Minimizing Risk -- setting limits

I'm updating my portfolio. I'm reconsidering what I own and how much. And how much is too much when it comes to stock ownership? This a core question that must be asked by all investors. Ignore it at your peril.

In an income-weighted retirement portfolio the rule of thumb is to put no more than 5% to 10% of the total portfolio value in any one stock. Following this rule lessens risk and encourages diversification.

Risk Management: As an investment in any one stock grows, one's exposure to company-specific risks grows. Think of Nortel. If you don't understand, Google Nortel or click the link.

Diversification: A well-diversified portfolio holds a variety of stocks spread over a good mix of sectors and asset classes. For instance, if it has been determined that the investment goal is to have 12% of the portfolio value invested in the telecom sector, this investment would encompass a number of telecoms and not just one. 

An equal weighting of 3% each of BCE, Cogeco, Quebecor and Telus would result in a 12% total investment in telecoms. Of course, equal weighting is not demanded. Personally, I would underweight BCE and overweight Telus and favour Quebecor slightly over Cogeco with the remaining funds.

Income Generation: Always be aware of the income potential of any investment. But a warning, do not let the need for income overly influence your investment decisions. A very large dividend can be a warning and not a carrot. Don't take the bait. 

BCE is yielding 8.5% today. That is a warning. I suggest underweighting BCE in your portfolio and overweighting your investment in better positioned telecoms is the right approach. I have done much better with Cogeco and Quebecor than I have with BCE. The jury is still out when it comes to Telus.

Portfolio Adjustments: As a retiree grows older, the usual recommendation is to reduce the exposure to equities and increase the fixed-income investments. This can be tougher than it sounds. Move funds from equities into bond ETFs and money can still be lost. Put the funds in GICs and if inflation outpaces the interest paid, one suffers a loss in buying power. Losing, like winning, is simply part of life. Just try to win more than you lose.

I swim against the tide here. I like to have massive dividend income generated by trusted companies. When expenses are as expected, there is money left to reinvest in the market. When unexpected costs arise, the flow of cash is used to meet or at least reduce the unexpected cost. So far, this approach has worked well for me. I usually have no more than 2% of my funds in cash but I am flexible.

Conclusion: I cannot state this too strongly. Never allocate more than 10% to any one stock. This is the one rule that I have that is carved in stone. Some analysts will advise putting more into a stock and they will call this an aggressive income strategy. Don't do it! Think Nortel.

By the way, the art shows a small piece of my actual retirement portfolio spreadsheet.

Using Ai to Evaluate Investments

Lately, I've been experimenting with an Ai program, Perplexity. It is proving amazing. Yesterday I asked Perplexity to play Canuckle, a word guessing game. It discovered the word in four guesses.

Today, I thought of asking Perplexity to compare Atco and Canadian Utilities and I wondered if there was any reason to hold each in one's portfolio as ATCO is the principal owner of Canadian Utilities Limited with a 52.7% stake. I loved its answer. 

It said, "When considering whether to invest in Atco Ltd. (ACO.X) or Canadian Utilities (CU), or both, it's important to analyze several factors such as dividend yields, growth potential, and overall business strategies. The following is also from its answer.

Dividend Comparison

• ATCO Ltd.:

  • Dividend yield is approximately 4.062%.

  • Recent quarterly dividend is $0.4898 Can. per share, reflecting a commitment to increasing dividends over time.

• Canadian Utilities:

  • Higher dividend yield at about 4.983%.

  • Quarterly dividend is $0.453 Can. per share, with a remarkable track record of increasing dividends for 52 consecutive years. It must be acknowledged that CU also has a history of increasing dividends over time.
    

Financial Performance and Growth

• ATCO Ltd.:

  • Reported adjusted earnings of CA$655 million.

  • Focuses on essential services with a diversified portfolio, including energy infrastructure and logistics, which positions it well for future growth.

• Canadian Utilities:

  • Adjusted earnings of CA$596 million, with a strong emphasis on regulated utility operations.

  • Plans to invest CA$4.6 to CA$5 billion in regulated utilities from 2024 to 2026, aiming for sustained earnings growth linked to infrastructure development.
    

Payout Ratio

• ATCO Ltd.:

  • Payout ratio: 56.5%. (Morningstar)

• Canadian Utilities:

  • Payout ratio: 91.1%, (Morningstar)

Strategic Focus

• ATCO Ltd.:

  • Diversified across energy, logistics, and structures.

  • Emphasizes sustainability and innovation in energy solutions.

• Canadian Utilities:

  • Strong focus on regulated utility businesses and energy transition initiatives.

  • Aims for long-term resilience through strategic investments in infrastructure and technology.

Credit Ratings Overview

• ATCO Ltd. has received a Baa2 rating from Moody's, which is considered to be the fourth highest level on their scale. This rating suggests that ATCO has adequate capacity to meet its financial commitments, but it is subject to some risk during adverse economic conditions.
• In contrast, Canadian Utilities Limited holds a higher rating of A3 from Moody's. This rating implies a stronger credit profile, indicating that Canadian Utilities has a solid capacity to meet its financial obligations and is less susceptible to economic fluctuations compared to ATCO
• Both ATCO Ltd. and Canadian Utilities Limited got similar ratings from S&P (A- with a stable outlook).

Conclusion: Which is the Better Investment?

As can be seen from the information supplied by Perplexity, ultimately the decision must align with one's investment strategy, risk tolerance, and income needs. My investment strategy revolves around dividends. I am retired, I need dividends to live, to make ends meet. 

My risk tolerance is high enough to allow me to own equities rather than GICs and the like. I can accept volatility. That said, stocks can go down but after that they must recover. I do not want a Nortel in my future -- a permanent loss. As this cannot be completely ruled out, I have set limits on how much I will risk by investing in any one stock. I never want to invest as much as 10% of my portfolio in one stock. Five or six percent is a much better ceiling and very few stocks should approach this maximum investment.

As Canadian Utilities yields almost a full percentage more than Atco, I find myself leaning towards making only one investment -- Canadian Utilities. I need the income. Moody's may see both as investment grade but it rates CU a little higher. That is another plus for CU over ACO-X.

To put all the above in perspective, those solid standbys in the utilities sector, Emera and Fortis, do not have ratings as high as either Canadian Utilities or Atco plus Fortis does not meet the four percent yield rule. 

I'm thinking of investing three percent of my retirement money in CU and a further one percent in Atco. Fortis will get the nod for two percent based on its narrow economic moat determined by Morningstar. Emera gets the nod for a three and a half percent investment as it yields the most and can be found in almost all published retirement portfolios.

There is one more utility that I would like to see in my retirement portfolio: AltaGas. Why? I have owned it for years and I have enjoyed a very nice capital gain along with a reliable dividend with sustainable increases. AltaGas gets one and a half percent of my portfolio.

My total investment in the utilities sector is eleven percent with no stock accounting for more three percent of my portfolio. Good income is assured and there is no possibility of a Nortel-like disaster. I can sleep at night. If Hydro One were to drop in value, thus raising its percentage yield, I would consider adding one or two percent of Hydro One to my portfolio but today the yield is simply too low.

Should I be looking at low beta stocks?

Beta is a measure of a stock's volatility in relation to an index like the S&P 500 or the S&P/TSX Composite Index. A beta of:

• 1.0 indicates that the stock moves in tandem with the index both up and down.
  

• Less than 1.0 indicates the stock is less volatile than the index. It tends to suffer smaller price fluctuations, suffering lower losses during market downturns and benefiting from smaller gains during bull market periods.
  

• Greater than 1.0 indicates higher volatility. Price moves are more extreme than those of most stocks. Gains can be exhilarating but when the inevitable losses occur, taking the hit can be tough.

Can retirees benefit from owning low beta stocks? I believe they can. Low beta stocks tend to have smaller losses during market corrections or bear markets. On the other hand, and this is surprising, studies have shown that low beta stocks can outperform the market over the long term despite their lower volatility. 

This casts doubt on the widely held belief that higher risk is necessary to enjoy higher returns. A back-test of a low-volatility portfolio, rebalanced annually with a maximum of 15 stocks, found that the low-volatility investment strategy followed from February 2007 to February 2018 produced an annualized total return of 12.7%. The S&P/TSX Composite total return index advanced only 4.9% over the same period. 

Clearly, these low beta stocks outperformed their high beta counterparts even though they must have endured both bull and bear markets together. A lot happens in the market over a course of 11 years. Some of the low beta stocks included in the study are the same low beta stocks often found in the portfolios of retirees.

• BCE
• Brookfield Renewable Partners
• Canadian National Railway
  
• Canadian Tire Corporation
  
• Emera
• Fortis
• Great-West Lifeco
  
• Hydro
• Loblaw Companies
  
• Pembina Pipeline

It appears low beta stocks, contrary to accepted dogma, may very well outperform high beta stocks over time and through varying market conditions. And many low beta stocks are issued by long established companies paying very nice dividends. The result is steady income thanks to the dividends plus out-performance and managed risk -- all qualities that are much appreciated in retirement, or anytime if one stops to think about it.

I knew there was a reason I liked Emera. (Just moments after posting this, I read the following on the TSX Internet site: "Emera Announces Increase in Common Dividend, Marking 18 Consecutive Years of Growth."

I'm wrong but I'm comfortable with my errors

There are a number of common myths surrounding investing. Most serious investors have seen and heard these myths and most of us ignore one of more of them at times. These may be myths but they do seem to fly in the face of common sense.

Just the other day I said I was taking money off the table and increasing my cash holdings. The market is booming and I am reducing my exposure to the market. Why am I doing this? I fear a correction or worse -- a bear market. This is called moving to the sidelines in anticipation of a market downturn and it is a myth-driven action according to the National Bank and others.

According to the National Bank: If you're anticipating a stock market pullback, you're probably right, as declines of at least 5% occur virtually every year; corrections of 10% occur in six out of ten years and corrections of around 15% occur in four years out of ten.

Nevertheless, history shows that investors willing to stay invested through these fluctuations are well advised, as even the average return in years marked by a correction of 10% or more is positive.

Investors whose investment horizon allows for patience are probably better off accepting rather than fearing the inevitable market pullbacks.

The above is a lot like the much discredited market timing belief. Timing your stock purchases to  the market highs and lows is much harder than it sounds and if you could do it you would not be rewarded with a greatly improved income. 

In the example given by the National Bank, invest when the market is at its low point for the year each year for more than three decades and you might see an annual return of 9.1%. If you had ignored market timing and simply invested at the start of each month, you would have had an annual return of 8.6%. But, do you really think you could nail the low for each year steadily for some three decades or more? I assure you; you can't. You would be lucky to see an annual return of 8.6%.

At least taking some money off the table when a downturn is anticipated protects some of one's investment -- or does it? Sadly, it is difficult to time the rebounds. If you stay in, you benefit fully from the rebounds. If you are out of the market, you may miss some or all of the rebound. Miss the rebound and you may finish out of the money.

Investing in the market is not gambling. With gambling, in the long run the house always wins. With investing, in the long run the investor wins. Look at any graph of the TSX. Over a long time period, the market always goes up. Buy, hold and win.

And while biding your time, patiently holding those stocks that have briefly tanked, cash you dividends and smile. According to the National Bank, dividends account for 70% of the total stock market gains since 1980.

Hold the right stocks and the dividend will be awfully secure. The Bank of Montreal has maintained its dividend without cutting or reducing it for over 190 years. The Bank of Montreal is not alone. Enbridge has paid its dividend without cutting or reducing it for over 69 years and Fortis Inc. has not disappointed for over 49 years and the telecom Telus has racked up an impressive 20 year winning streak.

Buy, hold and enjoy the dividends.

Taking some cash off the table

The Fortis price has surpassed its old high for the year ($61.46). A check of its target price shows Fortis to have also surpassed that goal as well. At the present price ($61.84) the Fortis dividend yield has slipped to only 3.847%. This is less than the 4% I look for in a stock holding. I can earn almost as much from a money market fund: 3.8%. I am lightening my exposure to Fortis.

When CIBC split and tumbled in price, both action occured at approximately the same time, I picked up some shares of CIBC with the goal of making a little money come the inevitable turnaround. It has turned around and I have now sold 300 of those shares. 

TransCanada Pipeline (TRP) has been on a roll for some months. It has surpassed its high for the year but it is still down considerably from the height attained by it historic highs more than a year ago. It may regain its old highs but I was happy to part with a few hundred shares at the present price. 

The iShares ETF XUS split a few weeks ago. It had doubled in price since my purchase, and now, at the new price thanks to the split, I feel comfortable dumping a few hundred shares. On the next dip, I will buy more of this ETF than I just sold. One does not want to be underexposed to the American market for too long. I am hoping a correction is coming --- and soon.

The markets have been on quite the roll and despite my lighting my equity load, I am still more exposed to the market than at almost any other time in my life. If the market continues to climb, I will rewarded. If the market pulls back, I have some cash to take advantage of the correction.

Highest yielding stocks for RRSPs

 I love dividends. In fact, I could not balance my books without them. Dividends keep my retirement world spinning comfortably. Today, I read a piece on the highest yielding stocks on the TSX. I was amazed at how many of these stocks many retired seniors have in their income portfolios. The following is a partial list:

• BCE Inc
• Telus Corp
• Enbridge Inc
• TC Energy Corp
• Bank of Nova Scotia
• Power Corp of Canada
• Cogeco Communications Inc
• Bank of Montreal
• Pembina Pipeline
• Brookfield Infrastructure PA
• Toronto Dominion Bank
• Algonquin Power & Utilities
• Nutrien
• Canadian Imperial Bank of Commerce
• Fortis Inc
• National Bank of Canada
• Altagas Ltd
• Royal Bank
• Brookfield Corp

I own, or have owned, almost all of the above at one time or another in my retirement portfolio. I lost a lot of my investment cash by owning any telecom, but especially BCE and Telus, but I have no doubt that the prices will recover. In the meantime, I will be collecting very nice dividends from each telecom in my portfolio.

Pipelines have been solid performers when it comes to dividends but they, like the telecoms, have gone through a very down period. Luckily, all my pipelines seem to be recovering nicely. If and when the pipelines retreat, I would buy if I did not have my investment goals already filled.

The Canadian banks have been long term favourites among retiree investors. Today the banks are on a roll. This means the yield is down today but if you bought low you are enjoying a good dividend plus a nice pop on your principal. For many of us, the banks have been a win-win proposition. 

Utilities are another investment favoured by Canadian retirees. I got into both Fortis and Emera at the urging of a retired friend. Algonquin Power was my own decision. I blew it. I bought too early. Today, two dividend reductions later, Algonquin is looking like a buy and hold. Watch for a price lower than $7 and then check why it is down and if it not a serious issue, buy and hold. Algonquin holds promise when held into the long term.

The market is well off its lows today. In fact, it is hitting new highs. I refuse to advise timing the market but my gut tells me if there was ever a time to time the market that time is now. I confess, I am growing my cash holdings in anticipation of a correction. I also confess that I have been wrong before.

Is it time to take some profits?

The market is up. It is off its highest highs but it is still up. Is it time to take some profits off the table?

For years I have simply practised buy-and-hold. Oh, I have been known to sell a little but not nearly enough. For instance, I held a lot of Nutrien when it was selling for about $145. I should have sold three quarters of my holdings but I didn't. By the time I sold, Nutrien was selling for $75. My tardiness cost me tens of thousands of dollars.

The money market fund I in which I park my cash, is no longer paying interest of four percent or more. Still, I am going to sell some of my portfolio and keep the cash in a money market fund (TDB8150). The hard decision here is what exactly do I sell?

I'm leaning to selling stock that yields less than the interest earned by cash in a money market fund. I am also considering parting with some of my stock that is selling for more than its target price.

If there is a downturn coming in the next 12 months, I will be ready to take advantage of any bargains being offered in the stock market.