I’ve been building my Freedom Fund for over four years now, shaping it from nothing into a portfolio chock-full of equity in high-quality companies that pay rising dividends. I now have investments in 46 companies, and for some that’s probably too much to manage. However, I love to manage a portfolio like this. To me, it’s fun to follow dozens of companies. I guess I get high on capitalism sometimes!
However, while it’s fun to manage a large portfolio, there comes a time when it’s too much for one person. I personally plan to stop investing in new companies right around the time I hit my 50th stock investment. I may go slightly over 50, but not by much.
While 50 isn’t a magical number per se, for me it represents income diversification.
Think about this for a second: How secure is your income? How much of your income is derived from your day job? Could you be fired from this job at any given time? If you were fired, what would you do? How would you pay your bills?
In life, our emotions are largely affected by money. Personally, financial security has a big impact on my ability to be happy and live a fulfilling life. And I can think of no better way to secure my financial future than to make sure my bills can always be comfortably paid for. As such, I’ve become a dedicated investor in high-quality businesses that pay rising dividends because it’s the best way I know to ensure financial freedom for myself. I realized a while ago that I want to minimize the risk of loss to my income, and having 50 income sources through a portfolio of dividend growth stocks is much less risky than a job where your income is derived from one source. Seeing as how I’ve recently taken a pay cut at work, I can only think of the me of four years ago as prescient.
50 different common stock investments means security, diversification, and freedom to me. At that level of diversification, it means that if one company were to eliminate its dividend, I would only be out 2% of my income, assuming an evenly-weighted portfolio. And while my portfolio is far from equally-weighted right now, it’s still being built every single month.
I often think of my portfolio as a castle of freedom – Chateau Freedom, just like Warren Buffett refers to individual businesses as castles. And while the moat around a business is the summation of their economic advantages, I like to think of the moat around my castle as the amount of income diversification within the castle. If I were to invest in just five companies and one eliminates its dividend, the moat between my castle (freedom) and the outside world (where I work for a living at a job I don’t enjoy) narrows by 20%! All of the sudden marauders (bill collectors) may start to sniff around the idea of taking my castle down, and I’d better have my résumé handy!
Conversely, investing in 50 different companies means my castle’s moat is quite wide. A 2% reduction in the size of my moat isn’t enough to cause extreme worry, assuming I have some margin of safety built in between my dividend income and my monthly expenses. Furthermore, a 2% reduction in annual dividend income would likely be made up by the 49 other companies’ dividend raises throughout the year anyhow, thereby replenishing the size of the moat. For instance, if I were receiving $20,000 in annual dividend income and one company eliminates its dividend which reduced my passive income by $400/year, I would see an increase in annual dividend income on the order of $1,176 if the other 49 companies raise their dividends in aggregate of 6%. Moat replenished! Résumé gladly goes back in the drawer. Marauders go home.
I’m not saying 50 companies is the ultimate form of passive dividend income diversification. This is all rather subjective. Furthermore, quality is just as important as quantity. Investing in 50 companies that do not possess high-quality aspects which improves their prospects of continuing to raise their dividends for the foreseeable future means your moat may be more shallow than you might think it is. No sense in investing in 50 companies of dubious quality if the slightest change in macroeconomics to their disadvantage means your income dries up, and with it the moat around your castle of freedom.
I’d personally recommend investing in a number of companies to where the raises by other companies in the portfolio throughout the year can make up for a dividend cut/elimination by one or more positions within the portfolio. If you can realize a dividend cut/elimination or two and still end up with a higher projected annual dividend income at the end of the year, then you’re in fantastic shape. Moreover, I’d recommend to stick only with the highest-quality companies you possibly can. I remain extremely picky with the companies I’ll personally invest in, and with only four or so potential roster spots open in my portfolio, I know it’s imperative I make sure the companies that go into the portfolio have substantial competitive advantages and great overall prospects at paying and raising dividends for the foreseeable future.
As such, some companies that I’m not yet invested in that remain high on my watch list for potential additions to the Fund include: General Mills, Inc. (GIS), Nestle SA (NSRGY), Colgate-Palmolive Company (CL), Automatic Data Processing (ADP), Unilever Plc (UL), and The Clorox Co. (CLX).
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How about you? What level of income diversification are you looking for?
Thanks for reading.
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