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URL:  http://boards.fool.com/author-yttire-date-81105-1120-pm-number-22882748.aspx

Subject:  Re: new invester needs help with portfolio Date:  8/13/2005  2:31 AM
Author:  rkmacdonald Number:  5356 of 6743

Author: yttire | Date: 8/11/05 11:20 PM | Number: 5353
>>This is why I currently estimate that adding 10% REITs to a 60/40 TSM/TBM mix will increase the 100% safe withdrawal rate significantly, maybe as high as 4.5%. It is also why I see no reason to overweight small caps vs the percentage already in the TSM.<<

Russ, what is your opinion on utilizing a strategy of dividend growth stocks and REITS as a hedge against volatility?

The theory being that the value of the equities do not matter if your dividend stream is significant enough.


There is no doubt that dividend stocks have lower standard deviation (ie, volatility) than non-dividend stocks. This coupled with the fact that REITs are very weakly correlated with the TSM is why I believe that adding REITs to a 60/40 TSM/TBM mix works so well. Even regular non-REIT dividend paying stocks are good stabilizers for a 60/40 portfolio.

However, there are a few very important things about dividend stocks that you have to understand.

First of all you can't pick just any high dividend stock and expect it to work well for lowering volatility. You may succeed in lowering volatility by sacrificing a large amount of potential return to get it.

You have to pick dividend stocks that have a long history of dividend growth, and a likelyhood that it will continue. And the easiest way to find those is to look for stocks with a long history of steady price growth.

It turns out that in the long run, dividend growth always equals price growth which always equals earnings growth, but dividend growth is usually delayed slightly behind price. So, a good way to find a stock that is ripe for a dividend increase is to look for a stock with an historically low dividend yield, that has fallen behind a strong price run-up. A stock that fits this description perfectly right now is XOM (ExxonMobil). It's historical dividend yield has been around 2.5 - 3.0%. Today it is at 1.9%. I believe that in the next few years they will drastically increase their dividend or do massive stock buybacks - either one would be good for the stockholder. If you add XOM growth added to XOM dividend growth you find that XOM has provided a very good 12% per year return over the last 50 years with a beta of 0.6 (meaning it is only 60% as volatile as the S&P 500.

You have to be very careful of stocks that pay high dividends, after a long period of price decreases. They are ripe for a dividend cut or elimination. And, if they bolster their dividend artificially, with return of capital (ROC), their earnings and their price will not be able to increase, and thus, their dividend will not be able to increase either. It will eventually have to be cut.

So, if you buy a stock that pays a high dividend, like a REIT, you have to be very careful to check the price history as well as the FFO (funds from operations) growth. If it has an extraordinarily high dividend, and slow price or FFO growth, look out. However, REITs can go for a very long time holding up their dividends with ROC, because they own so much real estate (check out EOP (Equity Office Properties) to see what I mean).

Also, there is no long term evidence that you can withdraw more than about 4% from a pure REIT portfolio. This means that if your REITs pay an average dividend higher than 4%, which most do, you should consider reinvesting some of it to try to make sure your REIT portfolio will survive long term with it's inflation adjusted income intact.

Russ
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