If you are a regular reader of this blog, you know that some sectors I keep to a low portfolio weighting. Financials and technology just to name a couple. These two sectors usually have a 30%-40% weighting in the S&P 500 and that’s too much in my opinion and for my portfolio.
I’m building a retirement portfolio over the next 5 years that needs to last another 30 year. This means there is a possibility I’ll need to be drawing on funds sooner than later. My sectors need low beta, low volatility in comparison to the market. Historically, financial services and technology (just to name two) have higher betas and can swing wildly every 15-30 years.
And that’s not something I’m wanting in my portfolio, at least not with a heavy weighting. Can you imagine having 30-40% of your portfolio in companies than can drop 65-95% within a year or two? That’s what can happen in the financial and technology sectors.
Also typical in the technology sector is seeing a stock run significantly higher in a short period of time (i.e. 1-2 years). It’s not unusual to invest $20,000 in a technology company worth 5% of your portfolio only to see it two years later become 30%+ of your portfolio. But a few years later you could see that technology stock do a 65-95% drop and then your retirement plans are toast.
Handling of your dividends when investing in the financial and technology sectors is another significant consideration. My opinion? Take your dividends in cash instead of reinvesting in those sectors. Why buy more shares through reinvestment when there is a high possibility of a 65-95% drop in value? Take the money and run … reinvest those funds in other sectors that are more suitable (i.e. stable) for a retiree.
Examples: Microsoft & Bank of America
My Master Stock List contains a wide variety of sectors and industry leaders. The list even contains financial and technology companies but with a caveat. In the list, I clearly state that these two sectors will not have a heavy weighting in my portfolio. But I still think they are important to own.
“Financial institutions make us nervous when they’re trying to do well.”
Charlie Munger
And for the record, I love both Microsoft and Bank of America. Them along with J.P. Morgan, Wells Fargo, Cisco, and a handful of other financial and technology stocks. Just because I love something doesn’t make it right for me forever and it doesn’t mean I want it to weigh heavy in my portfolio.
Just look at Bank of America. Yes, the Financial Crisis was brutal but banks were in a deep mess. That’s what they do and it happens every generation. A tiger has stripes and banks get greedy.
I do not want a heavy weighting in a quality stock that can drop 95%. This kind of stuff ruins retirements and I saw plenty of co-workers stay with our company because they lost too much money. Many are just now retiring … it took them that long to recover.
Personally, I do not consider financial services and technology sectors to be buy and hold forever sectors. I’ll buy them on the cheap and let them run for some time (5-10 years?) but I’ll sell before (I hope) they drop 65-95%. A retiree just can’t have too many of these stocks in their portfolio. Watching your stocks drop that much isn’t what I want to experience in retirement.
And look at Microsoft’s 67% drop. See how many years it was flat? You didn’t even get a bounce to recover your money until years later – that is painful to consider. Microsoft is a great company but it’s up over 50% year-to-date, which means it’s likely time to trim some of the position.
Focus On “Repeatables”
I call “repeatables” something that is bought over and over again. These are fabrics of our society: soap, soda, tampons, gasoline, candy, etc… Consumers need these items regardless of what the economy is doing. During bad times, consumers might not buy premium beer but they’ll still buy beer. I want to walk into a Wal-Mart and see my companies products.
Again, in my circumstances of building a retirement portfolio in the next 5 years, I’m more focused on Consumer Goods, Energy, Health Care, with a sprinkling of others to diversify the portfolio. A quick look at my Master Stock List shows that 35% of my list contains Consumer Goods companies.
I don’t need skyrocketing growth, just solid earnings and dividend growth over the next few decades. If the companies keep churning out solid cash dividends, then I’ll be happy. And yes, a little growth would be nice too.
I’m also focused to not overpay for a company. For me and my situation, I see little value in paying more than 25x earnings and definitely not more than 30x earnings. The more you pay for earnings the less return you’ll get over the next 20 years. I choose the companies I’m interested in and wait patiently to buy them at the price that will give me the greatest long-term return.
For example, I love (love) Coca-Cola but would never pay 50x earnings like we saw in 1998. Buying at those prices, even with a great company, guarantees mediocre (at best) future returns. Some companies demand a “quality” premium but there are limits to the premium.
Summary
Here’s the point of this entire article … it’s fine to invest in financial and technology companies but with limits. Be more active with your management of those investments, don’t be overweight in them as you get closer to retirement, and take your dividends as cash.
With my past losses, I’m just very cautious in what my portfolio looks like when the work paycheck stops. Knowing my downside in a consumer goods company might be 25% during a recession versus 50%+ for other sectors is important. Of course, that limits my upside too but I’m not trying to be a hero in retirement. Growth and income with a focus on income (and capital conservation) is the game I’m playing.
I’ve seen too many co-workers delay retirements because the Technology or Financial Crisis (or both) destroyed their portfolios. They road the wave up but didn’t actively manage their portfolios to limit their downsides. I can only imagine they were a little cranky at work knowing they should be retired.
The latest technical gadget will become outdated but people still go into buy soda, beer, diapers, gasoline, and medicine. Most of my stocks will have products that need to be purchased regardless of the economy. And this allows me to sleep well at night. Personal finance is personal, and we all have to tailor investments to our own situations and temprements.
Here’s the funny part of the article. Warren Buffett’s portfolio is highly concentrated in financials and technology (and consumer goods). It might appear that I’m going against the Guru himself but that’s not true. Again, I love these sectors but they won’t be heavy in my portfolio and I won’t hold them forever. I can’t stomach or tolerate a 65-95% drop in my retirement portfolio.
Thanks for reading!
Mr. TLR