Building an income portfolio made easy. Really? Yes! While there are mountains of books on portfolio building, it’s easy to go down the rabbit hole and get lost in tons of theory.
Here is a simple approach to building a portfolio that holds a good mix of dividend growers, which is what I believe to be the best way to create dividend income for life.
Most of your portfolio return is explained by your asset allocation and your sector allocation. If you’re mostly invested in fixed income products during a stock market crash, you will do well. If you moved your money into the energy sector at the end of 2020, you look like a genius today. In both cases, the allocation was the key to the success.
Get more in-depth information. Download our guide.
Since I’m a passionate dividend growth investor, I’ll leave the asset allocation discussion for another day, to focus on sector allocation. In short, there are 11 sectors that we can sort into three categories:
- Income/stability: Sectors where you find many mature businesses that are recession- resistant.
- Growth: Sectors where you find companies with multiple growth vectors, able to surge during economic booms.
- Both: Sectors where you find companies showing a balance between growth and stability.
| Income/Stability Sectors | Growth Sectors | Sectors Balancing Both |
| Consumer Staples | Consumer Discretionary | Financials |
| REITs | Information Technology | Communication Services |
| Healthcare | Energy | Industrials |
| Utilities | Materials |
To explore each sector thoroughly and learn each’s strength and weaknesses, I invite all DSR members to review our DSR fundamental newsletters about sectors and how to get the best of each one. If you’re not a member, you just found another great reason to subscribe 😉😉. In the meantime, here are answers to questions you might have about sector allocation.
Get more in-depth information. Download our guide.
Do I need to invest in all 11 sectors?
Not at all. You must invest in sectors that fit with your goals, i.e., stability vs growth, and that you understand. There’s no point in investing in tech stocks if you have no clue how the semiconductor industry cycles work. When investments are down, you won’t be happy, but if you understand the industry’s characteristics, you won’t panic.
How much to put in each sector?
Again, there are no hard rules here. I like to have a maximum 20% invested in my favorite sectors and around 10% in others. However, it happens that I go above 20% due to the great performance of a few companies. I make sure that I invest in various industries within the same sector to avoid getting wacked by a single market event.
For example, there is a big difference between having 25% invested in financial services that is spread across five Canadian Banks with 5% in each one, and having 5% in each of the following: Royal Bank (Canadian bank), BlackRock (asset management), Visa (payment processor), Great-West Life (life insurance) and Brookfield Corp (alternative asset management).
Which sectors are best?
There are no best or worst sectors, but rather good timing for specific sectors. Investing in the energy sector in 2015 or at the end of 2020 would have created two completely different outcomes. Again, the best sectors are the ones for which you understand how the companies run their businesses.
Get more in-depth information. Download our guide.
Number of stocks per sector?
That depends on how many stocks you want to hold in total and how many sectors you want to invest in.
You can select the best 2, 3, or 4 companies in each sector you want exposure to. That would likely lead to a 20-40 stocks portfolio. Purely by chance, that’s very close to what I think is the ideal number of stocks.
Number of stocks in my portfolio?
Holding fewer than 20 stocks means the room for error is thin. This strategy could be great for high-conviction investors, but I prefer securing a little bit more diversification.
On the other end, if you go above 40, you’re getting closer to building your own ETF. Monitoring 70 companies quarterly will prove daunting and you’ll eventually miss information. Also, if a stock represents 0.32% of your portfolio, even if it doubles in value or crashes by 80%, you will never feel it.
To help you select stocks see also Stock Buying Process – Here’s What I Do.
How to select one stock over another in a sector
As you dig into a sector you might find more than one company that looks interesting. But buying four railroad companies or five Canadian banks won’t improve your diversification. You must find a way to compare more than one industry in the same sector.
The first step is to understand each business model and identify their differences. For example:
- Pepsi Vs Coca-Cola: PEP is 50% snacks, 50% beverage while KO is all about beverages.
- TD Bank vs Scotiabank: TD is 2/3 in Canada, 1/3 in the U.S. while BNS is concentrated in Canada and expanded its business in Central and South America.
If you don’t find a business model more appealing than the others, compare numbers. I usually go with the companies with the strongest dividend triangle (5 years of revenue, EPS, and dividend growth). At DSR PRO, we’ve created a stock comparison tool that does the hard work for you:
You can add as many companies as you want to look at a sector or an industry. It’s usually easier to use hard data to make a choice.
Now that you know how to create an income portfolio, learn how you can create your own dividend from that portfolio, in Create Your Own Paycheck in Retirement.
