The U.S. stock market stumbled in recent weeks, prompting investors to worry about the possibility of a big downturn to come.
After all, if the market is on the precipice of a big crash, it might be wise to sell early. Mind you, correctly timing an exit from the market is easier said than done. It also has to be followed up by figuring out when to buy back in.
Fretful investors might opt instead for the comfort of the Stable Dividend portfolio, which has provided outsized returns over the years. The idea is to stick to dividend-paying stocks with low volatilities that have offered a relatively smooth ride to investors.
The Stable Dividend portfolio generated healthy average annual returns of 13.6 per cent over the 25 years through to the close of Jan. 17, 2025. In comparison, the overall Canadian stock market (as tracked by the S&P/TSX Composite Index) gained an average of 6.7 per cent annually over the same period. (The returns herein are based on backtests using data collected on the 17th of each month from Bloomberg. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs.)
The portfolio is formed by starting with the largest 300 stocks on the Toronto Stock Exchange by market capitalization. It then narrows in on the dividend-paying stocks, which recently reduced the list to 208 names. The next step is to buy an equal-dollar amount of each of the 20 stocks with the lowest volatilities over the prior 260 days. The portfolio is subsequently rebalanced monthly, but, as it happens, rebalancing it annually generated a nearly identical growth rate over the 25-year period.
The Stable Dividend portfolio is equally weighted and requires some maintenance to bring it back into balance each month. Alternately, investors can opt for a portfolio that is weighted by size (market capitalization), which can help reduce the amount of trading needed to rebalance it each month. The idea being that a stock’s market capitalization (price times shares outstanding) changes as its price changes.
The size-weighted version of the Stable Dividend portfolio gained an average of 11.7 per cent annually over the 25 years to the close of Jan. 17, 2025. Alas, it didn’t grow as much as the equally weighted portfolio and was about 24 per cent more volatile, which isn’t a great combination.
You can examine the return history of both portfolios, and the market index, in the accompanying graph.
Weighting a portfolio by size can result in a lopsided portfolio. In this case, roughly half the size-weighted portfolio is currently invested in its three largest holdings; the other half is invested in the other 17 stocks. As a result, only a few stocks dominate its returns.
The downside of lopsidedness can be seen in the second graph, which shows how far the portfolios fell in downturns from their prior highs. The size-weighted portfolio fared worse than the equally weighted portfolio in the vast majority of downturns.
In happier news, both portfolios basically dodged the market index’s plunge of 42 per cent in the early 2000s after the internet bubble burst in the summer of 2000.
The financial crisis of 2008-09 saw the market index fall by 43 per cent while the size-weighted portfolio declined 31 per cent and the equally weighted portfolio slipped 25 per cent.
The COVID-19 crash of 2020 was the second-worst showing for the portfolios, with both falling 23 per cent while the market index plunged 29 per cent.
Given the relatively poor performance of the size-weighted portfolio on both the upside and the downside, I’m going to stick with the original equally weighted portfolio. If trading is a concern when investing in the latter, one might opt for quarterly, semi-annual or annual rebalancing periods, which enjoyed average annual returns ranging from 13.2 to 13.6 per cent over the 25-year period.
While the Stable Dividend portfolio isn’t immune from downturns, it’s been a good option for investors who want to stay invested in good times and bad. I’ve high hopes it’ll continue to do well over the long term despite the bumps along the way.
You can find details on the stocks in the Stable Dividend portfolio via this link, which also provides updates to many of the other portfolios I track for The Globe and Mail.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.