Having investing rules is important as it is what keeps you from following the flock and making questionable moves. How often do you resist buying a hot stock? With some investing rules, you can avoid falling for hot tips or becoming emotional.
I will be the first to admit that it has taken me a few years to really sort out my rules. The goal is not to have a long list but to have some core rules that you cannot ignore when investing. It keeps you honest to your goals.
7 Dividend Growth Investing Rules
Rule #1 – Invest only in what I know and understand
Peter Lynch said it best, if you cannot explain the business so that a child can understand it, then it’s probably too complicated. This mantra is the first filter I apply to the companies I add to my portfolio.
It’s important to also differentiate between understanding what their business is versus understanding regulations and accounting procedures. Understanding the business means that you know how they make their money. For example, a railway stock, such as Canadian National Railway (TSE:CNR, NYSE:CNI), provides transportation services using the railroad and they get paid for taking goods from point A to point B. That’s all there is to know in understanding the business as opposed to trying to figure out what it means to cross the border.
By understanding the business at a high level, you can get an understanding of the necessity of the business, and how they intend to make money.
Related: Managing Your Stock Watch List
Rule #2 – Invest in companies that provide necessities
There are services or products in the world that we cannot live without, those are sustainable services with a consistent or growing demands. For example, financial services, oil & gas, food, utilities and so on. You can rationalize that something is going to be needed even though it’s not an essential product or service to our lives and that’s fine but your core portfolio should have companies with essential and necessary products.
Once those sectors or necessities are identified, you can start focusing on the best picks. The strength of this rule is that you can feel confident this company will be around due to the nature of their business. Often times, such companies can be part of an oligopoly and be a blue chip stock.
Rule #3 – Only invest in dividend paying stocks
I have made it a focus that I want to be paid when markets go sideways and to that end, my investments must pay a dividend. It also means I can expect a minimum return of my investment while I wait for the stock to appreciate. When you apply this to your stock watchlist, you filter out another really large number of companies.
Related: Why Dividend Investing?
During the accumulation phase, when you have a steady income, focus on dividend growth stocks. When transitioning to the income phase where you no more receive a steady income from any form of employment, you can look at more income-focused investments.
Rule #4 – Focus on companies with an economic moat
I look for companies with an economic moat. More often than not, those are large blue chip companies. I tend to focus on medium and large cap companies. Anything under $10B is a little small even if they are developing an economic moat. Companies with an established economic moat will often have grown to be large cap companies. To that end, I look for an economic moat with a medium to large capitalization.
Rule #5 – DRIP everywhereDRIP it all. It’s a form of compound growth. Many companies also offer a discount when you DRIP, so you can take advantage of a price discount of 2%, 3% or even 5% for some companies.
If your money is at work by buying stocks with the dividend then you are covered. If you wait a long time before putting the money at work because you get $100 per month, then your money is not working. When I earn $1,000 in dividend per account, I will be content to not DRIP and buy stocks selectively but I am far from that.
As long as you purchase dividend growth stocks, reinvesting in those companies should be simple.
Related: Easy investing with Computershare. Get your kids started with Computershare and teach them investing over many years.
Rule #6 – Sector Diversification
Diversifying by sectors allow you to add new money to underperforming sectors and take advantage of good buying opportunities. If your diversification is to buy 5 different banks, it’s not really much of a diversification from a risk perspective because they are all in the same sector.
For Canadians, it’s important to know that some sectors are weakly represented in Canada and you may want to look at buying US companies if you have US funds.
You’ll want to assess how much you want to allocate per sector and then start managing it that way. It makes choosing where to add new money an easy task as you want to try to keep the allocation you chose.
Related: Sector diversification
Rule #7 – Limit Your Holdings
I have set my number of companies to own and manage at 40. Any more than that and it’s too much to track. I am already there so if I intend to take a new position, I need to sell one. I am also at the point where I simply need to add more money to existing holdings. This number must really come from you and what works for you.
Related: How many stocks should you own?
There is an obvious one that I have not added but it’s a hard one … Buy Low, Sell High. The reason I have not mentioned it is that it can be hard to always buy low since you cannot predict what the markets will do. If the market drops for whatever reasons, you can’t beat yourself over it. If you have cash, you can add more but I prefer to rely on my sector allocation to choose where to put my new money. To be a value investor is also quite hard. It’s not easy to identify a good price for a company as it most often trades on future earnings. IF this was easy, why would analysts get it wrong all the time ?!? For some companies, you sometimes have to buy near 52-week high, that’s just how well those companies do.
The rules outline allow me to manage my portfolio effectively and make sound decisions. The next step is selecting a stock to purchase on a specific day. The stock selection process brings in another set of rules.
Readers: Do you have a rule not listed you want to share?
Image courtesy of Stuart Miles – FreeDigitalPhotos.net