The $10,000 5-Stock Market-Crushing Dividend Portfolio

Introduction

It’s time to talk about a few important things. After discussing several large portfolios last year, I want to go a bit smaller. I’m incredibly excited to discuss a $10,000 dividend growth portfolio that consists of just five stocks. My goal was to construct a portfolio for investors with smaller portfolios. As these are often younger investors, the goal of my research is to show you something that beats the market on a long-term basis, while offering a decent yield with high dividend growth. Even more important, it’s a portfolio that lets you sleep well at night, as it beats the market in various stages of the economic cycle with very limited volatility.

Even if you have a much larger portfolio and decades of experience, I think this article adds some value to your investment process. If anything, it has confirmed my own belief that I don’t need to own a lot of individual stocks to get the job done.

So, without further ado, let me show you one of the best portfolios I have ever backtested!

Be Aware Of These Pitfalls

While investing is mainly based on making rational financial decisions based on as much data as possible, it’s also something driven by passion. Isn’t it fun to invest hard-earned money in a company you picked yourself? After investing, you get to watch that company pay you a quarterly, annual, or even monthly dividend. I think it’s also cool to be part-owner of some of the world’s most exciting companies. Even if it’s just a minuscule percentage of shares outstanding.

I’m bringing this up because selecting stocks is hard. Beating ETFs on a long-term basis isn’t easy and, sometimes, eager investors with a lack of knowledge buy the wrong companies.

Using the FINVIZ stock market screener, I find that there are 951 companies with a market cap above $2 billion in the United States that pay a dividend. When adding smaller and international companies, that number becomes much larger. Picking the right ones is far from easy – especially on a long-term basis.

One of the biggest pitfalls that I encounter when dealing with starting investors or investors with limited funds is an eagerness to go for a high yield. Don’t get me wrong, there is nothing wrong with a high yield, and we’ll discuss high yield a lot in 2023.

What I’m talking about is people buying stocks with high yields of more than 10-15%. A lot of these people tell me that even if these companies cut their dividends, they will still enjoy a high yield.

Mathematically speaking, that’s correct. However, it’s the foundation for massive underperformance, as the market rewards stocks that show the capability to consistently hike a dividend, even if the yield is low. It’s a stamp of approval and the reason why dividend stocks often beat the market with subdued volatility.

While I couldn’t find scientific research to back it up, I believe that a lot of starting investors and investors with limited funds go for high-yield as it is a way to add some “significant” income to their portfolios. In this case, I can confirm this, as I have always felt a greater urge to buy high-yield investments when my cash flows were subdued.

One example I often encounter is AGNC Investment Corp (AGNC). This mortgage REIT stock currently yields 13.8%. Over the past ten years, its capital gains have been negative 66%. The total return (with reinvested dividends) is 11.5%. In other words, to some extent, it’s useful for income. However, it comes at a risk of underperforming the market by a huge margin.

I’m cherry-picking a bit, but I think my message is clear. Especially younger people should be very aware that TIME is their biggest asset – not financial funds. I incorporated this in the research of this article.

Now, let’s dive into the portfolio selection.

Picking Growth & Value

Continuing the yield debate, there are reasons to own a high yield and reasons to avoid a high yield.

This is what the famous Mr. Fischer Black (known for his Black-Scholes Equation) wrote back in 1976:

Corporations can’t tell what dividend policy to choose, because they don’t know how many irrational investors there are. But perhaps a rational investor can choose a dividend policy for his portfolio that will maximize his after-tax expected return for a given level of risk. Perhaps a taxable investor, especially one who is in a high tax bracket, should emphasize low-dividend stocks. And perhaps a tax-exempt investor should emphasize high-dividend stocks.

One problem with this strategy is that an investor who emphasizes a certain kind of stock in his portfolio is likely to end up with a less well-diversified portfolio than he would otherwise have. So he will probably increase the risk of his portfolio.

I could not agree more, which is why I like to balance different yields in my portfolio and most model portfolios that I present on Seeking Alpha.

Moreover, I believe that Mr. Black’s theory is supported by the fact that each year, the performance difference between strategies (factor performances) is truly remarkable.

For example, between 2008 and 2022, the best places to put money were low volatility, momentum, quality, and high dividend. When looking at the difference per year, we see big differences, depending on the state of the economy. In 2013 and 2014, value stocks did well. After that, momentum had some great years.

When combining different strategies, investors can smoothen their performance a bit, which lowers volatility and results in more consistent returns.

The 5-Stock Portfolio

This finally brings me to the 5-stock portfolio. Again, I’m fully aware that five stocks do not provide investors with a lot of diversification. However, $10,000 isn’t a lot either, and I do not believe that starting investors should overcomplicate things. There is simply no need for that.

While this may sound incredibly arrogant, I think investors with limited capital should focus more on improving their earnings than adding too many stocks to their portfolios. Spending too much time thinking about putting $1,000 in stock A or stock B is somewhat of a waste of time. Buy an ETF and focus on what you are good at (your job), or buy a limited number of stocks that allow you to beat the market as well.

Again, it’s one of the main reasons why I’m writing this article.

I started my first serious portfolio with EUR 30,000, which I put in five stocks for the reasons I just mentioned as well as these benefits:

• Investors do not have to waste a lot of time monitoring a lot of stocks. It’s simply not worth it when dealing with smaller portfolios.
• Investors can lower transaction costs, which is key for smaller portfolios.
• Some investors do not have access to fractional shares. Adding to a 5-stock portfolio regularly is easier than maintaining a much larger portfolio.

The portfolio selection was based on providing several things:

• All companies are safe dividend payers with healthy balance sheets and recession-proof business models. Meaning, even severe economic headwinds will not lead to dividend cuts or even bankruptcy.
• The average dividend yield is 2.6%, with average dividend growth being close to 10%.
• All companies are well-known, which makes it easier for starting investors to know what they own. I believe that is very important in successful investing.
• I include both high-yield and low-yield investments.
• The portfolio includes cyclical and anti-cyclical businesses.
• The portfolio is well-diversified.
• The portfolio has a very high likelihood of outperforming the market by a wide margin.
• The portfolio has a low-volatility profile.
• The portfolio is unlikely to make some “crazy” moves, which makes it easier for investors to avoid mistakes like panic selling during bear markets.

With that said, let’s discuss the stock selection.

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• Average dividend yield: 2.6%
• Average weighted dividend growth (3Y): 6.7%
• Average weighted dividend growth (10Y): 9.3%

*Raytheon Technologies is the result of a 2020 merger between Raytheon and United Technologies. Hence, take historic numbers with a grain of salt.

Note that the portfolio includes only one stock with a below-market yield. The S&P 500 currently yields 1.5%. Also note that I used a weighted dividend growth rate, not an average growth rate. After all, the dividend growth of higher-yielding investments has a bigger impact on the average yield.

Now, before I show you the stellar performance of this portfolio, let me quickly tell you why I picked these five stocks. As usual, I will use links to Seeking Alpha articles to allow you to do your own research.

PepsiCo is one of my current holdings. The company is quite boring, yet in investing, that’s a compliment. The company has a decent yield, stable and satisfying dividend growth, and a recession-proof business model with an A+ credit rating. The company does well in times of weakening economic growth when investors look for quality yield.

Realty Income is the highest-yielding stock in this selection. It comes with an A- balance sheet and one of the world’s largest portfolios of top-tier retail real estate. Even in a high-rate environment, the company is protected thanks to a low 5.2x debt ratio, 88% fixed-rate debt, and 6.3% years to maturity (on average). Just like PepsiCo, the stock does well when investors look for quality yield and value investments.

The Home Depot offers a great combination of a decent yield and high dividend growth. The company’s business model allows for fast growth in the consumer space where it benefits from organic growth and increasing market penetration. While the consumer isn’t doing so well right now, we’re dealing with a company that has an A2-rated balance sheet, and a history of strong outperformance during times of improving consumer sentiment.

Microsoft adds technology and growth exposure to our portfolio. It’s one of the few stocks in the tech industry that has a >1% dividend yield, a well-diversified portfolio including consumer/business/cloud, high dividend growth, and the ability to keep up with smaller, fast-growing startups. This also means that the company is holding up much better during tech weakness than pure-play growth stocks.

Raytheon Technologies adds industrial exposure to this portfolio. The company has roughly 50/50 defense and commercial exposure. It produces top-tier defense equipment like the engines for the F-35 fighter jet, as well as commercial products and engines via its Pratt & Whitney and Collins segments. Because of the 2020 merger between Raytheon and United Technologies, the current RTX ticker is very different from what used to be UTX before 2020. However, I still included the stock as RTX is looking like a more streamlined UTX ticker. In other words, the performance of this portfolio would even be better if the current company had existed for decades.

This also explains why it looks like RTX cut its dividend in 2020. That is NOT the case.

The Portfolio Performance

Like me, this portfolio goes back to 1995. Back then, a $10,000 investment in this portfolio would have resulted in a 16.5% annual return (including dividends). This would have turned $10,000 into $721,740. Not bad, right?

During this period, the market returned 9.8%, which isn’t bad either. However, the difference is that $10,000 would have turned into $138,000. That is still very impressive. However, the difference to our model portfolio is a decent-sized house in a state like Texas.

In this case, I’m fully aware that I’m backtesting a portfolio that includes a few high-flying stocks. Companies like Microsoft and Home Depot are among the biggest wealth creators of the past few decades.

However, the portfolio performance is consistent.

The portfolio has beaten the market on a 3, 5, and 10-year basis – returning double digits every year (on average).

Moreover, the portfolio volatility is not higher than the market volatility. This shows that:

• A higher return does not necessarily come with more risk
• A five-stock portfolio can beat the market on a risk/adjusted basis
• Investors are getting access to a decent yield, satisfying dividend growth, and outperformance without having to worry during market drawdowns.

After all, stressed investors make the dumbest mistakes – especially starting investors. I’ve been there.

As the overview below shows, this model portfolio has a stellar performance when it comes to periods of elevated market stress. During the COVID sell-off, the portfolio fell 300 basis points more than the market. During the 1998 Russian Debt Default, the portfolio underperformed by 60 basis points. During every other crisis, the portfolio beat the market – often by a wide margin.

Moreover, there are some impressive factors worth mentioning:

• During the Great Financial Crisis, the model portfolio lost only 39%. The market lost 51%. Investors buying the S&P 500 were underwater for 4 years and 10 months. The portfolio was under water for 2 years and 4 months.
• Since 1995, investors have been through just two sell-offs that took more than one year to fully recover.

Takeaway

In this article, I wanted to do a number of things. First, my goal was to discuss how I would start a dividend portfolio, as I believe that too many younger investors put too much emphasis on yield. I also wanted to show that investors do not need a large number of shares to properly diversify. While owning five stocks isn’t a lot, investors can build a solid portfolio with a limited number of stocks that allows them to gradually build wealth.

I also wanted to discuss five dividend stocks that make sense in any portfolio. Five companies that offer decent yields, satisfying dividend growth, and business models that withstand even severe economic pressure.

When I started, I owned five stocks that are similar to the ones discussed in this portfolio. I would start over with these stocks in a heartbeat.

After all, they are expected to continue beating the market with subdued volatility, a dividend yield of 2.6%, and dividend growth close to 10%. That’s a good deal in my book, even if some investors might argue that the yield isn’t juicy enough.

With all of this being said, let me know what you think! How many stocks do you own? Is this portfolio yield too low? What would you change?

Also, are you interested in a very high-yield model portfolio? Let me know in the comments!