Recently, I enjoyed two articles at Seeking Alpha about Realty Income Corporation (O). One post was written by Casey Hoerth “Realty Income Corp: Why Now’s A good Time To Sell” and the second one by Achilles Research “Realty Income: Why Now Is Not A Good Time To Sell This REIT Nugget“.

While it was interesting to watch (read) the reasoning of both authors on why it is good or bad idea to sell or hold, I noticed that both authors missed one important point in this decision making process whether to sell or hold. I believe that both are actually right in their arguing. It just depends on what investing phase you are with your portfolio.

Casey is arguing in his article that Realty Income has fared way up and that it would be a good idea to trim some gains and reallocate to another equity, while Achilles is opposing it urging not to take a trading mentality with an income vehicle such as this stock.
 

On a daily chart Realty Income shot up from its almost 6 months long consolidation phase at $46 a share reaching previous all-time highs from April 2013.
 

These are crucial words in determining whether to sell or hold based on where your portfolio stands and how you should react.

What phase of your investing career your portfolio is?

You would agree with me that there are generally two phases in building and maintain your wealth. One phase is called accumulation, the second one is a maintenance phase. What do you do in each phase? During your accumulation phase you build your portfolio and accumulate your wealth. During the second phase you just maintain its health.

Accumulation phase

There are many opinions on how to build your portfolio and there are many legit ways to do it. But generally the accumulation phase should consist of selection of stocks you want to invest in and start building up your portfolio by purchasing your selected stocks. Time to time you prune your portfolio by weeding out stocks no longer meeting your criteria and reallocating funds into a new stock. But overall you try to keep your portfolio balanced.

I have seen many experienced long term investors having two approaches how to balance a dividend growth portfolio – one approach is income based allocation, the second is a simple percentage weight allocation.

The income based allocation maintains allocation based on a percentage of income in your portfolio – for example you allocate your funds in such manner that every stock produces the same percentage of income (i.e. 3% income of the entire portfolio). This approach protects your income. If any stock fails to deliver dividends, you only lose 3% of your overall portfolio income.

The second approach is simple, you keep allocating an equal percentage of funds into selected stocks, let’s say 5% of every stock you own and you keep it balanced that way for the entire life of your portfolio.

However, during the accumulation phase you do not rebalance your portfolio. It is also impractical to do so. If you can invest let’s say $1000 monthly, and every month you buy a stock, that stock will become overweight in your portfolio until the next month when you buy a different stock and start smoothing the misbalance of your holdings. As of today, there are not many brokers which would allow you to buy increments of stock the same way as you do in your 401k (if you have one) where you deposit your monthly amount and it is equally distributed among all mutual funds in your account.

Also during accumulation phase you may only hold a few shares, so selling a portion would make sense either.

For example, I once held 24 shares of Johnson & Johnson (JNJ) stock and I once tried to rebalance – now holding only 12 shares. What a nonsense.
 

 

I only know about one broker so far which can allow you to do that and that’s Motif Investing. Motif allows you to select 30 stocks of your own, create a portfolio (a motif) and invest an equal amount of cash every month, for example, and that amount will be equally (or as per your target allocation) distributed among those stocks.

By doing so, you can create your own mutual fund or 401 k equivalent and start accumulating. Motif Investing even offers a great bonus. If youstart investing with them you get up to $150 to start investing with when you open an account.

If you are investing in a regular taxable account (as a bridge for your early retirement), you will not have this option available and you will not be able to balance your portfolio. From this perspective, if you are in an accumulation phase, Achilles is right. It is not a good time to sell Realty Income. In this phase value doesn’t matter. You only do not accumulate in this phase and wait for the next correction to start buying this gem again. And while you are waiting, you collect precious dividends.

Maintenance phase

But what if you already accumulated enough to live off of your investments? You are done with buying and you just collect dividends? In this case I would agree with Casey when he says to trim your gains. It is a standard balancing procedure in every large portfolio. It is a method I first learned many years ago when my investing teacher basically told me:

“When a mutual fund (or stock, as he was primarily referring to 401k holdings) goes up and beyond your target allocation, you trim it by selling a portion of your holdings above your target allocation and buy those stocks which underperform.”

This sounds great to me and I use this approach in my 401k and I also plan on using this approach in my dividend portfolio once I reach my target. This method would be acceptable in my opinion even with an income based allocation due to different dividend growth, but is great with a standard percentage based allocation.

Not doing this rebalancing would cost you a great deal of money which you can boost your portfolio.

For example, today, Realty income fared way up and is overvalued (as this stock was always overvalued), but other stocks in energy sector are mostly undervalued. This is a great opportunity to take some cash off the table by selling a portion of your Realty Income and buy energy stocks such as Legacy Reserves (LGCY), Chevron (CVX). Tallgrass Energy (TEP), or some consumer goods, or technology stocks such as Ford (F), Microsoft (MSFT), etc.
 

Five year chart shows how far and steep the Realty Income moved compared to previous all-time high. Will we see a similar reductio0n in price as we saw in 2013? If so, trimming some gains makes sense. But only if you own enough shares to do it without significantly reducing your holdings. In accumulation phase rebalancing doesn’t make sense and it is better to just hold and suspend investing for some time until the stock retreats again.
 

As these stocks recover and get back up and Realty Income lags this move, you do the opposite and rebalance back to Realty Income. This approach will help you to generate some capital gains which you can reinvest and create more dividends. All you need to do is to avoid trading and do this once a year to avoid short term capital gain taxes, and I believe this would benefit you well.

In this case I agree with Casey and his call to sell a portion of Realty Income and reallocate to other dividend gems out there which lagged because of being out of investors favor, but still continue paying nice dividends and even increasing them.

Conclusion

Choosing whether to sell, hold or accumulate a stock could be a difficult task. Many investors claim that they would never sell a dividend paying stock and I agree with them, but it is not a good approach to fall in love with any stock. It is something we have to learn over time. But it is a good thing to learn to trim gains in one equity and buy another lagging equity to keep your portfolio balanced. With dividend growth stocks this is an easy task to do. You can treat them almost as mutual funds. But if you are still in accumulation phase, it would be wasting your energy and funds trying to reallocate mainly when your holdings are still limited. From this perspective it is a good approach to hold Realty income and do not sell. In a maintenance phase it is a good time to trim some gains and boost other sectors.