This question ranks right up there with other tortured financial questions:
What is better: contribute to the RRSP or TFSA first?
What is better: focus on debt-reduction or asset accumulation?
How many dividend-paying stocks are enough?
It has been written that diversification is the only “free lunch” investors have. To help with this, every established dividend paying stock an investor adds to their actively managed portfolio, their portfolio volatility decreases. That’s a good thing, dividend investors need all the help they can get. As long as the number of diversified stocks in the portfolio increases, to a point, portfolio volatility should decrease and the relative risk for each stock in the portfolio will diminish. I guess one goal for dividend investors should be to reach a saturation point whereby the addition of one more stock in the portfolio marginally reduces volatility. To reach this goal, you’re gonna need more than a few stocks I’m sure…
Back to diversification, it is a serious issue for active investors. Too much weight in too few stocks or too many stocks in one particular sector can cripple a portfolio. For indexers using Exchange Traded Funds (ETFs), diversification isn’t really an issue; if you own some of the following products, a few companies removed in these ETF holdings are not going to change much of anything in terms of volatility or investment returns:
- CRQ (iShares Canadian Fundamental Index ETF) holds 89 companies.
- XIC (iShares S&P/TSX Capped Composite Index Fund) holds 248 companies.
Some giant U.S. ETFs hold even more companies than the ones above, WAY more. Heck, you could take away 50 or more companies within the following ETFs and never miss a beat:
- VWO (Vanguard MSCI Emerging Markets ETF) holds 900 companies.
- VXUS (Vanguard Total International Stock ETF) holds 6326 companies.
There is no way on earth I’ll ever own 6326 companies without an ETF let alone 89 held by CRQ. This is why I DO invest in ETFs, to take advantage of my free lunch. However, I also enjoying dining on dividend paying stocks that provide passive and sometimes rising income. Based on some books and articles written by some very bright people, I think 40 established dividend paying companies are plenty for me. Here is some support to back up this target:
“In our portfolios for individuals and institutions we tend to carry thirty to forty stocks.”
“The more stocks you have, the more your group will behave like an index.”
“If you don’t want to hold the thirty to forty stocks that satisfy my personal comfort level, you can reduce the number – bearing in mind that each reduction increases the risk that a single bad apple in your bushel will have an excessive impact on results.”
“Holding 100 stocks is yet another myth of the great Wall Street marketing machine.”
“If you’re going to do your own work/research, you should feel comfortable that with 25 to 30 names, you have enough diversification and you have enough skin in the game.”
“A popular rule of thumb asserts than an individual stock should represent no more than 5% of a portfolio. This would mean owning at least 20 stocks.”
“Some studies of past stock market performance have concluded that owning about 15 to 20 stocks provides the best return for the least risk.”
“Out of the many thousands of stocks I can choose from worldwide, I therefore really only need to look at 50 at most.”
While there will never be consensus on how many stocks are enough, by amateurs or experts alike, I think 40 established companies are plenty for me.
Regarding my dividend investing strategy
I figure 40 companies will be enough because an element within my dividend investing strategy is to review the stocks listed in many dividend ETFs as my starting point. I figure if some of the biggest equity ETFs in Canada and the U.S. hold many of these companies in their ETFs, I should too.
Take XDV for example. This ETF is comprised of the 31 highest yielding dividend paying companies seeking to replicate the performance of the Dow Jones Canada Select Dividend Index, based on factors such as stable dividend growth, yield and average payout ratio. To date, I’ve managed to build a portfolio (on my own) that includes about 50% of the companies held by XDV. I now own a proxy of this ETF. Either I can own XDV and pay the MER (0.55%) or I can own many of the companies directly and never pay management fees. I’ve chosen the latter. You can check out the other ETFs I follow under my Index Investing link above.
Admittedly, my target of 40 companies might be much higher if I didn’t:
1) Follow an indexed strategy using a couple of the ETFs above in my RRSP, and
2) Have a pension plan at work that I treat like secure bond in my portfolio.
For dividend investors, diversification is a serious issue that needs to be reckoned with and should never be dismissed lightly. Always remember with investing: “it is all too often true that the same things that maximize your chances of getting rich also maximize your chances of getting poor.” – Financial historian, celebrated author and neurologist William Bernstein.
Investors: How many stocks do you think are enough? Are 40 blue-chip dividend stocks too few to be successful? Tell me your thoughts!