mainly financial and energy companies. They are well established businesses and provide high dividend payouts.
Okay, but why diversify, we are looking for dividends here!
You are right, technically, you could enjoy a good distribution from a few sector concentrated stocks and watch it grows. However, this investment strategy won’t spare you from any market catastrophes. While the consumer, non-cyclical sector seems to be protected from most crashes, don’t forget we also thought that the housing market was solid as rock…
Through asset allocation, you can reduce the volatility of your portfolio and insure consistent growth of your dividend yield over time. How come? Because most companies ride their sector trend. If you fall on a “bad” stock, the company you have chosen in your portfolio may not increase its dividend, or worst, it can cut it. If you hold several companies in several sectors, you increase your chances of having dividend growth overtime.
And when I am talking about asset allocation, I am not only talking about sector investing but also about small caps, medium caps and large caps. While small caps can boost your returns, large caps will smoothen your investment return by providing steady dividend payout with regular increases.
We also may think that globalization has correlated all stock markets but there are still discrepancies in their timing. The best proof is the Canadian market vs the US market.
Other ways to generate income in your dividend portfolio
Depending on the type of market, I think having a part of your portfolio invested in bonds or mortgage funds can be interesting. While interest rates are very low right now, I would totally ignore bonds to look at mortgage funds. Bonds are usually attractive but right now, they don’t offer much (especially compared dividend stocks!).
If you are allergic to MERs (I know that mortgage funds charge a lot… like 1 to 1.5%), there are also preferred shares. While I will discuss this matter in another post, preferred shares are a good way to diversify your income in your portfolio. They don’t move drastically like regular shares and they offer steady dividends.
Do you have other ways to diversify your portfolio?
I tried to keep it simple for now, and would like to hear from you about other ways you consider when you are looking at asset allocation in your portfolio?
John @ Passive Family Income
That is a tough topic to keep things short! I will agree with you on the ETF plug for diversifying when you don’t have a lot to invest. I will tell you from personal experience I got really burnt investing in some high yielding CANROYS and am paying the price now for not diversifying properly.