Avoiding High Portfolio Ownership Of Successful Investments

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I have been investing in dividend growth stocks for the past decade. There have been hundreds of other fellow dividend investors, who have also invested in dividend paying companies over the same period of time. There are some, who have invested for even a longer amount of time. Unfortunately, when you invest for a long time, you may end up with a few very successful positions, which account for a disproportionate amount of your portfolio.

The question I have been getting recently has been what to do in this situation. I would note that this problem generally happens to investors who are not adding money to their portfolios anymore. A few examples cited include Realty Income Corp (NYSE:O), VF Corp (NYSE:VFC), and Altria Group Inc (NYSE:MO), which have delivered fantastic returns since 2008 – 2009.

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This of course is a great problem to have. If you are a long-term investor, it is very much possible that after a decade or two of patient investing, the power of compounding will result in many companies which not only pay more and more in annual dividend income, but also result in large unrealized gains for the stockholder. As a result, there may be several companies in your portfolio, which could end up with a very large portfolio weight. In my opinion, you own too much in an individual security if it accounts for more than 4% – 5% of your portfolio’s value.

This article only deals with individual stocks/securities – it is not relevant to mutual funds or exchange traded funds. In some situations like these, investors end up putting their whole portfolio in just one diversified fund, and this could actually be a prudent move from a diversification perspective.

As someone who takes investing seriously, you want to make sure that you are diversified. In my opinion, a dividend portfolio is diversified if it has at least 30 – 40 individual securities in it, and is representative of as much of the ten S&P industry sectors as possible. Preferably, you would have two or three leaders in each of the ten sectors ( now eleven) at the minimum. If you build a portfolio over time, this is not an unreasonable goal.

A position that takes a too high of a weight in your portfolio also increases risks to your income stream and net worth (as you are overallocated to it and corresponding sector). In an equally weighted portfolio with 40 components, your target weight for each company would be around 2.50%. It would then fluctuate of course, but this is a good guideline to go for, at least initially.

A position with a higher weight in your portfolio, could be costly if the company’s fundamentals deteriorate over time. As a general rule, you are likely to be a conservative investor who doesn’t just gamble away their hard earned money. Therefore, you need to design a plan to address this issue.

If I were in a situation where I had a very successful investment that had a weight of over 5%, I would do a few things, depending on my personal situation.

One of them would include taking the dividends in cash, and then reinvesting them into other dividend paying stocks. This would mean that I will not be reinvesting the dividends in a position that has too much weight in my portfolio. In a sample 40 position portfolio, I would stop reinvesting dividends if an individual stock position has a portfolio weight higher than or approaching 4%.

This is why I prefer to collect all of my dividends in cash over a one – two week period, and then use that cash to add to an existing position, or to initiate a position in a new company. It is easier to maintain portfolio weights that way, and avoid them from getting out of hand.

The second thing that you could do is a slight variation of the action, described in point number one. It involves situations where you are in a position to be adding money to your portfolio. In this case, you can simply collect all dividends in cash, and then combine them with fresh deposits, in order to add to existing positions or to initiate a position in a new dividend paying company.

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