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If a shared factor, such as interest rates or the price of oil, becomes unfavorable, your portfolio could significantly underperform the market. Picking stocks from different sectors and industries helps diversify away this risk because when some sectors are struggling, others are likely doing well. Sector diversification is important because you never know which areas of the market could come in or out of favor.
However, sector diversification should not come at the expense of violating valuation principles or extending outside of your circle of competence. Equally important, you should not diversify into a sector or industry that is outside of your comfort zone. For example, many conservative investors remain underweight the technology sector because its pace of change is too fast.
Trying to predict which tech companies will still be relevant in five years can be challenging. Stick to areas of the market you are comfortable with and use common sense as you look to diversify. Financial leverage magnifies returns received by equity holders and is one of the key factors to be aware of when searching for safe stocks. The more debt a company has, the more the price of the stock can fluctuate depending on business conditions. As such, companies with large debt loads and more cyclical business models usually have more volatile stocks.
If interest rates significantly rise and credit conditions tighten, some of the lower quality, highly levered firms could run into trouble. When constructing a portfolio, it is important to be aware of the overall credit quality of your holdings. Our Dividend Safety Scores place significant weight on these factors. Historically speaking, companies with small market caps have exhibited greater stock price volatility than large cap stocks.
The bigger the company, the more buyers and sells there are to trade shares back and forth. The availability of buyers and sellers is known as liquidity. When you enter an order to buy or sell shares of Coca-Cola, someone has to be on the other side of the trade and agree to your asking price for the trade to execute.
With fewer buyers and sellers, it is not always as easy to move in and out of positions, and the spread between the price that a seller is asking for and the price a buyer is willing to pay can become very wide. With less trading liquidity, small cap stocks can significantly outperform or underperform large cap stocks in different market environments.
Small cap stocks are also more volatile because their businesses are often less diversified than large caps. Expect your portfolio to also demonstrate greater volatility if it is mostly composed of small cap stocks. Source: Simply Safe Dividends. In addition to the four risk factors mentioned above, investors should understand beta price volatility and take advantage of their long-term holding periods to improve their dividend portfolios. By definition, the market has a beta of 1. A stock that swings more than the market over time has a beta above 1.
Smaller companies with high amounts of financial leverage and less predictable business models will usually have higher betas. While beta is backwards-looking i. A portfolio filled with stocks that have beta values greater than 1. Importantly, beta is based on relatively near-term price volatility ignores underlying business fundamentals. In other words, for long-term dividend investors, a high or low beta does not indicate whether or not an investment will be successful over the next five years.
It is generally better to own shares of a quality, growing business trading at a reasonable price than remain on the sidelines trying to time the market or play the quarterly earnings game. Let your long time horizon work for you. Building a dividend portfolio is part art, part science. Keeping the above factors in mind, you should review your personal goals.
Are you nearing retirement and looking to create a safe and steady stream of income to live off of? Are you investing for your grandkids, looking for more balance between income and long-term capital appreciation? What is your risk tolerance?
How much time are you willing to commit to stay current with your portfolio? Answering these questions will influence how many dividend stocks you choose to buy and the characteristics of each stock dividend yield, price volatility, Dividend Safety Scores, etc.
For investors interested in reviewing the risk profile of their existing dividend portfolio, you can input your holdings in our Portfolio tool to see your diversification by stock, sector, dividend income, and more.
You can get started by clicking here. Living off dividends in retirement is a dream shared by many investors. We have all been there. High dividend stocks are popular holdings in retirement portfolios. Learn about the 20 safest high yield stocks for dividend income. Download a list of all of Berkshire Hathaway's dividend-paying stocks, including their yields and Dividend Safety Scores.
See the complete dividend aristocrats list. The investment is measured for a specific time period, and then the absolute performance can be used to compare it to other benchmarks and portfolios to see what the relative performance has been. Relative performance is the difference between absolute return on a security or portfolio and the benchmark return. There are various types of benchmarks when calculating relative performance.
Rolling Returns: There are several portfolio measurement options and they generally fall into two categories — a single period and a multiple time period measurement. The latter is known as a rolling return measurement. This requires that the account be revalued every time there is an incoming cash inflow or outgoing cash flow. The formula for TWR is:.
Regarding MWR, it measures the compound growth rate in all funds investment in the account over the evaluation period. Essentially, the MWR is the discount rate where the present value of all cash inflows equals the present value of all cash outflows. Shown below, we have a portfolio over three 3 periods with different beginning and ending values, and various cash flows throughout the period. From here, we first calculate the period return i. The same is calculated as the ending value of a period minus any cash flows in that period divided by the beginning value of the period minus 1.
This eliminates the effects of portfolio cash flows on the returns which are calculated below.