Blog #3 - How to shape your portfolio - January 18th, 2024

Blog #3 - How to shape your portfolio - January 18th, 2024

How to properly shape your stock and investment portfolio?

I think the answer to that question depends on your goals for investing. The answer to that will then determine how you should be shaping your portfolio. But first, lets take a step back.

What is an investment portfolio?

A portfolio is just a collection of stocks and investments that you purchase and group together as a way of making your money work for you. One of the best parts about this is that, you are in total control. You choose what to buy and what not to buy, when to buy and when to sell and you determine the structure of your portfolio and you also determine what segments you want as parts of your portfolio. If you want lots of oil, or automotive, or food stocks, etc. that's what you buy. You determine where to put your money.

Like always, I'm going to use myself as an example, when I first started, I had no direction at all, I was simply buying stocks based on what was recommended to me. After that failed experiment that I explained in my previous blog about how to start investing, I decided to do things properly. Because of Covid and the timing of when I got into the market and when I really started buying the bulk of my first stocks. I was looking for those that fit my long term goals. For me I called those "Recovery Stocks". Which I define as stocks that had a good financial history, typically traded at a higher amount and in an industry that was hit fairly hard by Covid so it dropped. The plan was very simple, buy the stock when it dropped and then make the earnings in the years after Covid when the market recovered, thus, why I call them "Recovery Stocks".

I purchased several of them, but I'll use two as an example to show the good and the bad of this strategy.

Ovintiv - stock code OVV.TO

I spoke about this stock in my previous blog as well, but this is a stock that not only pays a quarterly dividend... which is a bonus, especially for my strategy. But it's in the Oil/Energy industry which will be the worlds economic driver as long as I'm alive. So I knew there wasn't much of a risk when I purchased it. The companies financials were great and it normally traded around $40 a share, but because of Covid, it dropped to about $6 a share. I got in at $6.46 per share, expecting that in the long term it would get back up to about $40 a share and I would do fairly well on that. In approximately 3 years, the market took an unexpected leap and I sold it when it jumped 1200%. 

So that stock "recovered" quite well and was a massive building block of my "recovery style" portfolio strategy. I still hold a bit of it to continue to contribute to my dividend strategy that I will explain below.

Now, to show the flip side and that it's not always that easy. 

Air Canada - Stock code AC.TO

Air Canada is Canada's major airline, it's financials were okay, but my thought process in buying this stock was that, before Covid, it was on an upward trend trading around $30 a share but heading upward of $40-$50 a share and there were rumors at the time that they were going to purchase one of their major competitors. Then Covid hit and it tanked. I got in around $18 a share. My thought process was that it would recover when Covid was over and people started traveling again, airlines should be busy and with the purchase of Transat, it should come back extremely strong. However, that's not exactly how that turned out. Travel has still yet to really recover from the Covid lock downs and the Transat deal was canceled in 2021. I'm still about even on this stock. So I haven't gained or lost and I still think over the next 10-20 years it's going to get back to where it was pre-pandemic. Simply, its going to take more time. This stock does not pay a dividend so the downside of that is that I wont make any money off it until it goes up and I sell.

Those are two examples of what I call "Recovery stocks" in what I call a "recovery portfolio" strategy.

I believe at this point, most stocks have likely recovered from the pandemic, a massive opportunity that I took advantage of to gain a bit of bulk very quickly into my portfolio. However, even though Covid is over now and that specific opportunity is gone, I think you still can find stocks on a regular basis that are in industries that get hit hard in various different scenarios and will take time to recover. 

Recovery stocks do still exist and when you find them, they are going to do well but for those it's about timing and that is a difficult thing to try and get right on a regular basis. For me, I wanted something a bit more stable, so after Covid, I changed up my strategy and started the transition from a "Recovery Portfolio" to what I call a "Dividend Growth" portfolio strategy.

This means very simply, that I now only buy stocks in companies that I think are going to grow in value over the next 10-20 years and beyond. Stocks that I plan on growing my portfolio with and holding onto long term. I also only buy stocks that pay dividends. I then take those dividends earned and I reinvest them to grow more dividends and it's sort of an endless cycle.

As I explained in a previous blog, dividends are a company paying you out a percentage of their earnings as a "thank you" for you owning their stock. Now you can use this strategy and dividends to get some massive results.

It's called a "Dividend snowball". The basic idea behind this is to use compounding interest to create passive income (which is income that you don't have to work for... it just shows up).

I'm going to use some unrealistic numbers here but to keep math fairly simple and for a bit of dramatic effect.

Say for example in 2023 I invest $100 in stocks and I earn $1 a month of a dividend. In theory after a year, I'll have $112 because of that dividend earning $1 a month for 12 months.

However, if I reinvest those dividends, I'll own more stocks so it'll earn me more dividends. So reinvesting $1 for 12 months would in theory bring me up too $112.68 by December 2024. Now, 68 cents is nothing to write home about, however, compound that over 10 years by December 2034 that original $100 will  have turned into $371.90 without any more investment, just by putting the dividend back in and compounding it. I should note that a 1% dividend every month isn't realistic, most companies will have a dividend of 1-4% per year. But whats interesting and what makes this strategy so good, is the more time you add the more it compounds.

So what if I use some more realistic numbers?

Lets say I start with $20,000 and I add 3% compounded yearly from 2024 until 2050. I would have turned a $20,000 investment into $43,131.83 just by using dividend reinvestment and time.

This is obviously assuming there are no fluctuation in the market and assuming that the dividend never gets cut or changed. Which is unreasonable but I'm using it to highlight my point: that the compounding effect, plus time can have absolutely massive outcomes. It takes good companies and a lot of patience. Most people, myself included, do not want to wait that long to realize those earnings.

Now lets do a different experiment.

Lets assume you  don't have $20,000 to invest right away, so instead you invest in chunks. You start with investing $2000 on January 1st 2024  earning 3% dividends each year, but you continue to invest $2000 every January 1st for ten years and you reinvest the dividends on that same day each year.

By that 2050 you will have invested the same $20,000 total of your original money, but with dividend reinvestment and compounding interest, your portfolio will be worth a bit less then the previous example at $37,896.09 because it's had less time in the market. However, you spread out that 20,000 over ten years, so it was less of a financial strain and much easier to do.

That's the thing with the dividend growth strategy, consistency plus time in the market will always equal growth.

I'm not going to do the math on it, but I always suggest to anyone getting started, if you can't afford to put thousands in all at once, that's fine, I tell everyone the same thing, put $500 a month and reinvest the dividends. With compounding interest you will be a millionaire with enough time and earning enough passive income to live off in retirement.

Hopefully that was clear but that is the dividend snowball effect. It's very simply dividends, earning dividends by reinvesting dividends. It's like the old saying goes "Slow and steady wins the race"

The dividend snowball or dividend growth strategy seems to be one of the best ways to grow wealth consistently over the years. Just please be aware the dividends are not guaranteed and companies can cut dividends anytime they want. Which is why you should never purchase a stock, just for dividends. If there isn't a solid company behind it, then it'll just go down, lose money and eventually cut the dividend so you get nothing and just have to accept the loss.

Both the "Recovery" strategy and the dividend growth strategy seem to be the two best ways to go when it comes to building and shaping your investment portfolio and these are the two strategies I continue to use when investing.

There are other strategies such as index funds. These are basically funds that compile thousands of stocks together and are usually pretty safe. However, I prefer a bit more of a hands on approach.

There are "call" and "Put" options. These are basically borrowing money and gambling that a stock is going to go up or down. You can make absolutely massive returns using this strategy, however, this isn't really investing... This is gambling. I don't have any experience doing this and I doubt I'll ever do this, I prefer to build my portfolio for the long term, not hoping for a quick payday, but I will say, those who are successful at this, are typically very successful.

Now, how do you pick good stocks to invest in. I'm going to save a bit of this for future blogs like explaining market cap and P/E ratios, etc. But here is the trick to picking good stocks in my opinion... Don't worry about trying to pick the perfect stock or time the market. When you buy a stock, you are buying a small piece of that company. So the way to pick good stocks, is to pick good companies. It's that simple.

For me, I look into the companies financials, P/E ratios, market cap, etc (Which again I will save definitions for a later blog), but keep it simple, buy companies that you use, because if you represent the average person, then that means millions of other people use that companies products and services as well. Which means, provided that companies management is even decent, then it's a good company that is likely earning profit. So, buying their stock is a piece of the company, so you basically are just trying to earn your little slice of the companies profit.

That's all, keep it simple. Don't try to time your way into the market to earn a payday, be consistent, be strategic and your portfolio will grow over time and try to buy in a few different industries just to diversify a bit. I've done fairly well with oil/energy stocks, however I continue to buy into other industries such as banks, food, real-estate, etc... because that way if oil/energy goes down, the others might jump up and make up for it. Sort of a way to hedge the market a bit and cover yourself. Plus even if a stock goes go down a bit, that's fine because you'll still be earning those dividends and reinvesting and given enough time, good companies always do well. The question is how much time?

In my experience, the secret is to come up with  a strategy, stick with it, be adaptable and if you want to get into a segment, do your research and get into it. But get into it for the long term, you may get lucky on a few short term stocks and that's great, but always remember you want long term gains.

Hopefully this blog was fairly clear and understandable and like always there is more to come and if you have any questions, ask me.

I hope all is well,

Brett Rae