How to diversify a dividend-yield portfolio

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vineviz
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How to diversify a dividend-yield portfolio

Post by vineviz »

Despite many rational arguments to the contrary, a significant subset of investors seem to have an intrinsic preference for cash dividends. This has been discussed many times on this board.

I personally think this preference is irrational, but I'm slowly coming to believe there is limited usefulness in trying to convince investors to change their innate preferences.

To that end, I became curious about what an optimally diversified yield-oriented ETF portfolio might look like. Starting with a list of Vanguard funds and supplementing it on the fixed income and small cap side, I used a method similar to my previous look at effective number of bets to narrow down the universe to an efficiently diversified portfolio.

I'll spare the gory details and tell you that what I ended up with is this:
  • SPDR ICE BofAML Crossover Corp Bd ETF (CJNK)
  • Vanguard High Dividend Yield ETF (VYM)
  • Vanguard Intl Hi Div Yld Idx ETF (VYMI)
  • SPDR SSGA US Small Cap Low Volatil ETF (SMLV)
  • Vanguard Utilities ETF (VPU)
You could allocate between the funds as you choose, obviously, but it seems to me a simple equal-weighting (20% in each) gets you a pretty well rounded portfolio: 80% stocks (60% US and 20% Intl) and 20% bonds.

TTM yield is 3.38% versus 2.13% for Vanguard LifeStrategy Growth (VASGX).

One of the things I was curious about is whether a traditional high-yield bond fund would be either helpful or necessary, and for the most part I have decided that it is not. The unfortunately named "SPDR® ICE BofAML Crossover Corporate Bond ETF", or CJNK, appears by description to be similar the "falling angels" strategy of ANGL or FALN but it has a relatively low correlation with both and also with Vanguard High-Yield Corporate (VWEHX) for which there is no ETF.

I'd never heard of CJNK before though, and also don't think I fully appreciated the value (no pun intended) of VPU to an investor who wants more yield.

2018 has been a rough year so far for a couple of those funds (CJNK, VYM, and VYMI especially) but I expect over the long run their total return would be roughly in line with the broad market even though, as I said, I personally don't use yield as an input in constructing my own portfolios.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Pajamas
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Re: How to diversify a dividend-yield portfolio

Post by Pajamas »

A high yield portfolio can't be appropriately diversified by definition because it is all high-yield, in my opinion.
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Re: How to diversify a dividend-yield portfolio

Post by patrick013 »

To really get the benefit of high yield you need to stay
with the structure of yield funds that beat the market
portfolio. Primarily yield or equal weight, 50 to 100
stocks, and large cap is the most common bet although
ticker PEY has multi-cap. SPHD and SPYD aren't bad but
usually contain non-qualified dividends which makes them
look better in a Roth, but in the studies after tax expense
they can still beat the market portfolio. They do force
people to diversify into Utilities and REIT's.

O'Shaughnessy has a well defined study on dividend stocks,
mostly large cap, but has some figures on multi-cap index
like dividend funds as well that he studied for decades.

I think dividends should be a separate factor, like the Jones or
Fama and French factors. I guess they forgot.
age in bonds, buy-and-hold, 10 year business cycle
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Re: How to diversify a dividend-yield portfolio

Post by vineviz »

patrick013 wrote: Mon Jul 30, 2018 3:31 pm I think dividends should be a separate factor, like the Jones or
Fama and French factors. I guess they forgot.
They didn't "forget". They just found that dividend yield is not very useful at explaining the return of stocks.
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Re: How to diversify a dividend-yield portfolio

Post by JoMoney »

Dividend income portfolios are a frequently discussed topic. The interesting thing about qualifying the discussion as how to "diversify" such a portfolio, is "diversification" can imply different things to different people. It's a pretty common justification people give for why they think some portfolio should be weighted a certain way... you need to "diversify" into junk bonds, "diversify" into small caps or international, etc... What I find ironic, is that the benefit of diversification is as a strategy to mitigate risk, but in most cases I see people using it as a justification to increase weightings in things that empirically have more risk. :shock:
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Re: How to diversify a dividend-yield portfolio

Post by vineviz »

JoMoney wrote: Mon Jul 30, 2018 5:44 pm Dividend income portfolios are a frequently discussed topic. The interesting thing about qualifying the discussion as how to "diversify" such a portfolio, is "diversification" can imply different things to different people. It's a pretty common justification people give for why they think some portfolio should be weighted a certain way... you need to "diversify" into junk bonds, "diversify" into small caps or international, etc... What I find ironic, is that the benefit of diversification is as a strategy to mitigate risk, but in most cases I see people using it as a justification to increase weightings in things that empirically have more risk. :shock:
Obviously there’s alwsys a chance that investors will look for ways to justify an ill-advised action.

But diversification is, by its very definition, the process of balancing risks not of reducing risk.

Reducing risk is easy and can be done by holding only a single asset: cash.

The very nature of proper portfolio construction involves taking risky assets and combining them in such a way that the overall risk exposure of the portfolio is optimized. Adding risky assets to a portfolio doesn’t necessarily increase the risk of the portfolio: often it does the opposite.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: How to diversify a dividend-yield portfolio

Post by JoMoney »

vineviz wrote: Mon Jul 30, 2018 5:58 pm...
But diversification is, by its very definition, the process of balancing risks not of reducing risk.
Demonstrating my point, that "diversification" implies different things to different people. As far as I'm concerned, it's benefit is a strategy to reduce/mitigate risk.
... Reducing risk is easy and can be done by holding only a single asset: cash.
True, if the "risk" is defined as a short term loss of nominal dollar value, and that is precisely why cash/bonds are pretty much universally suggested as the option for short term savings and to lower risk in a portfolio. But when adding in longer term risks, like inflation adjusted purchasing power, and having the portfolio generate enough growth to reach a goal, it's not so simple.
...The very nature of proper portfolio construction involves taking risky assets and combining them in such a way that the overall risk exposure of the portfolio is optimized.
I regard the idea of "proper" portfolio construction as funny talk. There certainly are portfolios that most would regard as totally improper for a specific situation, but defining one particular way as being "proper" would seem a bit far-fetched. Despite the pseudo-science airs some put on, there isn't much we can say for certain between a multitude of various possible arrangements especially with regard to what will be "optimized" for some future time period. It's more opinion and personal preference than being "proper". There are "many roads to Dublin".
...Adding risky assets to a portfolio doesn’t necessarily increase the risk of the portfolio: often it does the opposite.
More funny talk, probably depends on how you're using the term 'risk'. Certainly diversifying among many assets with similar risk mitigates the idiosyncratic risk of holding a single risky asset, but adding additional/more risk doesn't reduce it (even if it increases return in some situations).
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
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Re: How to diversify a dividend-yield portfolio

Post by vineviz »

JoMoney wrote: Mon Jul 30, 2018 6:45 pm
vineviz wrote: Mon Jul 30, 2018 5:58 pm...
But diversification is, by its very definition, the process of balancing risks not of reducing risk.
Demonstrating my point, that "diversification" implies different things to different people. As far as I'm concerned, it's benefit is a strategy to reduce/mitigate risk.
... Reducing risk is easy and can be done by holding only a single asset: cash.
True, if the "risk" is defined as a short term loss of nominal dollar value, and that is precisely why cash/bonds are pretty much universally suggested as the option for short term savings and to lower risk in a portfolio. But when adding in longer term risks, like inflation adjusted purchasing power, and having the portfolio generate enough growth to reach a goal, it's not so simple.
...The very nature of proper portfolio construction involves taking risky assets and combining them in such a way that the overall risk exposure of the portfolio is optimized.
I regard the idea of "proper" portfolio construction as funny talk. There certainly are portfolios that most would regard as totally improper for a specific situation, but defining one particular way as being "proper" would seem a bit far-fetched. Despite the pseudo-science airs some put on, there isn't much we can say for certain between a multitude of various possible arrangements especially with regard to what will be "optimized" for some future time period. It's more opinion and personal preference than being "proper". There are "many roads to Dublin".
...Adding risky assets to a portfolio doesn’t necessarily increase the risk of the portfolio: often it does the opposite.
More funny talk, probably depends on how you're using the term 'risk'. Certainly diversifying among many assets with similar risk mitigates the idiosyncratic risk of holding a single risky asset, but adding additional/more risk doesn't reduce it (even if it increases return in some situations).
I suspect you could easily find the flaws in what you wrote if you checked an investment textbook out of your nearest public library and skimmed through it. Or maybe you’d find the fundamentals to be just more “funny talk”.
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Re: How to diversify a dividend-yield portfolio

Post by snarlyjack »

Vineviz,

I have spent a lot of time studying Fama & French factors.
The conclusion that I came to is were looking at the
same info, only calling it different names.

Fama & French call it value investing. Large blue cap
value stocks & Small cap value stocks.

My portfolio is:
Vanguard High Dividend Yield Index (Large Value stocks).
Vanguard Mid Cap Value Index (Mid Cap Value).
Vanguard Small Cap Value Index (Small Cap Value).

This is using Fama & French Factors & recommended by Paul Merriman,
(except for mid cap value).

What do I call it?
Vanguard High Dividend Yield (high dividend yield).
Vanguard Mid Cap Value, (medium dividend yield).
Vanguard Small Cap Value (small dividend yield).

What do they all have in common? Dividend's & dividend growth.
Plus, the historical data that shows value stocks over 90 years out
performs growth stocks. I can sit back in the weeds (Kevin O'Leary)
while I' am waiting & collect dividends (Like a chicken on a spit)...

I' am very young & letting things compound out for many years.
If I need money (for expenses) I can use my dividends.
Currently all my dividends are reinvested...

Imho, same strategy...different name...
A person could add bonds depending on their age making it
a 60/40 portfolio or 40/60 or 80/20.
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Re: How to diversify a dividend-yield portfolio

Post by patrick013 »

vineviz wrote: Mon Jul 30, 2018 2:22 pm To that end, I became curious about what an optimally diversified yield-oriented ETF portfolio might look like.
Image

Putting PEY alongside some general indexes helps keep Beta
low. You could put PEY or SPHD alongside some CD's and
pick an AA for a desired Beta, whatever Beta is low enough.
I think the yield would be over 4%. Overall expected return
could be lower than above.
age in bonds, buy-and-hold, 10 year business cycle
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Re: How to diversify a dividend-yield portfolio

Post by snarlyjack »

Vineviz,

You seem to be the type of investor that would
enjoy this analysis/study by Ibbotson.

Enjoy...The Ibbotson Style Indices.

https://corporate.morningstar.com/ib/do ... ndices.pdf

Paul Merriman "Decade Returns".

https://paulmerriman.com/decade-returns/
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Re: How to diversify a dividend-yield portfolio

Post by vineviz »

snarlyjack wrote: Tue Jul 31, 2018 1:38 pm Vineviz,

You seem to be the type of investor that would
enjoy this analysis/study by Ibbotson.

Enjoy...The Ibbotson Style Indices.

https://corporate.morningstar.com/ib/do ... ndices.pdf

Paul Merriman "Decade Returns".

https://paulmerriman.com/decade-returns/
Thanks
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Re: How to diversify a dividend-yield portfolio

Post by NoRegret »

Call writing on a portfolio of growth stocks.
Market timer targeting long term cycles -- aiming for several key decisions per asset class per decade
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Re: How to diversify a dividend-yield portfolio

Post by Sandtrap »

vineviz wrote: Mon Jul 30, 2018 5:58 pm
JoMoney wrote: Mon Jul 30, 2018 5:44 pm Dividend income portfolios are a frequently discussed topic. The interesting thing about qualifying the discussion as how to "diversify" such a portfolio, is "diversification" can imply different things to different people. It's a pretty common justification people give for why they think some portfolio should be weighted a certain way... you need to "diversify" into junk bonds, "diversify" into small caps or international, etc... What I find ironic, is that the benefit of diversification is as a strategy to mitigate risk, but in most cases I see people using it as a justification to increase weightings in things that empirically have more risk. :shock:
Obviously there’s alwsys a chance that investors will look for ways to justify an ill-advised action.

But diversification is, by its very definition, the process of balancing risks not of reducing risk.

Reducing risk is easy and can be done by holding only a single asset: cash.

The very nature of proper portfolio construction involves taking risky assets and combining them in such a way that the overall risk exposure of the portfolio is optimized. Adding risky assets to a portfolio doesn’t necessarily increase the risk of the portfolio: often it does the opposite.
Good point. Well said as always.,

Please explain the latter if you can.

thanks,
j
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Re: How to diversify a dividend-yield portfolio

Post by Sandtrap »

snarlyjack wrote: Tue Jul 31, 2018 12:05 am Vineviz,

I have spent a lot of time studying Fama & French factors.
The conclusion that I came to is were looking at the
same info, only calling it different names.

Fama & French call it value investing. Large blue cap
value stocks & Small cap value stocks.

My portfolio is:
Vanguard High Dividend Yield Index (Large Value stocks).
Vanguard Mid Cap Value Index (Mid Cap Value).
Vanguard Small Cap Value Index (Small Cap Value).

This is using Fama & French Factors & recommended by Paul Merriman,
(except for mid cap value).

What do I call it?
Vanguard High Dividend Yield (high dividend yield).
Vanguard Mid Cap Value, (medium dividend yield).
Vanguard Small Cap Value (small dividend yield).

What do they all have in common? Dividend's & dividend growth.
Plus, the historical data that shows value stocks over 90 years out
performs growth stocks. I can sit back in the weeds (Kevin O'Leary)
while I' am waiting & collect dividends (Like a chicken on a spit)...

I' am very young & letting things compound out for many years.
If I need money (for expenses) I can use my dividends.
Currently all my dividends are reinvested...

Imho, same strategy...different name...
A person could add bonds depending on their age making it
a 60/40 portfolio or 40/60 or 80/20.
Trying to understand your well outlined points.
"Value" vs "High Dividend" funds, simplistically?
As in?
Image
Over the long run, I can't see the substantial gain.
Please explain?
'
Thanks,
j
Wiki Bogleheads Wiki: Everything You Need to Know
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Re: How to diversify a dividend-yield portfolio

Post by vineviz »

Sandtrap wrote: Wed Aug 01, 2018 9:24 am
vineviz wrote: Mon Jul 30, 2018 5:58 pm The very nature of proper portfolio construction involves taking risky assets and combining them in such a way that the overall risk exposure of the portfolio is optimized. Adding risky assets to a portfolio doesn’t necessarily increase the risk of the portfolio: often it does the opposite.
Good point. Well said as always.,

Please explain the latter if you can.
Let's look at two Vanguard ETFs to create an extreme example.

The most volatile broad-market equity ETF at Vanguard is VTWG (Vanguard Russell 2000 Growth ETF). From January 2011 until July 2018, it had a CAGR of 12.87% and a standard deviation of returns that was 15.79%.

The most volatile broad-market fixed income ETF at Vanguard is EDV (Vanguard Extended Duration Treasury ETF). From January 2011 until July 2018, it had a CAGR of 8.99% and a standard deviation of returns that was 19.34%.

You might think that adding EDV to a portfolio which already contained VTWG would increase the risk, but it's not so. Because EDV and VTWG have a low (actually negative) correlation with each other, combining them in a 60/40 portfolio greatly reduces the volatility of the portfolio. The combined portfolio had a CAGR of 12.55% and a standard deviation of returns that was just 8.55%.

In other words, combining these two highly risky assets created a portfolio that was about half as risky as either asset on its own. In fact, the combination was less volatile than Vanguard's LEAST volatile equity ETF (which is Vanguard High Dividend Yield ETF).

PV link: https://www.portfoliovisualizer.com/bac ... tion2_3=40

EDIT TO ADD: Interestingly, it is often true that the MORE risky the uncorrelated asset is that you add to the portfolio the more you REDUCE the risk of the portfolio. Adding a relatively stable short term bond fund (like BSV) to VTWG doesn't reduce the portfolio volatility as much as adding a risky fund like EDV.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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Re: How to diversify a dividend-yield portfolio

Post by snarlyjack »

Hi Sandtrap,
(I love your posts by the way).

Just to reiterate what Vineviz has posted. By combining
a fairly low risk fund (VYM, high dividend yield index) with a higher
risk fund (VOE, small cap value) it actually reduces your
risk & has the potential to increase your returns substantially.

See posted table of long term returns. Your graph went from
2008-2018 (10 years) which in the stock market is a relative
short time period. The table of long term returns goes from
1930-2013 (83 years). The longer the time frame the more
accurate the (probabilities of success) statistically speaking.
What we want to do is put the odd's in our favor with long
term investing.

VYM has about 400 stocks.
VBR has about 900 stocks.
Total diversified stocks about 1300.
Large cap. value & Small cap. value

Study this table of long term returns (it's very interesting).
The table includes the great depression, WW2, Korea, Vietnam,
gas shortages in 1970's, recessions, high interest rates, high inflation, etc...

https://paulmerriman.com/decade-returns/
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Re: How to diversify a dividend-yield portfolio

Post by spdoublebass »

snarlyjack wrote: Wed Aug 01, 2018 3:59 pm Hi Sandtrap,
(I love your posts by the way).

Just to reiterate what Vineviz has posted. By combining
a fairly low risk fund (VYM, high dividend yield index) with a higher
risk fund (VOE, small cap value) it actually reduces your
risk & has the potential to increase your returns substantially.

See posted table of long term returns. Your graph went from
2008-2018 (10 years) which in the stock market is a relative
short time period. The table of long term returns goes from
1930-2013 (83 years). The longer the time frame the more
accurate the (probabilities of success) statistically speaking.
What we want to do is put the odd's in our favor with long
term investing.

VYM has about 400 stocks.
VBR has about 900 stocks.
Total diversified stocks about 1300.
Large cap. value & Small cap. value

Study this table of long term returns (it's very interesting).
The table includes the great depression, WW2, Korea, Vietnam,
gas shortages in 1970's, recessions, high interest rates, high inflation, etc...

https://paulmerriman.com/decade-returns/
Wouldn't it make more sense to use Vanguards Large Cap Value fund instead of VYM?
I know VYM is labeled as a large Value fund, but there are still differences, especially in a taxable account. Another major difference is that in your portfolio you aren't holding any BRK, and I know how much you like Buffett.

I think Sandtrap used those dates because that's when VYM started.

Many of the historic tables you show and link are for Large Value, not for High Dividend Yield.
I'm trying to think, but nothing happens
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Re: How to diversify a dividend-yield portfolio

Post by snarlyjack »

Hi spdoublebass,

To answer your question Vanguard Large cap. value vs. VYM.
When I first started with Vanguard I picked VYM because I
thought I might need the dividends & I' am basically a dividend
investor. Both are good funds...

I love Warren Buffett & have read his articles, watched his videos
& read his book "The Snowball". I also like BRK. But, BRK
doesn't pay a dividend. I like to get paid while I' am holding
a stock...In the future BRK might change & pay a dividend.

Your right High Dividend Yield is different than Vanguard Large Value.
I think both would work just great (long term). I like dividends &
my fund has substational gains in it & I don't want to pay any
capital gain's tax moving things around.

I' am basically a income investor that loves value stocks...
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Re: How to diversify a dividend-yield portfolio

Post by KlangFool »

OP,

How about this fund?

Vanguard Wellesley Income Admiral (VWIAX)
https://finance.yahoo.com/quote/VWIAX?p ... in-srch-v1

One fund. Fully diversified.

KlangFool
30% VWENX | 16% VFWAX/VTIAX | 14.5% VTSAX | 19.5% VBTLX | 10% VSIAX/VTMSX/VSMAX | 10% VSIGX| 30% Wellington 50% 3-funds 20% Mini-Larry
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Re: How to diversify a dividend-yield portfolio

Post by Always passive »

no REITs? Why?
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Re: How to diversify a dividend-yield portfolio

Post by vineviz »

Always passive wrote: Wed Aug 01, 2018 11:53 pm no REITs? Why?
I don't recall precisely when they got eliminated in the process, but adding them to the five funds I ended up with would not improve the overall diversification of the portfolio.

In general, REITs tend to behave as if they are a balanced fund containing small cap stocks and intermediate bonds. I suspect that because the portfolio already has exposure to both of those asset classes in more pure forms, quantitatively the REITs add nothing new.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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