HOW TO BUILD
A DIVIDEND PORTFOLIO

With some basic planning, you can build a dividend-led portfolio that matches your personal investment goals. This article will explore the key factors to consider while doing so and potential ways to optimise your returns.

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Dividend stocks are popular with many investors, but making the most of the opportunity they present, involves building a diversified portfolio tailored to your investment strategy and financial goals. This involves a careful weighing up of the risks and evaluating each decision to construct a robust portfolio. 

The good news is that there’s a plethora of dividend stocks to choose from, each with specific characteristics that may render them a good (or bad) fit for your portfolio. Understanding how to assess and compare this information is essential for building an effective portfolio. This article aims to equip you to do so by exploring how to build a dividend-led investment portfolio.

How to start a dividend-led investment portfolio

One of the distinctive features of dividend stocks is that, if things go as expected, your dividend-led portfolio will generate a regular and passive income. How you treat that passive income, however, will differ according to your personal circumstances.

For instance, investors who are retired or are approaching retirement and are prioritising cash flow, may see dividend cash payments as a neat way to supplement their income. Those with a longer-term investment horizon, such as younger investors with more potential time in the market, may opt instead to take dividends in the form of extra stock so that their portfolio benefits from the effects of compounding.

Establishing which approach to dividend investing best applies to you, is one of the first steps to dividend investing.

When starting a dividend-led portfolio, your key considerations will predominantly depend on your strategy. For instance, if you plan to receive your dividends as cash payments, you will also want to consider the timing and frequency of dividend payments as different companies pay dividends to their shareholders in different ways.

This being said, there are also some universal truths that, regardless of your strategy, are important to recognise. All investors should ensure that their chosen broker is reputable and regulated to ensure the safety of their funds. If that broker also offers cost-effective trading, it means investors will keep more of their returns, so this should also be considered. In addition, it is always worth noting the tax implications of dividend investing and whether it is possible (and would be beneficial) to hold your stocks in a tax-free investment vehicle.

eToro does not provide tax advice and the information provided should not be interpreted as such. Customers should seek independent tax advice.

Balancing your dividend portfolio

Once you have established the best framework for your investments, the next step to building your dividend portfolio is to start buying dividend stocks. This is the time to be realistic about your appetite for risk-return and remember the five golden rules of investing. 

One of those golden rules relates to the benefits of diversification, highlighting the importance of spreading your capital across different positions for risk-management purposes. 

By nature, most dividend stocks tend to sit at the lower-risk end of the risk-return spectrum. This being said, building a varied portfolio of dividend stocks from across different industry sectors and regions can help to prevent a portfolio from becoming heavily concentrated or oversaturated in any one area of the stock market. 

To balance a portfolio, there are various strategies to consider, including:

• Sector diversification: Certain sectors, such as utilities, consumer staples, and banking, are known for containing a high volume of dividend stocks. Spreading your capital across the market reduces your risk of overexposure to any one industry.

• Regional diversification: By implementing diversity in the spread of your capital across various geographical regions, you can manage the risk of overexposure to any one country, economy or market and mitigate against some macroeconomic risks.
• Market cap diversification: Allocating capital across a range of small-, medium- and large-cap firms will also help to balance a portfolio, spreading risk across various-sized companies with various opportunities for growth and stability.

Of course, you can set your portfolio up within the parameters that meet your own particular investment objectives. But as a general rule of thumb, most investors will avoid investing more than 25% of their capital in any one sector, country or investment vehicle. 

A convenient way of gaining exposure to a wide range of stocks in one trade is to buy an exchange-traded fund (ETF). These funds contain a basket of stocks with similar characteristics, allowing investors to gain exposure to a wide range of assets by purchasing only a singular instrument. An example of such an ETF is the iShares Core High Dividend ETF which targets high-dividend stocks in the United States.

ETFs also offer a cost-effective method of investing. If you were to invest $10,000 in the Vanguard Dividend Appreciation ETF, for instance, the annual management fee on your position would only be $1.

ETFs provide instant diversification at a company level, but can still be concentrated in one particular sector or region.

So, how often should you rebalance a portfolio? Ultimately, this depends on your personal financial goals and whether you prefer taking an active or passive approach to managing your portfolio. Some investors opt to review and rebalance each fiscal quarter, while others might reconsider annually. 

Managing risk in dividend investing

As with any investment, there are some inherent risks involved in dividend investing.

• Dividend sustainability: One of the largest risks is investing in companies with unsustainable dividend policies. Companies may face financial difficulties or declining earnings, leading to dividend cuts or suspensions.
• Market and economic risks: Dividend stocks are still subject to overall market volatility and economic downturns. Economic recessions or industry-specific challenges can impact companies’ ability to maintain dividends. Dividend stocks can be sensitive to interest rate changes, for instance, and when rates rise, dividend stocks may become less attractive relative to fixed-income investments.
• Industry risk: Concentration risk within specific sectors or industries can expose a dividend portfolio to sector-specific challenges. Economic shifts, regulatory changes, or technological disruptions can impact certain sectors disproportionately.
• Inflation risk: Dividend income may not keep pace with inflation, eroding purchasing power over time. Investors should consider diversifying their portfolios with assets that can provide protection against inflation.

When building a dividend portfolio, effective risk management is crucial for long-term success. Consider the following strategies for mitigating against risk:

• Diversification across sectors, industries, regions and assets to reduce exposure to specific risks associated with any single context. 
• Evaluating a company’s dividend history, payout ratio, and overall financial health is essential to gauging the sustainability of dividends. Companies with consistent earnings growth and manageable debt levels are generally more reliable dividend payers.
• Monitoring macroeconomic trends and market conditions is also important to anticipate potential impacts on dividend-paying stocks. 
• Having a clear exit strategy and regularly reviewing the portfolio’s performance can help adjust to changing market conditions and mitigate risks effectively.

By incorporating these risk management practices into their dividend investing strategy, investors can better optimise their dividend portfolios for resilience, stable income and long-term growth regardless of market conditions.

Dividend portfolios — the Berkshire Hathaway example

Warren Buffett’s Berkshire Hathaway presents a great example of a successful dividend-led portfolio.

Between 1965 and 2022, Buffett’s Berkshire Hathaway Inc. investment fund outperformed the S&P 500 Index by an average of 9.9% each year. Subsequently, the total gain of Buffett’s fund was 3,787,464% compared to the market average return of 24,708%. 

Any investor who decides to study Buffett’s moves in and out of different stocks will soon establish that part of the reason Buffett has been so successful is his heavy weighting towards dividend stocks.

Buffett’s view is that regular and consistent dividends are an indication that the underlying company is a financially healthy and stable business, with a commitment to returning profits to shareholders.

Some of Buffett’s stock picks are relatively low-risk, but one crucial element of the Hathaway approach (and a key reason the fund boasts market-beating returns) is that dividends are typically reinvested in more stock, rather than taken as cash. That allows the size of the fund’s positions to grow each year and boost the amount of dividend income the next time one is paid.

Building a dividend portfolio for retirement planning

If you’re taking a long-term view, with the intention of building a dividend stock portfolio that will help you to be financially independent through to retirement, then, adopting a similar approach to Buffett could be a good fit. But as well as ensuring that you buy the right stocks in a balanced portfolio, there is also a need to consider the tax structure of your investments. Specialist pension funds may offer tax advantages, and reinvesting dividends in the form of new stocks rather than taking a cash dividend payment avoids you taking a tax hit now.

Final thoughts

Successful dividend investing is about spreading your exposure across a wide number of different stocks. The greater the number of positions you have, the more likely you are to track the overall market. There is room to go overweight with particular stocks which your research suggests might outperform, but bear in mind the tried-and-tested approach which has worked so well for Warren Buffett.

Use the eToro Academy to learn more about dividend investing.

Quiz

FAQs

What stock has Buffett’s Berkshire Hathaway fund held the longest?

Coca-Cola is Berkshire’s longest-standing equity position. The fund first started buying KO stock in 1988 and Buffett has gone on record as saying that he will never sell any of his shares in the firm.

Why is reinvesting dividends so important for investors planning for retirement?

Reinvesting dividends in the form of additional new shares allows you to benefit from a compounding effect; your stock positions will grow, and so will the amount of your future dividends. This virtuous circle is a secret to successful investing.  You will also defer your tax liability until the stage of your life where you will not be receiving a salary and could be in a lower tax bracket, so any dividend income drawdown could then be taxed at a lower rate.

How can I find out more about what stocks are held in an ETF?

All ETFs provide a term sheet or prospectus which is freely available. That will detail the fund’s investment objectives, outline what market benchmarks it intends to follow and provide details of current holdings in particular stocks.