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Trend Following Trading – I Am Now a Richard Dennis Turtle

You’ll have seen in a few of my portfolio updates that I have restructured a bit of my portfolio to allow room for multiple strategies. One of which is using Richard Dennis’ trend-following technique. In this article I will explain who Richard Dennis was, why he is awesome, what his strategy was, and how I am implementing it into my dividend portfolio.

All of the information I’ve come to know about Richard, his story, and his strategy has come from a book by Michael W Covel called “The Complete TurtleTrader: How 23 Novice Investors Became Overnight Millionaires” and a bit of extra online research. Covel has been the leading expert on all things Turtle traders for some time and has the first ever “on-record” interviews with actual Turtle traders. It is a great read, not only to learn about the strategy, but also for the riveting story.

Who Was Richard Dennis

Richard J. Dennis, the legendary trader with an uncanny knack for spotting trends, has left an indelible mark on the world of finance. Born and bred in the Windy City, Chicago, Dennis was a natural-born market aficionado from an early age. At 17 he became an order runner at the CME trading floor in the 60’s. He worked his way up to trading his own account and ran his own orders with his dad’s help.

Richard borrowed $1,600 from his family to invest, $1,200 went to buying a seat at the MidAmerica Commodity Exchange where he traded. That left him with only $400 in trading capital. By 1973 he grew that $400 to over $100,000. In 1974 he made over half a million in profit trading soybeans and became a millionaire at 26. He quickly earned the nickname “Prince of the Pit”.

Dennis’s illustrious career can be traced through different phases of amazing achievements. He established himself as a commodities trading legend, riding the waves of market trends with surprising ease. He had an unbelievable ability to spot profitable opportunities in the chaos of the markets including the era of commodity volatility in the 70s. Sugar, coffee, soybeans, and wheat all experienced crazy surges in prices due to Soviet Union demand and hoarding shifting the market.

It was in the 80’s that Dennis really made a name for himself with his “Turtle Traders” experiment. Dennis believed that anybody could be taught to trade, while his partner and friend, William Eckhardt, believed success in markets was a product of talent and skill.

In order to settle their debate, they created the Turtle Traders, a hand-picked group of 23 aspiring traders, fondly known as the “Turtles,” and trained them in his proprietary trend-following strategy. The Turtles were trained for only two weeks, taught the simple rules of Richard’s trend-following strategy, and then set loose with Dennis’s own capital to trade. These Turtles went on to make serious dough, earning millions and hogging the limelight in the trading community and the media.

Dennis’s legacy is the stuff of trading legends, challenging the notion that trading success is all about gut instincts. His trend-following strategy and risk management principles have inspired traders worldwide and ushered in the era of systematic trading. Dennis’s work continues to be a beacon of wisdom in the ever-changing landscape of finance, and his legendary status as a trading maverick remains unshakable.

So, here’s to you, Richard Dennis, the trend-whisperer, the Turtle maestro, and the guru of systematic trading. His contributions to the trading world have left an indelible mark and has planted in me the confidence to make the trend my friend! But how exactly do you do that?

The Strategy

Instead of quickly scalping commodity contracts on the CME floor like most other traders did, Richard developed his own strategy that allowed him to scale into strong trends like the sugar spike of the 70’s and earn greater returns over time.

Richard and his Turtles used two trading systems for trend following. I’m only going to follow the first strategy, so if you’re interested in the second, go read the book. The first system used a 20-day price breakout as a signal for an entry and a ten-day breakout in the opposite direction for an exit. Notice that I don’t point out which direction, this is because the strategy can be used both long and short. I will only be using it long for positions and inverse positions.

While this rule is straightforward, there are some more caveats to it. First, is the filter rule. The Turtles used a filter that was designed to increase the odds of finding a trend. They would ignore an entry alert if the last twenty-day breakout indication was a winner. Even if they did not take that trade, if it was a theoretically winning trade, they would not take the current breakout.

Once a breakout is found, you must measure the volatility of the investment. The Turtles used the Average True Range (ATR) as their measurement and nicknamed it “N”. ATR is the absolute distance the equity moved in a 24 hour period, they would use the 20-day moving average of this value as it gave the sample volatility for the last few weeks. The Turtles used a hard 2N stop, which is known as their contract risk. They used the term “contract” within their own terminology frequently, this is because they traded in futures contracts. For me, however, I am following this strategy with shares, so we will keep our examples in that context. For an example of a stop, if $AAPL had an ATR of 10, your hard stop would be $20.

Once N was understood, the Turtles had to determine how much to invest. They would bet a fixed 2% of their capital on each trade, each 2% bet was called a unit. They had unit limits on any market sector and unit limits on individual positions. Then they would determine their contract risk. The number of contracts to buy is determined by taking the 2% account risk and dividing it by contract risk. Again, if we are using $AAPL as an example, on a $10,000 account, the most the system will let you lose is 2% or $200 on a trade. If $200 is my account risk and the contract risk is 2N (2ATR) which is 20 in this example, then my position size would be 10. If your calculation gives you a decimal, always round down to the nearest whole number.

These rules made any futures contract for any commodity an equivalent figure. A unit of corn was equal to a unit of gold and was equal to a unit of $AAPL shares, essentially making Richard’s strategy a numbers game with no fundamental expertise in any individual market or industry.

In this strategy, N really has almost two meanings. One is a measurement of volatility and the other is a measurement of unit size. It takes a little bit to wrap your head around, but eventually the light bulb turns on and you get it. Once you understand volatility and position sizing, the next step is pile into your winning trades.

Richard’s partner, William Eckhardt, told the Turtles to add into their winning trades. This would maximize their winners and is what helped to create the strategy’s edge. Once a breakout was alerted, and a turtle entered a trade, their next step was to add to the trade at every N level. If a particular stock broke out at $50 and had an N value (ATR) of 5, a new unit would be added at every N level of $55, $60, $65, $70, and so on. They were allowed to pyramid into a trade for a maximum of 5 units. On the first day of an entered trade, stops were 1/2N, then after that the customary 2N was used. When N levels were hit and new units were added, all stops were brought up to the newest unit’s 2N stop.

This strategy protected profits, but not to the point that it would prevent the Turtle from missing out on the larger trend. This idea also guaranteed that profits would be piled into those big unpredictable trends that the Turtles were able to catch.

There is a catch here though, aggressive pyramiding had a downside when false breakouts occurred, and no big trend materialized. Those little losses would eat away at capital. When dry streaks happened, the Turtles cut back on the unit sizes. The rule was that for every 10% drawdown in their account, the Turtles would reduce the size of their units by 20%. Once their capital started going back up, they would revert back to normal unit sizes. If they were going to ruin their accounts, they would ruin them effectively, however this wasn’t the case as most Turtles did tremendously well under this strategy.

Under these rules, Richard Dennis and his Turtles made millions. Several of the Turtles had gone on to pursue their own professional trading careers. Their continued performance is proof that sticking to a system over the long haul can bring great success. The most notable of the Turtle traders had amazing years, with returns as great as 188% and losses controlled to -32% at the most in a single year. Most of the Turtles were able to grow their accounts from Richard manyfold in a few years before the end of the experiment, only to continue trading for themselves afterwards.

Their story is motivational in that it shows that it is possible to learn the steps that top traders follow and replicate the process. However, the story also shows that mental toughness and drive is needed, as not every Turtle found vast success. Regardless, the overall win rate and performance of the Turtles was proof enough for me, so I decided to give it a shot as part of my portfolio.

Dividend Dollars’ Implementation

As is evident in the new restructuring of my portfolio (read the latest portfolio update here), I have allocated 15% of my account to following the Turtle’s strategy. I have been playing with the strategy a little bit in my trading accounts on the side and am excited to deploy it into my main account. If this strategy works, any gains on those funds over and above the 15% allocated amount will be used to grow my long term positions. Investing long term is boring and slow, but it is the best and safest way to build wealth, so I am sticking too it! However, if I can deploy this strategy properly and grow my funds a bit faster with a portion of my funds, we may be able to reach the end goal of financial independence sooner compared to without! So that’s the goal, lets dive into the implementation.

I will only be trading ETFs under this strategy, not futures contracts like what the Turtle’s traded. This has caused me to need to tweak the strategy a little bit, as contracts are much more volatile than stocks, therefore, when using the 2% profile risk and 2N (ATR) contract risk to calculate position size, the resulting positions sizes were much larger than I would have liked. Therefore, I have shifted the risk per trade down from 2% to 1%.

Through my experimentation, I also found that it was rare for a large enough trend to form and take my position through a full 5 units before breaking. Because of this, losses were way more common than winners. I decided I needed to find a way to ensure that the breakeven point, and therefore profits, would come in sooner unit adds rather than all the way through the fifth unit. Therefore, instead of adding the same unit size at every add level, I have scaled down the consecutive units by 40% with each add. So If my first unit is 10 shares, the next would be 6 shares, then 4 shares, 2 shares, and finally 1 share. This way, as the trend grows, my average cost of shares doesn’t grow in step and my breakeven point would occur somewhere between third and fourth unit, allowing me to make minor gains rather than a loss of the trend breaks earlier than desired.

This also means I have less total capital deployed in each trade with each added unit compared to the standard strategy, this frees up capital for me to put to other trends if I can find them. Below is a screenshot of a table I have created to track my trend trades, the ATR, the add and stop levels for each unit, and the projected profit/loss at each 2N stop level.

How do I go about finding the ETFs that are hitting 20 day highs? Using ThinkOrSwim, I have stock scanner set up with some ThinkScript that finds stock prices that are pushing above their historical 20 day highs. I also used the same code to create a chart indicator that shows the 20 day highs and 10 day lows so that I can visually track the entries and exits of these plays. Below is a screenshot of the code for the scanner and for the chart indicator. Use the same logic for a 10 day low. Also below is a screenshot of $SPY using the indicators that show the 20 day high and 10 day low.

With all of this set up, ThinkOrSwim alerts me to when a new ETF fits the criteria of my scanner. This triggers an entry assuming the filter rule is not broken. At that point, I use my spreadsheet to calculate my risk, I get my ATR, I calculate my entry size, figure out my add level, calculate my stop level, and follow the systems rules.

So how well does this work? Currently, I have no actually rode a trend all the way to 5 units yet. But when that happens, anything above and beyond 5 units is a stellar gain. We are in such a choppy market right now that I have been achieving small losses. But that’s okay. That is how the system operates. It’s like throwing spaghetti at a wall and seeing what sticks. Most times the trend breaks within a few days, but that one or two strong trends that you may catch could make your whole year.

For example, lets look at $SGG, this is Barclay’s sugar futures ETF tracker which has had an absolutely wild 2023. On January 6th, the ETF went above its 20 day high, triggering an entry (it also cleared the filter check as you can see by the first arrow and the break of 10 day lows). At entry on January 6th, the ETF cost $65.73 and had an ATR of .91. Using a $10,000 portfolio risking 1% per trade as an example, our entry size would be 54 shares with a stop of $63.91 and an add level of $66.64. Below is a screenshot of the table I use to track entries, stops, and unit sizing for this example also refer to the chart below the next paragraph.

The add level was actually hit the next day, at which point we reevaluate our N stop and add levels and add our next unit size of 32 shares at $66.64. Next add is $67.61 and the stop is moved up to $64.79. Again, this add level was hit the next day, even though it ended up being a red day for the ETF. We go through the same exercise of adding now 19 shares, recalculating ATR, and moving adds and stops to $68.61 and $65.73. Again, the add was hit the next day and this time we added 11 shares and moved levels once more. The next and final add would be at $69.77 and stop is $66.74. Now here is where it gets interesting, the next add is never hit till March 1st, however the stop of $66.74 is never hit, neither is the 10 day low. So we would have held onto the position the entire time. On March 1st, we would add out final unit of 5 shares at $69.77 and move our stop to $68.09. From there, the 2N stop and the 10 day low stop has yet to be hit as of this writing. Your total position of 97 shares with a cost basis of $66.55 per share would be worth almost $8,800 and result in a trade gain of 35% or $2,300. That’s a 23% gain on the entire portfolio in one trade, and the best part is that the trend is not done yet. Who’s to say how far it will continue.

I won’t break down step by step other examples, but I will provide the screenshots! Take a look at $PNQI, $EWW, and $KOLD! Absolutely wild runs!

I’m hoping I begin to catch some wild runs myself by implementing this strategy. I haven’t caught a wild one yet, but it will come! Stay tuned to the website and my portfolio updates to see what trends I try to find with the turtle strategy!

Thank you for reading this. If you found it helpful please subscribe to the website on the homepage and follow my Twitter and CommonStock accounts. If you ever have any questions, feedback, compliments, etc. you can reach out there or leave comments here! Please do any kind of interaction, I do all of this research for free, run this website at my own expense, and write and share all that I am learning for your benefit. Any interaction with you all means a lot to me.

Categories
Dividend Stocks Dividends Portfolio Strategy

Dividend Portfolio: 4/14/23 Weekly Update & Big Shift!

Welcome back to the weekly Dividend Dollars portfolio review, and a very special one at that! You’ll notice within the screenshot of my portfolio that the general structure has changed a little bit. I am starting to implement a new strategy! I am quite excited about the new direction of the portfolio, so read on to see what we’re doing!

This portfolio update is brought to you by Sharesight, a portfolio tracking tool that I am happy to partner with. Their platform makes tracking trading and dividend history, understanding your performance, and saving time a breeze. I wrote a review of the product that you can read here if you’re interested in learning more! Click the link above or the picture below to get a special offer only for Dividend Dollar readers!

Here at Dividend Dollars, our investing approach is a dividend growth strategy with aspects of value investing and fundamental analysis. I am a young investor in my 20’s and by sticking to this strategy over the long term, the magical powers of compounding are on my side. This allows me to more easily build substantial positions in dividend paying stocks over time, which will one day help me reach the ultimate goal of being financially free through the sources of passive income they provide. You can read more about the strategy here. Let’s dive into the portfolio review!

Portfolio Value

To date, I have invested $15,290 into the account the total value of all positions plus any cash on hand is $15.712.20. That’s a total gain of 2.76%. The account is up $177.46 for the week which is a 1.14% gain.

We started building this portfolio on 9/24/2021 and when compared to the S&P 500 we are outperforming the market so far! Within that same timeframe, the S&P 500 is down -7.13% which puts us 9.89% higher than the market! I love tracking my portfolio against a benchmark like the S&P. The above chart comes from Sharesight which makes portfolio and dividend management a breeze!

We added $120 in cash to the account last week, trades made will be broken out below.

Portfolio

Above is a dashboard of the portfolio that tracks annual dividend income, yield, beta, dividend growth, and more.

Below is a table of everything we are invested in so far. There you can see my number of shares, shares bought through dividend reinvestments, average cost, gains, and more. The tickers in green are positions that I bought shares in this week, the blue ones are positions that I reinvested dividends into, the yellow ones are positions that announced a dividend increase this week, and the red are positions that I trimmed. Our PADI decreased from $638 to $532. This large decrease was intentional and part of the new strategy I mentioned above.

So what is this new strategy, what has changed? Overall, I’m being pickier about the allocation percentage of my capital to different aspects of the portfolio. 70% of my capital will go to my stock picks which coincides with my long term strategy.

I have been reading a number of books like CommonStocks & Uncommon Profits, The Joys of Compounding, 100 Baggers, One Up On Wall Street, and many others. These books have inspired me to be pickier with my individual stock holdings and narrow down my number of positions. As I continue to study these investors and use their lessons to develop my own long-term stock picking strategy, I will create an excel sheet/dashboard that will allow me to track relevant qualitative and quantitative information such as leadership quality, cash flow generation, debt levels, capital allocation, margin of safety, intrinsic value, and more. There’s a lot of work I need to do to get to that point, but we are in the process of upgrading our strategy!

The other 30% will be equally split between ETFs and a new swing trade strategy. The 15% in ETFs will allow me to continue investing in the ETFs that afford me a level of diversity and dividend income that I will continue to grow.

The other 15% will be allocated to a trend following strategy inspired by legendary trader Richard Dennis. I have been studying him and his Turtle Traders for sometime and am working on article to publish the specifics about my strategy for these funds. That should be out soon, so stay in touch with this website or my Twitter account. I have morphed his strategy into a variation that will allow me to follow trends in dividend paying ETFs. The goal with this strategy is boost the medium term gains of my portfolio and use any gains over the allotted 15% to reinvest into my stock and ETF picks.

I look forward to this new phase of evolving my portfolio and am excited to bring you guys along with me!

Dividends

This week we received two dividends: $8.60 from $BBY and $2.27 from $O.

In my portfolio, all positions have dividend reinvestment enabled. I don’t hold onto the dividend, I don’t try to time the reinvestment, I just let my broker do it automatically.

Dividends received for 2023: $144.74

Portfolio’s Lifetime Dividends: $555.14

Trades

Obviously, because the restructure and the goal of cutting down on some of my positions, this was a week of selling. The positions I sold were either intended shorter term holdings or positions I felt I hadn’t researched enough to earn a spot within my portfolio. The short list has been chosen!

Full details for my trades are below:

  • April 4th, 2023
    • SPDR S&P 500 ETF ($SPY) – added $10 at $407.83
    •  Global X S&P 500 Covered Call & Growth ETF ($XYLG) – added $10 at $26.47
    • Schwab US Dividend Equity ETF ($SCHD) – added $10 at $72.68
    • ETRACS 2xMonthly Leveraged US Small Cap High Dividend ETN ($SMHB) – added 1 share at $5.37
  • April 10th, 2023
    • ETRACS 2xMonthly Leveraged US Small Cap High Dividend ETN ($SMHB) – added 2 shares at $5.34
  • April 13th, 2023
    • New York Community Bank ($NYCB) – Sold 130 share position at $8.94 for a 18.46% gain of $181.10
    • Orsted ($DNNGY) – sold 4 share position at $29.99 for a 7.26% loss of $9.73
    • Atlantic Infrastructure ($AY) – sold 13.09 share position at $27.72 for a 6.15% loss of $24.96
    • Steve Madden ($SHOO) – sold 3.01 share position at $35.02 for a 0.23% loss of $0.24
    • Ally Financial ($ALLY) – sold 13.27 share position $26.47 for a 4.80% loss of $18.00
    • SPDR S&P Biotech ETF ($XBI) – added 5 shares at $79.81 under the trend strategy
    • Best Buy ($BBY) – reinvested dividend
  • April 14th, 2023
    • Vanguard Financials ETF ($VFH) – added 8 shares at $78.80 under the trend strategy

Next week I will look to continue my weekly buys into $SPY, $SCHD, and $XYLG and watch for opportunistic adds as well as trend opportunities. I’ll be looking to add to my redder positions in $MMM, $BBY, $FIS, and $INTC to take advantage of the coming ex dividend date.

Summary

That is it for the update this week. Big week for DividendDollars!

The market recap and outlook will be posted later this week and provides tons of information on what macro statistics I look at to keep a temperature gauge on the market and inform my portfolio movements. Read last week’s here while you wait for the new one!

I will also work on finishing my write up on the trend following strategy to share with you, so stay tuned for that.

Let me know what you think of the progress so far, share with me your progress and questions, interact with me on Twitter and CommonStock and other socials using the links below!

Thank you for reading! See you next week and stay safe!

Regards,

Dividend Dollars

Categories
Economics Market Recap Market Update Stock Market Strategy

Stock Market Week in Review (12/23/22) – A Weak Week to Lead Us Into The “Santa Rally”

This weekly market recap is brought to you by Koyfin, a powerful analytical tool that I am proud to partner with. Their platform is entirely customizable for whatever data you want to look at including stocks, ETFs, mutual funds, currencies, economic data releases (one of my personal favorites used often for these posts), crypto, and even transcripts of company events! Click the link above to get a special offer only for Dividend Dollar readers or go give my product review a read if you’re interested!

Weekly Review

Well, this was a disappointing week, and one that solidifies the absence of a Santa Clause Rally to end the year. The S&P 500, which touched 4,100 last Tuesday, was drawn to the 3,800 level all week which proved to be a key support area.

With tax loss harvesting likely to be beginning and with sentiment falling over all due to 2023 earnings estimates feeling too high, the market was lower this week. Many analysts suggest downward earnings revisions in the coming weeks and months as the economic environment shifts.

The week started on a weaker note as the market digested a weaker-than-expected NAHB Housing Market Index report for December on Monday.

Treasury markets moved on a surprise policy change from the Bank of Japan (BOJ) on Tuesday. The BOJ announced a change to its yield curve control (YCC) policy to allow the 10-yr JGB yield to move +/- 50 basis points from 0.00% versus its prior band of +/- 25 basis points as part of an effort “to improve market functioning.”

This announcement, which came in conjunction with the BOJ’s decision to leave its benchmark rate unchanged at -0.1%, also caused some upheaval for the Nikkei (-2.5%) on Tuesday and the currency market in addition to sovereign bond markets. The yen surged as much as 4.0% against the dollar.

The Market also had to deal with some disappointing housing data before Tuesday’s open, namely an 11.2% month-over-month decline in November building permits (a leading indicator) to a seasonally adjusted annual rate of 1.342 million (consensus 1.480 million).

The S&P 500 dropped below 3,800, scraping 3,795 at Tuesday’s low before buyers showed up for a small rebound effort that ultimately left the main indices with modest gains. At this point, the indices were in a short-term oversold position. At their lows Tuesday morning, the Nasdaq Composite and S&P 500 were down 9.7% and 7.5%, respectively, from their highs last week. That oversold posture triggered some speculative buying interest in a bounce.

Things really took off Wednesday when some well-received earnings reports from Dow component Nike ($NKE) and leading transport company FedEx ($FDX) triggered some decent buying interest.

The market also got some better-than-expected consumer confidence data for December, which was another support factor for the broader market. That report overshadowed a weaker than expected existing home sales report for November that was released at the same time.

Unfortunately, the rebound move soured promptly on Thursday following some disappointing earnings results and commentary from Micron ($MU) and CarMax ($KMX), a sour Leading Economic Indicators report, and some cautious-sounding remarks from influential hedge fund manager David Tepper say he is ‘leaning short’ on the stock market.

He expects the Fed and other central banks to keep tightening and for rates to remain high for a while, making it “difficult for things to go up.” His comments resonated with market participants who recalled the hugely successful “Tepper Bottom” call he made in March 2009.

The resulting retreat was broad in nature with the major indices moving noticeably lower right out of the gate, dealing as well with rate hike concerns after the third estimate for Q3 GDP showed an upward revision to 3.2% from 2.9%. The Nasdaq, S&P 500, and Dow were down 3.7%, 2.9%, and 2.4%, respectively, at Thursday’s lows.

The S&P 500 was stuck below the 3,800 level and Tuesday’s low (3,795) for most of the session before the main indices managed to regain some of their losses in the afternoon trade. There was no specific news catalyst to account for the bounce, possibly just speculative bargain hunting.

Friday’s session also started on a downbeat note after the November Personal Income and Spending Report showed no growth in real spending and PCE and core-PCE inflation rates that are still too high on a year-over-year basis (5.5% and 4.7%, respectively) for the Fed’s liking.

This report meshed with a Durable Goods Orders Report for November that was weaker than expected and was subsequently followed by economic data that showed new home sales were stronger than expected in November and that easing inflation pressures helped boost consumer sentiment in December.

Once again, the S&P 500 slipped below the 3,800 level, but soon found support as the new home sales and consumer sentiment data bolstered investor sentiment and spurred some bargain hunting interest. The major indices finished modestly higher on Friday, taking a positive first step during the Santa Claus rally period (last five trading days of the year plus the first two trading sessions of the new year).

Separately, the week concluded with the House passing the $1.7 trillion government funding bill after the Senate passed it, leaving it to be signed by the president early next week.

Overall, sector performance was mixed this week with 6 of the 11 sectors in the S&P ending green. Energy, financials, utilities, and a few others finished higher. The weakest links were consumer discretionary and technology which were dragged down by their mega cap components.

Dividend Dollars’ Opinion

That’s it for the recap. Now for my opinion!

Last week I was half-way right in expecting a near term bounce, however I was not expecting it to only last two days (Tuesday and Wednesday). We broke back under the bear market line and stayed there Thursday through Friday.

This here is the key to me. We are under all major moving averages AND the bear market line. There is significantly more resistance than there is support.

Next week, the 3,800 level will be key. We found substantial support at that level as everything under it was just a long wick. There are no major economic releases next week, which make me think we won’t see any crazy catalytic moves in one direction or the other.

We have some claims and housing reports, but that’s about all that’s worth watching, domestically that is. China and Japan have some releases that could bleed over into the US market.

With that, I will just reiterate what I said last week: “With the next earnings season on the way, Fed commentary continuing to spark volatility, and mixed economic data, the next move is anybody’s guess. I think a near-term bounce is likely with more downside to follow after the new year. Then, January will be the month to watch as history shows that it sets the market’s mood for the rest of the year.”

I think the action we saw on Tuesday and Wednesday very well could be the bounce, leaving more downside as my expectation. There are no huge economic releases next week, the Santa Rally so far has been week, therefore I think next week will be red mostly off of tax-loss harvesting.

However, if we open significantly higher in the earlier days of next week, I could see buyers coming in heavy off of the hopes of a strong Santa Rally to push us up through the end of the year. I think this scenario is less likely.

I would love to see more red next week so that I can buy more discounted stocks like I did this week. You can read about my buys in my weekly portfolio update here.

And if you like updates like this, follow my Twitter or my CommonStock page where I post updates on the economic data throughout the week.

Regards,

Dividend Dollars

Categories
Dividends Stock Market Strategy

What Dividend Strategy Does Best in a Bear Market?

As the economy falls further into bear market territory, it is clear that dividend investing strategies have held up better than most other investing strategies this year. Today I read an article from a Morningstar writer about which dividend investing strategies are outperforming year to date 2022. This article looked at how much that performance has varied depending on specific dividend investing approaches.

Generally speaking, there are usually two schools of thought when it comes to dividend investing: dividend yield investing vs. dividend growth investing. Dividend yield is calculated as the latest dividend payment annualized divided by price. Dividend growth is defined as the rate of change of dividends paid by a company over time, generally the most recent 3 or 5 year period. Clearly, a high dividend investor is more focused on the size of the dividends they receive while a dividend growth investor cares more about the historical and potential growth of the dividend. Both styles generally have the same goal, which is create an income stream.

However, an investor’s time horizon can play a significant role in determining which strategy they focus on. Older folks may want to put their money in high yielding yet consistent payers like Realty Income ($O) or Enterprise Products Partners ($EPD). This is because reliable income now is more important to them than growing long term wealth. For younger investors, it may make more sense to focus on a dividend growth strategy by investing in companies that have low payout ratios and potential to create a long track record of increasing dividends like Lowe’s ($LOW) or Visa ($V).

With dividend strategies faring better than most other for 2022, the article looked at which one is doing the best. The article concluded that strategies that invest in high yield companies with healthy financials outperformed the most. After reading that, I decided to evaluate that conclusion for myself by back-testing a handful of dividend paying ETFs which follow various strategies. Below are the ETFs that I was able to back-test through using Sharesight:

  • ProShares Dividend Aristocrats ETF ($NOBL) which contains the numerous stocks of varying yields and growth potential that are on the dividend aristocrat list
  • Vanguard High Dividend Yield ETF ($VYM) which contains the highest yielding stocks after being filtered by market cap adjustments
  • Vanguard Dividend Appreciation ETF ($VIG) which contains stocks with at least a 10-year history of growing dividends after passing market cap and trading volume criteria
  • Schwab US Dividend Equity ETF ($SCHD) which contains stocks that meet the criteria of both yield and fundamental aspects
  • Global X S&P 500 Covered Call ETF ($XYLD) this is not a dividend ETF perse, however lots of dividend investors use covered call funds to use their high yields for income purposes

As you can see in the graph below, the S&P has fallen by 20.55% year to date. The best performer of the dividend strategies was the dividend yield strategy down by only 9.46% year to date, followed by the dividend fundamental strategy down by 10.74% year to date. Surprisingly, the covered call high yield ETF was a very close third down by only 10.77% year to date!

High yield investors (assuming sound quality of stocks) have stayed strong in this market, in part by the strong finances of their holdings but also sizable exposure to the energy sector. A high yield dividend strategy almost inherently has extra exposure to energy and little exposure to tech. High yield strategies with a quality focus on seeking profitable firms in a position to consistently pay their dividends over many years and dumping the ones that can’t, are in a great position to keep the dividends flowing which is provides important financial stability even if a recession hits.

Though energy is starting to waiver, the sector’s performance this year is primarily the determinate of the success of these dividend funds. Energy tends to be much more prominent in dividend and value portfolios. $VYM, our high yield ETF, has the second highest yield at 2.79% and has greatest exposure to the energy sector at over 10%. That is more than double the S&P’s energy exposure at 4.68%

Dividend growth strategies haven’t done as well this year, mainly because of their exposure to tech. For example, our high yield ETF $VYM has 8.37% exposure to tech whereas its growth counterpart $VIG has more than double that at 16.78%. Prior to this year, most dividend strategies in general had not performed well when compared to the market. Even with a focus on which quality, dividend stocks tend to have a hard to keeping up when the market is focused on growth. However, now that the tide of the economy has turned, dividend investing, whether that is with an emphasis on yield or on dividend growth, is shining bright as the safeguard against this volatile market.

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Dividends General Portfolio Strategy Welcome

Dividend Growth Investing While Young

It is a common adage that young investors should take on more risk than older investors and pursue high-growth investment strategies. There is a lot of reasoning behind this approach, but I believe it can be boiled down into three main points.

  1. Certain stocks have the potential for massive gains via quick increases in stock price. If you are successful at identifying these, you can get rich quickly.
  2. If you are unsuccessful at investing in the next “multi-bagger”, you still have plenty of time to make up for your losses.
  3. If you’re young and have a job that provides you with sufficient income, you don’t need to rely on the slow-growth or passive income that dividend stocks provide. Dividend income is not needed at a young age.

While I think that a portion of high-growth stocks have a place in every portfolio, I disagree with the approach that younger investors should overlook dividend investing entirely. Young investors do not need to entirely pursue growth-stocks, they don’t need to risk the potential large losses of this strategy, and I do not think that younger investors should avoid dividend paying stocks simply because they don’t need the income.

As an investor in my 20’s, my personal investing strategy is one of dividend growth investing. My strategy incorporates aspects of traditional dividend investing, value investing, and growth investing. I look for stocks of companies that pay dividends consistently, grows them consistently, appears to be undervalued (using a handful of techniques), and looks to be successful over the long term.

Through doing this, young investors can realize capital appreciation through successful use of both value and growth investing, they can have exposure to passive income through the dividend, and can build up their position over time by reinvesting the dividend overtime to compound their money.

Compounding is the key here. By reinvesting dividends, you are using that dividend to produce more dividends every time a dividend is declared. Compounding dividends is a powerful force for the long-term wealth builder, but it takes time for that power to grow and become significant. For this reason, young investors may not appreciate why dividend growth investing is such a sensible strategy for people who won’t be retiring till 40+ years from now.

Compounding is the 8Th Wonder of the World

Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.” Over time, your dividends will earn more dividends. Then your dividends that were earned by prior dividends will earn you more dividends. It seems simple, but it is surprising hard to wrap your head around just how powerful compounding is till you play some numbers and graphs. We will do that here.

Take Lowe’s (LOW) for example. For the last ten years, the stock’s average dividend yield has hovered around 2%. 10 years ago today, one share of LOW cost you $26.98. Let’s assume an initial investment of $10,000. Using Sharesight, I can back-test the performance of that investment with dividends reinvested and the result is shocking.

From June 2012 to June 2022, the stock price from $26.98 to $186.33. In 10 years, the stock price grew by almost 6x. Add to that appreciation, 10 years of growth and compounding dividends your position grew from $9,982.60 on June 11th, 2012 to $64,920.20 on June 10th, 2022.

Meanwhile, your quarterly dividend payout began at $59.20 and grew to $296 which yielded you total dividend payout of $5,960.70. With just 10 years of holding, your dividend payout grew by more than 5x and yielded you a total of $5,960.70.

The magical variable in this formula is time. In 10 short years, you can see in the graph below that the dividend payouts start to resemble an exponential curve. If I had back tested for 20 years instead of 10 years, the dividend would have grown from $4.24 to $339.20 and that curve would be more pronounced. This simply goes to show why it is a good idea for dividend growth investors to start early. The younger you are the more time you have available to you for compounding.

Comparison with Aggressive Growth Investing

The graphics above show the potential outcome of a dividend growth investing strategy played out over 10 years with only Lowe’s (LOW). Assume an investor was 55 when they started investing in LOW, held it for those 10 years, then decided they wanted to retire at 65. However, now assume that that investor was persuaded that Facebook (now Meta Platforms META) would be the next big thing and decided to invest in that instead. Instead of finishing the 10-year stint with nearly a $65,000 position in LOW that pays him over $1,000 in dividends per year, this investor now has a $55,000 position in META that pays him nothing.

Though I am picking and choosing stocks for this scenario, it clearly demonstrates that the early emphasis on dividend growth provides a greater return and a stream of cashflow to rely on in retirement.

Some of the popular growth names would have caused you to lose money over that 10-year time frame (think Achillion or Blackberry). Others produced lesser gains like Google and Apple. Others barely outperformed like Amazon and Microsoft. Only a handful really took off like Netflix and Tesla. However, are you confident that 10 years ago you could have picked Tesla while you risk accidentally picking the Blackberry? And are you confident that you could make that same decision today?

Dividend Dollars Strategy

While it’s hard to pick the next Tesla, it is not hard to pick stocks that pay consistent dividends, grow them, and have potential for future growth. As I said before, my strategy incorporates aspects of traditional dividend investing, value investing, fundamental analysis, and growth investing. I look for stocks of companies that pay dividends consistently, grows them consistently, appears to be undervalued (using a handful of techniques), and looks to be successful over the long term.

10 years ago, Lowe’s already had nearly a 50-year streak of paying and growing dividends, they had good financials, a growing P/E and a growing EPS. Fundamental analysis shows that the company has value, value that may have been overlooked in 2012 depending on what quarter you look at. From a value standpoint, 2012 had some dips in the stock price that would have made sense to buy. From a dividend standpoint, Lowe’s already had great history of payments that would make any income investor feel fuzzy inside. Overall, there was nothing fancy about them back then, and there is still nothing fancy about them today.

In conclusion, it is much easier, and much safer to take the road less traveled as a young investor. Achieving long term wealth is much more realistic when considering the compounding opportunity that already successful and healthy companies can offer you.

Young investors should not feel obligated to follow the conventional advice of pursuing high growth investing or risk day trading. Taking on excess risk with goal of achieving wild returns might not materialize. Even though they have the time to recoup those losses, they may not be able to avoid the consequences of lost time for compounding.

Here at Dividend Dollars, I am a young investor trying to avoid just that. I invest in safe dividend paying companies that long-term have the greater potential support me in retirement and may even help me retire early! I have educated myself and built a sensible long-term strategy and highly encourage you to do the same.

This website is here to help you do just that by following our posts which include weekly portfolio updates, market analysis, occasional stock due diligence articles and the shared investing resources to give you all the tools you need to start!

I am also open to conversations to help! Comment below or reach out to me on my socials if you ever need anything.

Regards,

Dividend Dollars