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By Josh Peters, CFA and Jeremy Glaser | 05-20-2015 02:00 PM

Measuring the Success of Your Dividend Portfolio

Worry less about beating the benchmark and more about dividend growth and achieving your desired outcomes, says Morningstar's Josh Peters.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here today with Josh Peters--he is the editor of Morningstar DividendInvestor newsletter and also director of equity-income strategy. We're going to talk about how he picks metrics to measure his performance and how that helps him manage the portfolio.

Josh, thanks for joining me.

Josh Peters: Good to be here, Jeremy.

Glaser: Let's start by talking about how you pick the way that you measure your performance, measure the portfolio. A lot of people think about maybe looking at it against a benchmark or something like that. How do you think about the success of your portfolios?

Peters: Benchmarks are important. To be able to compare your returns over a long period of time against, say, the S&P 500 is not a bad idea because that's sort of a default option that you can get with very low cost. If, over a very long period of time, you're taking just as much risk as--or more than--the S&P 500 and not getting as much return, then maybe you should just index. So, for active managers everywhere who are sort of under siege, that is what you have to do. You have to add some value either with less risk or more return or preferably both.

Fortunately, that's what we've been able to achieve in our first 10 years with the DividendInvestor model portfolio strategy, but that's actually not how I manage it. I figure to really achieve the best results you have to start by thinking, "What is the desired outcome?" And for the portfolio I manage, the number-one objective is to generate income that can either be used to fund withdrawals for people who are in retirement and have living expenses to meet or for people who like the strategy and want to reinvest that income to drive future income growth so that they've got that much more income available to them when they retire.

So, my preferred metric for looking at the performance of our portfolios is to look at the annualized income it throws off. So, if I have 200 shares of XYZ that pay $1 per share annually, then that's $200. I add up that value for each position in the portfolio--have 27 individual stocks in the portfolio right now--and that comes up with a single number that expresses the income of the portfolio as a whole. It's a little over $17,000 now for a portfolio that's worth $440,000 or $450,000. So, that correlates to about a 4% yield right now. But the yield itself--half of it is a function of the stock prices. The market could be high or it could be low--that's going to influence the yield.

What I really figure I have some control over and what I want to manage and measure the progress of is that $17,000 today. Is it $18,000 or $19,000 next year? Is it $21,000 or $22,000 year after that? Or am I having dividends cut or not getting the dividend growth I expect and, therefore, my income is stagnating? So, to me, that's really the most powerful indicator of whether or not we are moving in the right direction. And historically, we've had a very close correlation between the market value of the portfolio and the annualized income.

So, you might think of it as our yield has been pretty stable over time and as we've grown our income, that in turn has helped push up the value of the portfolio. That's where you get your total return. Total return is always the bottom line. The question is, "How do you achieve the total return that you're looking for?" To try to compete, head to head, with a benchmark--saying, "I'm going to try to beat the S&P over the next 12 months"--that's a very different game. It's a very difficult game, and it doesn't even necessarily serve your personal investment objectives directly.

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