Dividend growth investing is a powerful way to compound wealth over the long term, especially if you know what you are doing. In this article, we will discuss the why, the how, and the what of building a high yielding dividend growth portfolio with funds.
Why Dividend Growth Investing Works
This is because:
- You get a more consistent sequence of returns given that dividends are generally much more stable and predictable than stock price appreciation given how volatile the market can be at times. Moreover, a rising dividend tends to provide a floor of sorts for the stock price as income-oriented investors are likely to swoop in and purchase shares if the stock price gets too low and the yield gets too high.
- Dividend stocks – and especially dividend growth stocks – tend to outperform the market over the long-term thanks to the inherent quality and shareholder friendliness of companies that can pay rising dividends year after year over the long-term.
- You get exponential passive income growth as your dividend income grows from both per share dividend growth and the effective of reinvesting dividends into purchasing additional shares.
- It helps investors to keep a cool head and continue to buy shares of dividend stocks whenever the market crashes since their focus is on the passive income, not short-term gains.
How To Build A Dividend Growth Portfolio For Lifelong Passive Income
Building a dividend growth portfolio that can last a lifetime ultimately boils down to finding stocks that have the following qualities:
- Durable and defensive business models so that they can sustain their dividend payouts through good times and bad as well as during periods of rapid technological disruption.
- Strong balance sheets so that even if their underlying business model experiences a period of weakened profitability and/or negative cash flow, they still have reserves that they can tap into to tide them over until the macroeconomic environment improves.
- A well-covered dividend payout which gives them some margin of safety in the event that their cash flow declines for a period of time as well as excess cash flow to reinvest in strengthening and even growing the business.
- A growing payout over time which helps to offset the corrosive effect of inflation while also helping to drive the share price higher as well as the market adjusts the share price to the higher dividend payout.
- A high enough starting yield which gives investors a healthy return without needing to depend on much less predictable growth rates and stock price appreciation. Moreover, if your goal is to retire on dividends, a higher starting yield can help accelerate your retirement timeline.
While these principles apply to individual stocks, they can also apply to funds like exchange-traded funds, or ETFs, and closed-end funds, or CEFs, with some slight modifications:
- Well-diversified ETFs mitigate the risks associated with factors 1-3.
- Factors 4-5 still apply to dividend ETFs.
A Model 6%-Yielding Dividend Growth ETF Portfolio
With this in mind, here is a model 6%-yielding dividend growth portfolio made up of the following CEFs and ETFs:
Tickers | % Allocation | Yield |
SCHD | 35.00% | 3.5% |
SPY | 10.00% | 1.4% |
RQI | 15.00% | 7.9% |
AMLP | 15.00% | 7.9% |
UTF | 25.00% | 8.3% |
Total | 100.00% | 5.8% |
1. Schwab U.S. Dividend Equity ETF (SCHD)
The largest individual holding in this portfolio by far is SCHD, which is the gold standard for dividend growth ETFs due to its attractive combination of diversification across 104 individual holdings balanced across numerous sectors, quality underlying holdings that include the likes of Broadcom (AVGO), The Home Depot (HD), and Coca-Cola (KO), low expense ratio of just 0.06%, decent current yield of 3.5%, and impressive 5-year dividend CAGR of 13.05%. Using this as the core component of a dividend growth portfolio provides a powerful dividend growth machine without sacrificing too much yield.
2. SPDR® S&P 500 ETF (SPY)
As the best-known S&P 500 ETF with significant options market liquidity, SPY gives investors the option of selling covered calls if they want to further enhance this component of the portfolio’s yield beyond the meager 1.4% it offers on a standalone basis. Otherwise, the reason behind holding this fund is simple: it gives investors significant exposure to mega cap technology stocks like Microsoft (MSFT), Apple (AAPL), Nvidia (NVDA), and Meta Platforms (META), as well as the world-class investors at Berkshire Hathaway (BRK.A, BRK.A) without sacrificing too much yield.
3. Cohen & Steers Quality Income Realty Fund (RQI)
Given that both SPY and SCHD have very little exposure to real estate, RQI serves as a very well-managed, monthly paying, high yield holding that gives us significant exposure to one of the best long-term passive income investment asset classes. Its dividend weathered the headwinds of COVID-19 without being cut at all and with blue chips like American Tower (AMT), Prologis (PLD), Realty Income (O), and Simon Property Group (SPG) at the stop of its portfolio, it is well-positioned to weather future headwinds.
4. Alerian MLP ETF (AMLP)
Given that the portfolio lacks any meaningful exposure to energy elsewhere and the sky-high and very well-covered distributions in the midstream energy space right now, AMLP is an obvious candidate for any sustainable high-yield portfolio. With its top holdings including some of the best blue chips in the sector such as MPLX LP (MPLX), Energy Transfer (ET), and Enterprise Products Partners (EPD) – all of whom have stellar balance sheets, well-covered distributions, and solid distribution growth outlooks – AMLP is likely to not only sustain but grow its payouts for years to come.
5. Cohen & Steers Infrastructure Fund (UTF)
Last, but not least, UTF rounds out our portfolio with a very attractive monthly payout that – like its fellow Cohen & Steers fund – weathered the COVID-19 lockdowns without being cut and exposure to some very high quality infrastructure holdings diversified across 254 individual stocks. Its top holdings include NextEra Energy (NEE), Southern (SO), TC Energy (TRP), Enbridge (ENB), and Union Pacific (UNP).
Risks
While this portfolio appears to generate sustainable passive income through good times and bad, no investment is risk-free. Keep in mind that both RQI and UTF implement a modest amount of leverage in order to enhance yield. As a result, while they have navigated crises and challenging environments in the past well, there is no guarantee that they will be able to do so again in the future and – should they fail – there is a risk of outsized losses. Moreover, SPY could experience headwinds if mega-cap tech stocks have a correction after their very strong run in recent years. Finally, AMLP can be volatile given that its underlying holdings tend to trade in tandem with the broader energy sector (XLE) even though their cash flows are largely energy price resistant.
Investor Takeaway
Dividend growth investing is one of the most proven and user-friendly approaches to compounding wealth over the long-term, regardless of what your current age is. By using a diversified basked of quality ETFs, investors can make that process even easier and simpler. While we like to pick our own stocks because we have been able to enhance our returns and yields through that method, building a portfolio similar to the one provided in this article may work just as well.
As always, keep in mind that this article is a mere thought exercise and is not personalized financial advice. Be sure to consult with your own financial advisor/planner to devise an investment strategy that is suitable to your personal situation.
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