Can ETFs and Stocks Coexist in a Portfolio?

Can ETFs and stocks coexist in a portfolio and make that portfolio better? ETF or index ETF investing versus do-it-yourself dividend growth investing is always a big debate. You know I favor stock investing, but I keep an open mind. There is room for ETFs even if you invest in stocks.

I see both ETF investing and dividend growth stock investing strategies work very well. Should you put both in your portfolio? It depends. Let’s elaborate.

So yes, I see situations in which combining individual stocks with an ETF, or several ETFs makes a lot of sense.

Listen to Mike’s podcast.

Adding different asset types to your portfolio

Combining ETFs with some dividend growth stocks works well if you want to have several types of assets, exposure to several markets, and not have to spend too much time building that up and monitoring it.

You could start with an all-in-one ETF that has exposure to fixed income, maybe to some basic materials stocks, international markets, and the U.S. market. Use this to build your core portfolio without too much effort. Perhaps 50% of your portfolio is that ETF or split between two ETFs that don’t overlap. Your ETF is rebalanced automatically and gives you exposure to the markets and other types of assets like bonds or preferred shares that you want.

Chef adding a pinch of spice to a dish on a plate
Add the right “ingredient” to your portfolio

Then you add a few stocks that you like that you want to follow regularly, maybe a dozen stocks to complete the portfolio. This could work very well because you are well-diversified; a very smart way to build a portfolio.

It’s like cooking; you have your basic recipe and then add a few spices on the side, your special ingredients that make the soup even better. Start with an ETF that holds many ingredients and add a few dividend growth stocks as special ingredients.

Adding exposure to specific markets or sectors

It’s also logical to combine ETFs and stocks in the opposite situation, one in which you have a well-diversified portfolio of stocks—perhaps about 30 stocks—but you want exposure to a specific market or a specific sector.

You could use ETFs to invest in emerging markets for maybe 5 or 10% of your portfolio. Investing in emerging dividend growth stocks can be quite difficult. Adding an ETF tracking emerging markets does the job.

You could also add an ETF to get exposure to a sector or industry, artificial intelligence for stocks, or the whole information technology sector for example. If you don’t know how to choose individual stocks in this sector, or you’re concerned about their current high valuation and  P/E ratios, adding an ETF can work well. It completes your portfolio adding more diversification without having to spend a lot of time and energy trying to understand a sector you’re not comfortable with. See our post about sectors and industries to learn more.

Remember investing has a lot to do with having confidence in your strategy to not worry when the market goes down. The best way to have confidence is to make sure that you understand what you own and why you own it.

Get great stock ideas in our Rock Stars list, updated monthly!

Two ways to make ETF and stocks work well together in your portfolio are having a core ETF portfolio and adding some stocks you like and want to monitor, or having a portfolio of stocks and selecting specific assets or specific sectors you want to have exposure to and go with ETF.

However, there are scenarios where combining stocks and ETFs in your portfolio is a bad thing.

Beware of duplication

Venn diagram shoing overlap between ETFs and individual stocks in a portfolio
Overlap producing duplicate holding don’t help your portfolio

A common investing mistake is having an overlap between ETFs and the stocks in a portfolio. For example, you invest in an ETF tracking the Canadian market. Then you add Canadian stocks for banks, pipelines, telcos, and utilities. A lot of these stocks are included in your ETF, so you’re just adding more of the same.

The problem with that is that you don’t know your complete exposure to each individual stock that you own because you also have some through the ETF. You could end up with 10% of your portfolio in TD Bank without even knowing it or wanting it. Combining an index ETF with individual stocks in the same market requires a bit more work to avoid overlap between them; look at the top ten or 20 holdings of ETF you have, to ensure you don’t buy those individual stocks.

Just like cooking: adding coarse salt, sea salt, and Himalayan salt won’t make your dish better, just saltier. Add too much, and it’s inedible.

Get great stock ideas in our Rock Stars list, updated monthly!

Don’t over-diversify

More and more often becomes…too much!The second mistake is going on a shopping frenzy. Let’s say you bought a bunch of ETFs because you love to go from one idea to another or because they all just look so good! Then, you add stocks over and over again. You’ll end up with too many holdings in your portfolio.

Having 40 stocks plus 10 ETFs doesn’t make your portfolio better. You lose yourself in your diversification and strategy because you have so many different things. Several of your holdings, especially stocks, will be less than 2% of your portfolio; they don’t add much value to your portfolio returns; if they double in price, you won’t even notice.

Crowded beach
More and more often becomes…too much!

Combining a bunch of ETFs with a bunch of stocks is over-diversification or “diworsification”, making your portfolio worse. You’ll spend so much time and energy monitoring everything in your portfolio without necessarily getting any added value. You might suffer from paralysis by analysis as too much information to track and analyze leads to doubt. Most importantly, key information can fall through the cracks. As an investor you’re responsible for your portfolio, you must know what’s going on. Losing track is bad.

The takeaway

ETFs and stocks coexisting living together in a portfolio is a good idea if you’re able to build a core portfolio of ETFs and add some stocks that aren’t duplicates. Buying ETFs also works to add exposure to specific asset types, sectors, or markets you aren’t exposed.

Having duplicate holdings is a problem, as is over-diversification. Having 60 lines in your statements is not good. It leads to doubt, paralysis by analysis, and loss of control over your investments.

The post Can ETFs and Stocks Coexist in a Portfolio? appeared first on The Dividend Guy Blog.

Over Diversification is a Big Problem [Podcast]

Subscribe

Sector allocation and diversification are essential aspects of a portfolio. But sometimes, too much is as hurtful as too little… Let’s discuss diworsification, its impacts, and how to maintain a well-balanced portfolio.

Download the Dividend Rock Star List and Pick among the Best Assets Only!

You’ll Learn

  • We must first define good diversification. What does it mean to have a balanced portfolio?
  • Although investing across all 11 sectors is not a problem per se, it could become a burden if investors select industries they don’t understand just for the sake of diversification. Mike explains why you don’t need all 11 sectors.
  • A similar issue sometimes happens for investors who want to invest in international markets. The principle is not wrong, but why is it better to limit ourselves to 2 or 3 markets? The answer is between taxes, currency, lack of context and weak regulations.
  • The biggest problem comes when an investor has 60, 70, 80, or even 100 stocks in his portfolio. The first issue is time. Analyzing so many companies quarterly quickly becomes heavy. How could lacking time harm someone’s portfolio?
  • An aspect that has a more significant impact than expected is how businesses are interconnected. A problem with one could hurt many. Mike gives the example of Home Depot (HD) and Tractor Supply (TSCO).
  • Over-diversification often means buying very similar companies in the same industry. For example, investors buy all the Canadian Banks, all the AI stocks, or all the big oil companies. An investor’s portfolio could be significantly affected if a recession impacts one or many industries. How many holdings per sector would Mike recommend to investors?
  • Also, buying many companies with the same business model could lead someone to pick a weaker one instead of focusing on the best assets only.
  • Let’s talk about performance. Are portfolios with 70-90 holdings offering better, weaker, or similar performance than those with 20-40 stocks?
  • In summary, the more stocks in your portfolio, the more diluted the results. So, while investors may feel they reduce risks, they also reduce their wins.
  • Vero wants to offer listeners a solution to prevent them from over-diversifying their portfolios. What’s the best way to avoid this and maintain a well-balanced portfolio?

Related Content

You can watch our most recent webinar here!

For even more tools on diversification, we highly recommend our Subsectors Series!

Insights into Military & Aerospace and Banks – Subsectors Series [Podcast]

How has Mike’s buy-and-sell process served him so far? We put it to the test last week!

Stocks Sold: A Look Back at Mike’s Trades [Podcast]

Learn more about DSR Stock Comparison Tool in the video below.

Subscribe


The Best Dividends to Your Inbox!

Download our Dividend Rock Star List now and do not miss out on the good stuff! Receive our Portfolio Workbook and weekly emails, including our latest podcast episode!


Follow Mike, The Dividend Guy, on:

  • Twitter
  • YouTube
  • Facebook

Have Ideas? 

If you have ideas for guests, topics for The Dividend Guy Blog podcast, or simply to say hello, then shoot me an email.


This podcast episode has been provided by Dividend Stocks Rock.

The post Over Diversification is a Big Problem [Podcast] appeared first on The Dividend Guy Blog.

Investing in Real Estate Through REITs

Real estate investment through REITs (Real Estate Income Trusts) is not only popular because REITs distribute generous dividends, but also because they’re easy to understand. We can easily picture an apartment building or an office tower and imagine tenants paying their rent. Investors are willing to purchase units of those businesses in exchange for income and peace of mind.

Toy house and a keyREITs are landlords; they own and manage real estate in exchange for rental income. They have properties such as apartment complexes, hospitals, office buildings, timberland, warehouses, industrial facilities, data centers, hotels, and shopping malls.

By their very nature, REITs offer great investment opportunities. A growing economy leads to growing needs for properties. REITs can grow organically as the population requires more industrial facilities, healthcare centers, offices, and apartments.

Get great stock ideas with our Rock Stars list, updated monthly!

REIT types

Equity REITs own and invest in property. They might own a diversified set of properties, and they generate income primarily in rent payments from leasing their properties. Mortgage REITs finance property. They generate income from interest on loans they make to finance property. Hybrid REITs do a bit of both, as they own some property and finance other property.

Most REITs are equity REITs and they must follow these rules:

  • Invest most of their assets (75%) in real estate or cash equivalents. They cannot produce goods or provide services with their assets.
  • Receive at least 75% of their income from those real estate assets in the form of rent, interest on mortgages, or sales of properties.
  • Pay a minimum of 90% of their taxable income as dividends (also called distributions) to shareholders. Therefore, the classic earnings per share (EPS) and dividend payout ratios metrics aren’t well-suited to gauge the health of a REIT.

Sector strengths

REITs are unique in that they exist to pay generous distributions, making them a favorite for retirees! It’s easy to understand how most of them offer relatively high dividend income. This is one of the rare sectors where you can find “relatively safe” stocks paying 5%, 6% even 7%+. We must not get too greedy, though. Several REITs cut their distributions due to poor management or economic downturns.

Along with higher yields, REITs usually bring stability to a portfolio. It’s a great sector to start with if you’re looking for additional income. Real estate brings great diversification to your portfolio.

Finally, most REITs have built-in protection for their income in their leases. Many use escalator contracts that include yearly rent increases to ensure rental income matches inflation. This makes REITs a good protection against inflation for investors. Some REITs also operate a Triple-Net model where tenants are responsible for insurance, taxes, and maintenance costs. This not only reduces the REIT’s expenses but also its risk of unexpected charges!

Learn about our top-3 favorite Canadian REITs.

Sector weaknesses

real estate investment: Looking up at skyscrapers from street levelOne way REITs finance new projects is by issuing more units (shares). If a REIT purchases a property generating income of $20M/year, but issues more units to finance the purchase, you must consider the net outcome for unitholders. With REITs, the amount of profit per share is measured using the Funds From Operations (FFO) per share/unit metric.

Despite the new real estate, its $20M of income, and some new profit, the FFO per unit could drop because of the additional units that were issued to buy it. This isn’t necessarily good for investors as it affects the REIT’s ability to raise its dividend later on. Financing with new units can be difficult in a down market because investors will want to pay a lower price for the units.

The other way REITs finance projects is with debt. Some REITs are highly leveraged which won’t end well with the current state of interest rates. High interest rates also hurt tenants. REITs can increase the rent, but only if tenants can pay. In a recession, some tenants might encounter difficulties and eventually fail to pay rent. That has an immediate impact on the REIT’s FFO.

Another downside of REITs is rigidity. We’ve seen several REITs try to shift from one industry to another. In most cases (H&R, RioCan, Boardwalk, and Cominar come to mind), the shift comes with a dividend cut and a loss in unit value. Wanting to get rid of shopping malls to buy industrial properties probably means selling at a price lower than what you’ll pay for the more appealing assets. RioCan seems poised to get back on track, yet still pays a very low distribution compared to 2019.

Finally, don’t be fooled into thinking that real estate investing through REITs is safer than other sectors. REITs face challenges while benefiting from tailwinds. While it’s true that an apartment building can’t go anywhere, having one hundred empty apartments due to an oversupply in a neighborhood means your investment can’t go anywhere either.

Get great stock ideas with our Rock Stars list, updated monthly!

Getting the best of the sector

While REITs are on the short list of sectors that are perfect for retirees or other income-seeking investors, it’s important to understand you cannot analyze them using the same metrics as other sectors.

The Funds from Operations (FFO) and Adjusted Funds from Operations (AFFO) are the most useful metrics to analyze a REIT’s financial performance. They replace the earnings and adjusted earnings for a regular stock.

We can find those metrics in REITs’ quarterly reports and related press releases. It’s important to also follow the FFO/AFFO per unit (share) of a REIT. This is akin to EPS and Adjusted EPS for stocks in other sectors.

FFO = Earnings + Depreciation (Amortization) – Proceeds from Property Sales

AFFO = Earnings + Depreciation (Amortization) – Proceeds from Property Sales – Capital Expenditures

The loan-to-value ratio (LTV) is useful to analyze a REIT’s ability to raise low-cost capital. You can calculate the LTV using these two pieces of data from the financial statements:

LTV = Mortgage Amount / FMV (fair market value) of properties

A REIT showing a high LTV might have its credit rating at risk, making future debt pricier, and leaving less money for dividends.

Another metric to follow for a REIT is Net Asset Value (NAV). The NAV (usually shown by units) is analogous to the Price-to-Book ratio.

NAV = Total Property Fair Market Value – Liabilities

Use the metrics to compare a few REITs against one another and to find those with the best results. A lower-than-industry average NAV is either a riskier play or a value play. The AFFO and LTV will tell you which one it is.

Should you invest in REITs?

The REIT sector is best for income investors. Target sector weight: For income-seeking investors, you can aim at 15% to 30% (if you invest in various industries). For growth investors, REITs could represent a 5%-15% portion of your portfolio.

Some of my favorites:

  • U.S.: Stag Industrial (STAG), Essex Properties (ESS), Equinix (EQIX), American Tower (AMT), Realty Income (O).
  • Canada: Granite (GRT.UN.TO), CT REIT (CRT.UN.TO), InterRent (IIP.UN.TO), Canadian Apartment Properties REIT (CAR.UN.TO)

The post Investing in Real Estate Through REITs appeared first on The Dividend Guy Blog.

Stocks Sold: A Look Back at Mike’s Trades [Podcast]

Subscribe

There are three main good reasons to sell. How has Mike’s buy-and-sell process served him so far? Was he right to sell Disney (DIS), McDonald’s (MCD), Andrew Peller (AW.UN.TO), or Algonquin (AQN)? Here’s a look at these and more of Mike’s trades and what investors can learn from them.

Download the Dividend Rock Star List and Pick among the Best Assets Only!

You’ll Learn

  • Before we dive into the companies, Mike reminds us of the main reasons for selling your shares: investment thesis & dividend triangle, dividend cut, and trimming.
  • Mike used to be a big fan of Disney (DIS). In 2020, it suspended its dividend due to the pandemic, shutting down its principal business activities. After three years of waiting for a dividend, Mike sold his assets at the end of 2023. However, Disney has now reinstated a small dividend payment. Does he still believe his decision was the best?
  • The pandemic also greatly impacted CAE, leading the company to suspend its dividend. Again, Mike sold his shares in late 2023 since they no longer fit his investment thesis. A couple of months later, how does he look back at this trade, and what are his current thoughts about CAE?
  • Mike waved goodbye to Andrew Peller (AW.UN.TO) some years ago because of significant changes in its business model. How is the company doing now? Was it a good move to sell?
  • Mike sold Algonquin (AQN) about a year ago. Still, he keeps getting asked about its potential recovery. So Vero asked a different question this time. With AQN as an example, what would make him interested in looking back at a company he sold?
  • Despite its dividend king title, 3M doesn’t show the same glow it used to have. How does Mike look back at it?
  • Mike sold his shares of McDonald’s (MCD) a while back. Does he consider his decision a mistake?
  • The last is a company that Mike likes. However, he still sold his shares. Why did he buy Gentex (GNTX), and what made him sell it?
  • Mike ends by sharing his best tips for selling and never looking back.

Related Content

In March, we shared 4 Tools to Buy and Sell with No regrets. Catch them up!

4 Tools to Buy and Sell With No Regrets [Podcast]

How do you know when to cash in on your winners? A stock is up 20%-50%-75%. Will it keep going up? Is it about to crash? You feel you should sell, but you like that stock…

When to Cash in on Your Winners

Subscribe


The Best Dividends to Your Inbox!

Download our Dividend Rock Star List now and do not miss out on the good stuff! Receive our Portfolio Workbook and weekly emails, including our latest podcast episode!


Follow Mike, The Dividend Guy, on:

  • Twitter
  • YouTube
  • Facebook

Have Ideas? 

If you have ideas for guests, topics for The Dividend Guy Blog podcast, or simply to say hello, then shoot me an email.


This podcast episode has been provided by Dividend Stocks Rock.

The post Stocks Sold: A Look Back at Mike’s Trades [Podcast] appeared first on The Dividend Guy Blog.

When to Cash in on Your Winners

All investors share a goal. Making profit. How do you know when to cash in on your winners? A stock is up 20%-50%-75%. Will it keep going up? Is it about to crash? You feel you should sell, but you like that stock… Selling winners isn’t easy.

Costco stock price over 5 years shows that selling for a profit can make you miss out on a lot of growth
Sell Costco at $385 because of a gain cap trigger

Some put a limit on the stock price gain, for example, when they’re up 50% they sell the position. As a dividend growth investor, I choose stocks I want to keep for a long time, not for a quick buck. When you hold on to solid holdings for a long time, you can get to triple-digit growth—much more interesting than 50% isn’t it? Patience can generate a lot more return than selling triggered by a cap on value appreciation.

That said, there are appropriate moments to cash in on your winners. Below, I’ll explain what I do to decide whether to sell, or trim, my winners.

Never miss a thing! Subscribe to our newsletter here.

Why sell?

I have two main reasons to sell a winning position or trim it of a few shares. The first is when my motives for buying the stock aren’t valid anymore. In other words, things have changed for the company and my thesis for investing in it in the first place is no longer true.

The other reason relates to portfolio management. When a position becomes too large, i.e., it’s overweight, my portfolio isn’t perfectly balanced, and my exposure to risk increases. Let’s look at these in detail.

Stock no longer fits my investment thesis

Magnifying glass
Review if your investment thesis is still valid

Every quarter, I review all holdings in my portfolio to see how they’re evolving with their most recent quarterly results. For each stock, I verify whether my investment thesis is still valid.

The investment thesis is the narrative, the story that explains why I bought the stock in the first place. It explains what I found compelling about the company and why I’d want to hold its stock forever (or 10 or 20 years).

For example, what made me confident and liked about Alimentation Couche-Tard (ATD.TO) is that: it was constantly growing by acquiring other convenience stores around the world, and also innovated to grow organically, for example, by selling fresh produce, coming up with new promotions, digital transactions, loyalty programs, etc.

During my review, I’ll see if this story changes. If ATD stops acquiring other companies or runs out of ideas for organic growth, I’ll flag it and I might eventually sell.

Backing it up with the numbers

During my review, I look beyond the narrative. Numbers. I review the dividend triangle to see the company’s trends for revenue, earnings, and dividend growth.

tree leaves, from green to red, hanging from a string
Change happens!

When the investment thesis no longer applies, looking at the triangle can confirm my suspicion that the stock isn’t as appealing as it once was. If I see revenue and earnings growth slowing down, dividend growth will likely slow down too, eventually. The company is not the company I bought originally.

I’m not trigger-happy. I don’t sell immediately following one poor quarter. However, if it’s one bad quarter after another, and my thesis isn’t right anymore, it’s time to sell and cash in my profit. Sticking to a quarterly review gives me great odds of being able to spot the issues and sell while the stock price is still high, making a nice profit.

Overweight sectors or positions

Should you cash in on your winners that still match my investment thesis and show good growth trends, as is the case with ATD.TO?

I like to let such winners run, but I might trim them if it’s needed. You see, my quarterly ritual includes reviewing my portfolio sector allocation and stock weight.

Am I overweight in a sector? If so, I could suffer a lot if a crisis happens in this sector. Remember tech stocks in 2000? I will trim winning positions in an overweight sector to rebalance the portfolio.

Overweight positions

Type of scale that we see at a doctor's office
Trim overweight positions

How can you tell you’re overweight on a single holding? That depends on two factors: how many stocks you want in your portfolio, and how much you are willing to lose on a single bad investment.

If you want 40 stocks, having equal-weighted positions means each stock should occupy 2.5% of your portfolio (100/40). If it’s 30 stocks, then each one would occupy 3.33% of your portfolio. You might let your favorite stocks exceed that maximum weight at 4% or more, with others occupying less than 3.33%.

As stock prices fluctuate, your stocks’ weight changes. Some winners can exceed the maximum weight by a lot. You can trim such positions right away by selling enough shares to get their weight back to where you want it.

But I love this overweight stock…

Bored woman sitting at computer, chin on her had looking away from screen
“How much am I willing to lose on a single position?”

We get attached to our winners; I know. If your investment thesis for the company is still valid and the numbers back up your feelings, ask yourself how much you’re willing to lose on a single bad investment. Is it $5K, $10K, or $20K? You come up with this arbitrary amount based on your situation and risk tolerance. Let’s say it’s $20K and your portfolio is worth $800K; you’d be okay with losing (20/800*100) = 2.5% of your portfolio on a single bad investment

The worst that happens on the market is a ~50% crash of its value. We saw this when the tech bubble burst in 2000 and during the 2008 financial crisis. With that in mind, look at your overweight position: if it drops 50% in value tomorrow, is that loss lower or higher than 2.5% of your portfolio? If it’s more, time for a diet! Trim that position, even if you love the stock.

Knowing that the worst market loss is ~50%, and you’re okay losing 2.5% of your portfolio value, your maximum weight per stock is 5%. Trim any position that exceeds 5% to rebalance your portfolio and reduce risk.

Overweight winners are usually stocks that have performed well and gained value. Trimming them by selling a few shares lets you cash in on your winners while staying invested in the company to benefit from its future growth.

Liked what you read? Don’t miss anything. Subscribe to our newsletter here.

In retirement

If you are retired, you might have to cash in on your winners by selling a few shares to supplement your income. Perhaps your dividend income isn’t enough, inflation outpaced dividend growth in your portfolio, a holding cut its dividend, or extra expenses came up. Whatever the reason, these guidelines can help you choose which stocks to sell, how much to sell, and feel good about it.

The post When to Cash in on Your Winners appeared first on The Dividend Guy Blog.