I have received a few inquiries of late as to:
- how much should an investor have before beginning to invest in individual equities;
- what is a reasonable number of equities to hold in a portfolio for proper diversification;
- how to construct a diversified dividend income producing portfolio.
I don’t think there is a definitive answer to any of the above but I thought I would devote a post to share my thoughts.
I wish you to keep in mind that:
- my suggestions on how to construct a diversified dividend income producing portfolio may not fit your investor profile or temperament;
- I am not licensed to provide financial advice;
- I have no knowledge of your personal circumstances, risk tolerance, goals, or your investment knowledge.
What I express in this post are my opinions and I strongly suggest you only make decisions based on your knowledge of the facts and that you fully accept any responsibility for your personal finance decisions.
Why Equity Investing
I like investing because there is no “one” correct way to do it. Just because I prefer to invest in blue-chip companies with a consistent record of annual dividend increases does not mean this is the only way to build wealth. There are countless ways to create inflation-adjusted wealth over the long-term. Secondly, I think it is extremely important that you invest within your circle of competence and in a manner that fits your investing style and risk profile.
You may, for example, have rental properties which will, or already, address your income requirements. Equity investing is merely an avenue through which you are looking to diversify your stream of investment income.
In my wife’s/my case, our rental properties are not generating the rate of return we have been able to generate from our equity portfolio. Had our rental properties been far more profitable, I would likely be focusing on that means of generating a stream of income and my posts would be heavily skewed toward the world of rental property investing.
Given that equity investing has, to date, been the best method by which we have increased our net worth and have generated a reliable income stream, I will explain what I think is a prudent manner in which to approach equity investing.
Start With Low Cost Broadly Based ETFs
Before I get into the construction of a portfolio consisting of individual equities, I am of the opinion that investors with limited available funds for investment purposes should start by investing in low cost broadly based exchange traded funds (ETF); I strongly suggest the broadly based ETFs as opposed to specialty or sector specific ETFs so as to diversify your risk.
The iShares S&P/TSX 60 Index ETF (TSX: XIU) or the iShares Core S&P 500 ETF (NYSE: IVV) are examples of two ETFs which would serve as a good starting point. If you only have $50,000 to invest, for example, I can think of no better way to get exposure to a diverse group of the largest publicly traded companies by market cap while keeping investment expenses to a minimum.
Progressing to Individual Equities
Once you accumulate ~$100,000, this is an arbitrary value I have chosen, you can consider investing in individual equities. In my opinion, until such time as you reach this figure, you don’t really have enough money to properly diversify your portfolio. If you have $50,000 invested in individual stocks, for example, and one of the companies in which you have invested $2,500 fails, or cuts its dividend, then 5% of your portfolio is negatively impacted. This can certainly be disheartening.
The reason I use $100,000 as the cut-off is because at this level you can invest a reasonable amount in 10 companies. If you invest roughly $10,000/company and the average dividend yield 3% you would be generating $300/year, or $75/quarter, in dividends from each company. At this level, each quarterly dividend may be sufficient to automatically purchase one additional share of a company by simply turning on the automatic dividend reinvestment feature.
The number of equities held within a portfolio is a subject for debate. I have seen other blogs where 100+ shares are held in a portfolio valued at less than 10% of our portfolio. We hold shares in roughly 50 companies from various sectors and I am comfortable this level of diversification is adequate for our purposes.
In addition, the appropriate dollar value of an investment portfolio depending on your age bracket is also a subject for debate. I think it is more appropriate to look at the size of an investment portfolio relative to your personal circumstances and the income you have generated over the course of your lifetime.
When my wife/I embarked on our journey to financial freedom, we certainly had no desire to be the richest people in the cemetery if that meant we had to sacrifice all else. In my opinion, sacrificing all else for the sake of dying wealthy is tantamount to never being able to die for one has never lived. This is why we have always viewed money as a tool to provide us with the wherewithal to experience life.
Our desire was to create a portfolio of dividend income producing equities which would generate sufficient income to sustain our lifestyle without the need to liquidate investments other than for tax planning reasons. We certainly did not embark on our journey to become wealthier than Warren Buffett.
When constructing a portfolio it is imperative you do not view this process as merely investing in excellent companies. It is imperative that consideration be given to the value being assigned to a share in the company in which you wish to invest.
Allow me to use Cisco Systems, Inc. (NASDAQ: CSCO) as an example. CSCO is a company that has created substantial wealth for some investors. Other investors, however, are not so fortunate in that they decided to invest in CSCO in 1999 – 2000 at the height of the “dotcom” craze. At the time, Mr. Market valued CSCO on the basis that nothing could go wrong. When the bubble burst, the value of each CSCO share plunged and to this day, roughly 17 years later, each CSCO share has still not fully recovered to levels exhibited at the height of the “dotcom” craze.
Tax Implications for Canadian Residents
The vehicle in which you hold your equity investments will have an impact on your overall returns. If you are a Canadian investor, for example, you will likely want to hold any US listed investments in a “Registered” account (RRSP, RRIF, LIF, and LIRA) to avoid the US withholding tax on your dividend income.
If you hold US listed shares in a non–Registered account, a Registered Education Savings Plan (RESP), or a Tax Free Savings Account (TFSA), you will incur a non-recoverable 15% withholding tax on any dividend income.
The withholding tax could be greater than 15% if you have invested in American Deposit Receipts (ADRs). With ADRs, the withholding tax could apply regardless of the type of account (registered or non-registered) in which the ADR is held; the percentage withheld depends on the tax treaty between Canada and the country in which the company whose ADR you own is based. For example, withholding tax is levied on dividends earned from our Total S.A. (NYSE: TOT) (France) and Eni SpA (NYSE: E) (Italy) holdings but not on our Diageo plc (NYSE: DEO) (UK) dividends (these ADRs are held in various self-directed RRSPs). You may, therefore, wish to contact your broker/discount broker to ascertain the withholding tax rate before acquiring any ADRs.
Individual Equities Worth Considering – CDN and US Starter Portfolios
Once you have accumulated roughly $100,000 and have decided to invest in individual companies, I suggest you restrict your initial investments to the companies which typically have the largest weighting within ETFs and mutual funds.
As previously noted, there are repercussions as it relates to the types of equities held in various accounts. I have, therefore, created two possible starter portfolios. One is exclusively Canadian listed equities while the other is exclusively US listed equities.
Should you be a Canadian taxpayer and you are creating a portfolio of equities in a non–Registered account, a TFSA, or a RESP then you may wish to consider holding only Canadian equities in these accounts given the tax consequences I previously mentioned.
The equities reflected in these “Starter” portfolios would represent the core component of your portfolio. I view these companies as long-term holds that will continue to reward you, and most likely your heirs, with an increasing stream of dividend income.
I recognize you may disagree with some of the companies within my “Starter” portfolios. If such is the case, then merely replace them with companies you view as being more suited to your risk profile. My intent in creating these portfolios is to provide examples of companies I think will be able to reward you over the long-term.
Over the course of time you can then start to add other excellent companies to your portfolio. On the Canadian front you may wish to consider Scotiabank, Bank of Montreal, CIBC, Brookfield Asset Management, Sun Life, and Canadian Pacific Railway. On the US front you may wish to consider some of the names reflected in my FFJ Master Stock List.
Based on our personal experience, I strongly recommend you start at an early age to lay the groundwork to generate an ever increasing stream of dividend income that will require minimal additional effort on your part. In order to do this you will need to set priorities and will need to practice delayed gratification.
Start by investing in low cost broadly based ETFs. If you can, put the “pedal to the metal” and do what you can to accumulate a reasonable amount ($100,000 is my recommendation) so you can then branch out to investing in solid blue-chip companies with a track record of growth and in rewarding shareholders with steadily increasing dividends.
Focus on getting to the stage where your investments start throwing off dividends which can service some of your living expenses. Get to this stage and you’re pointed in the right direction on your journey toward financial freedom.
Note: I sincerely appreciate the time you took to read this post. As always, please leave any feedback and questions you may have in the “Contact Me Here” section to the right.
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long BCE, BAM.a, CNR, ENB, IFC, RY, SLF, T (Telus), TD, MMM, T (AT&T), TOT, E, DEO, ADP, BDX, CVX, XOM, JNJ, MCD, UPS and V.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.