When to Buy, When to Sell
The previous pages outlined the Dividend Tactics I utilize to dictate how I allocate assets within my investment portfolio and how I select individual companies to hold within the equity portion of my portfolio. I would now like to outline the Dividend Tactics I use to manage the assets within my portfolio.
The main problems I initially identified that impede the achievement of investment goals included what I call the human error factor. The human error factor is present when we trade more often than we should, when we trade based on an emotional response, or when we trade because we think we know more than we do. My endeavor to eliminate the human error factor from my investment management strategy led me to the conclusion that I needed to define mathematical rules to trigger investment actions.
Defining the Target Value
Now, the share prices for the 33 assets will, of course, fluctuate as the market dictates. Every day both the target value and the number of shares needed for each company will change. The problem is, if one were to attempt to manage to the exact target value for each holding, trading fees alone would decimate the value of the portfolio. To combat this, I established the following classifications for my holding values:
- Buy Required: Market value less than 77.5% of target value
- Really Underweight: Market value between 77.5% and 82.5% of target value
- Underweight: Market value between 82.5% and 87.5% of target value
- Slightly Underweight: Market value between 87.5% and 92.5% of target value
- Just Below Target: Market value between 92.5% and 97.5% of target value
- On Target: Market value between 97.5% and 102.5% of target value
- Just Over Target: Market value between 102.5% and 107.5% of target value
- Slightly Overweight: Market value between 107.5% and 112.5% of target value
- Overweight: Market value between 112.5% and 117.5% of target value
- Really Overweight: Market value between 117.5% and 122.5% of target value
- Sell Required: Market value greater than 122.5% of target value
This gives me a 5% range for each of the different levels, centered around the target value. Going back to the example outlined above, market value of the total holdings would need to be 77.5% times the $2,091 target value, or about $1,620 to require a purchase of more shares, or conversely 122.5% times $2,091 ($2,561) to trigger a mandatory sell-off. For these associated buy and sell transactions, the quantity involved would only be enough to bring the holding back to the target value. (plus or minus $470 only in this example). In short, I only make trades when my mathematical classifications indicate that there is need to align an individual holding with my target value.
With that being said, I frequently use this classification system to dictate which companies to purchase additional shares in when I have funds available to add to my holdings, say for re-investment of dividends.
The biggest advantage to this simple mathematical system is that it forces me to buy low and sell high. Emotional human errors are completely eliminated from the equation and buying and selling is only conducted when required by simple mathematical principles.
I am a huge proponent of Excel based tools used to manage investments, and I favour clear visible signals to show me my investment status. One tool I use is a simple bar chart showing where my overall holdings fall based on my classification system. I am including a snapshot of my current chart below as of the time of writing, to illustrate my point further. (It actually looks so perfectly symmetrical right now that I just had to share it!)
What about DRIPs?
In setting up this Dividend Tactic, I had a fundamental decision to make on whether or not to utilize Dividend Re-Investment Plans or DRIPs. I ultimately decided not to. This was a tough decision, because I know that DRIPs often allow investors to purchase additional shares at a discounted rate (typically around 3% less) from the market value. The reason I chose against using DRIPs is due to the fact that I would like to take an overall view of where my dividends need to be re-invested to, rather than just buy more shares of the same asset. I have found that finding the appropriate location to re-invest dividends is never a problem, of my current portfolio of 33 companies there is routinely one holding that could use a boost to bring the market value I hold closer to my target value. The only issue is that these re-investment trades are subject to trading commissions, and thus must be large enough to make the commissions paid relatively insignificant in the grand scheme of things. I currently pay about $10 per trade, which is pretty typical. With this in mind, I prefer to keep the value of any trade made to a minimum of $500 to keep the commissions paid down to about 2% of the total trade amount.
While employing this Dividend Tactic on my portfolio, I learned the hard way that some additional rules are required to help protect the overall investment portfolio from falling prey to a lackluster holding that continues to drop in value. Without any additional rule in place, the continual reduction in share price of a holding will call for continued re-investment. To a degree this is a buying opportunity if the company brand, value of services and dividend performance are and will remain strong; however, this is quite often not the case. Continued re-investment in an under performing asset is like sinking funds into a black hole, funds that could be better re-invested elsewhere in the portfolio. But how can I know when something is under performing in this manner vs being a great buying opportunity?
Truth is I can’t. Not without insider knowledge into the company anyway (which I do not have). What I can do is build rules to protect myself. I came to the decision that I was willing to accept the risk of losing up to 50% of an investment made into a single company. Therefore as a rule, if ever my invested amount for an individual holding doubles the current market value I get out entirely and find a new investment to fill the void. This approach allows me to take advantage of buying opportunities up to a fixed point within my risk tolerance. I would like to believe that my principles for asset selection in the first place will eliminate the need to ever implement this rule, but unfortunately this is not always the case. I am human after all…