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By Josh Peters, CFA | 02-24-2015 04:00 PM

Finding the Dividend Growth and Income Sweet Spot

A balanced approach to dividend income and growth generates the best risk-adjusted outcome, says Morningstar's Josh Peters.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Dividend investors spend a lot of time doing research on individual securities, but sometime they spend less time thinking about portfolio construction. I'm here today with Josh Peters--he is the editor of Morningstar DividendInvestor newsletter and also our director of equity-income strategy--to look at some changes he has recently made in his portfolio and what lessons investors can learn from them.

Josh, thanks for joining me.

Josh Peters: Good to be here, Jeremy.

Glaser: Let's start with some of those changes that you have made to your newsletter portfolios. Could you walk us through why you decided to take the two separate portfolios and combine them into one?

Peters: Just a little bit of backstory: Our performance starts in January 2005, so a more than 10-year track record. Those first two years, we had just a single portfolio--it was called the Dividend portfolio. Then, in 2006, I noticed that a lot of subscribers were looking for us to concentrate on a lot more high-yielding names, which back then could yield 6%, 7%, 8%, or maybe 10% or 12% on some stocks. And so, at that point, we divided the strategy. We set up a new brokerage account because both the accounts were represented by real Morningstar money that had been deposited into a brokerage account and set about having what we called our Builder Strategy--kind of the carryover from the original portfolio--and moved some of those higher-yielding names we owned earlier on into the higher-yielding-focused one called the Harvest portfolio. They used the same basic investment discipline but targeted very different yields.

What happened, though, was that experience taught me the best results are really in the middle. So, where initially that Builder portfolio focused on yields between 2% and 4% but 8% to 10% dividend growth, I found that was actually more than you could reasonably expect over the long-term from most of those kinds of companies that could meet those yield requirements, [and the same was true for] the Harvest portfolio looking for 6% to 8% yields. Now, I wanted at least some growth to offset inflation; but frankly, even in that environment--even more so in today's environment--if you are looking at stocks with those kinds of yields, you are taking too much risk.

So, as I maneuvered these two portfolios over the succeeding eight years, I found they are getting closer and closer together--because I'm finding that the best results are in the middle--to the point where, at the very end, the Harvest yield objective was 4% to 6% and the Builder was 3% to 4%. They were right next to each other. So, at that point, I had to consider whether it made more sense to keep them separate or whether the whole was worth more than the sum of the two parts.

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