Wednesday, June 18, 2014

The cost of TheMoneyMadam’s Dividend Machine Strategy

What does it cost?

Of the three income investments I write about, my Dividend Machine Strategy is the cornerstone of income investing.  In this post I explore the cost of Dividend Machine investing.

A well known tenant of successful investing is that investors should keep track of what it costs them to invest and they should keep those costs at a minimum.    Costs include fees you may pay an adviser, commissions to the brokerage, mutual fund loads and fees, and ETF fees etc. 

I looked at the costs of my Dividend Machine model portfolios and the costs of two benchmark ETF’s.  I also explored the costs of the typical income investor with fewer restrictions on investing than I impose on the model portfolios.

Dividend Machine Model Portfolios

My model portfolios are the absolute definition of buy and hold.   Once each portfolio was completed, I simply follow the price and dividends of those stocks.   I don’t buy anymore and I don’t sell any.   I don’t reinvest dividends because I am gearing the portfolio to create the income a person needs to pay their bills.   When stocks split, the number of shares held in the portfolio also splits.   If there is a spin off, the new stock is added at a zero cost basis and the original stock continues to be held at the original cost basis.  Results of mergers are included in the portfolios at the appropriate adjusted share basis.   And when a stock is bought, the proceeds are recorded as cash and that cash is not reinvested but it is held as cash. All of these events occurred in the 2011 portfolio if you want to see examples and study the actual effect of these events on the portfolio.

Now think about this.    A commission of $8.95 for each buy is the only cost of these portfolios.  I use Schwab as my custodian (which I did with my clients as well) and that is their flat internet trade fee.  Each portfolio takes one year to complete so all costs are in the first year.   Every year thereafter, the portfolios have no expenses.

The 2011 model portfolio consists of 52 stocks with a cost basis of $207,336.   The commissions on those 52 buys was a total of $465.40.   That is about .22%.   You can review the expense ratio of each portfolio in the table below.

Benchmark ETF’s

Two ETF’s are most similar to my strategy and I use them as benchmarks.   They are a SPDR product that is designed to own stocks that are dividend aristocrats.   The symbol is SDY.    Vanguard Funds has an ETF that is designed to own dividend stocks that increase the dividend.  That symbol is VIG.   Their expenses are very low compared with mutual funds.   SDY’s expense ratio is .35 and VIG expense ratio is.10. Remember you have to pay these every year.

I compared my 2014 portfolio with these benchmarks.  The table below shows how these benchmarks compare with the 2014 Portfolio which we are still building.  The Dividend Machines basis includes the cost of commissions.   The VIG and SDY returns include their respective fees.

The Rest of the Story – The Ordinary Investor

In real life few people will buy and hold like the Dividend Machine Portfolios.   For instance, in this very blog I recommend selling calls on dividend stocks in order to boost income.   Selling calls means that you may have your stock “called” away.   Now you have to pay the $8.95 to sell your stock to the call buyer.  And you had to pay a commission when you originally sold the covered call.   At Schwab the charge for options is $8.95 per option + $.75 per contract. 

Provided you always sell your calls at strike prices that are greater than your basis, including commissions, the covered call strategy is still worth it.  You pocket both the call premium income less $9.80 for one contract and you pocket the capital gain less the $8.95 for the sell.  You still have a very nice net gain.

Even without selling calls on dividend stocks, most investors buy and sell for other reasons.   I write about selling a good dividend stock whose price has increased to the point where the income investor who needs more income has to consider selling the stock and buying a different Dividend Machine with more yield.   Again your cost is $8.95 to sell one stock and another $8.95 to buy the next one.  You made a lot of money on the original stock so the $8.95 is negligible.  If you hold this new stock for several years, you have no additional expenses.

The most difficult income investors I dealt with were the emotional investors who were absolutely convinced a stock was going to go down or vice versa absolutely convinced a stock was going to go up and they moved constantly among and between these stocks.    If all the stocks pay good dividends, they did not suffer too much, but often times these investors were wrong and the costs can eat into income. 

When you realize how hard it is to get a four percent yield from you dividend stocks, you don’t want to spend even one half of a percent of the income on buying and selling.  A $200,000 portfolio should produce about $8,000 of income.  If you trade 45 times during the year or around 4 times a month, you will have spent $400 on trades reducing your yield to 3.5%.   


In summary, there is no question in my mind that using a simple strategy with discipline, a strategy like Dividend Machines, is the cheapest way to build and maintain a portfolio of income stocks.