I recently heard from a reader who mentioned that his wife had over 2,700 shares of AT&T stock sitting in an individual retirement account (IRA), and was seeking my input on whether such a heavy concentration in one stock was wise (this constituted almost the entirety of the IRA assets, in addition to a plain old bond index fund).

I posed the same question to him to rely on to his spouse that I pose to everyone wondering about proper portfolio risk management, “If something super weird happened and this stock went bankrupt, could you deal with it? Would it wreck your life? Would it set back your standard of living substantially?” If your answer is, “Yeah, it would cause me a whole lot of harm”, then there is no reason why you should stay super concentrated. You can reduce the risk substantially by dividing that money into Coca-Cola, Procter & Gamble, Johnson & Johnson, Disney, Nestle, Exxon Mobil, Chevron, PepsiCo, Colgate-Palmolive, McDonald’s,  and Wells Fargo. The only sacrifice would be a reduction in income, but the diversification acquired by such a maneuver would be substantial.

Or, you could treat that AT&T stock as a giant mother goose that would create its own blue-chip dividend portfolio over time. Even though the reader mentions that his wife is sitting on 2,700 shares of AT&T stock now, let’s pretend that I got this e-mail in 2004 so I can use real, hard numbers for illustrative purposes.

If you owned 2,700 shares of AT&T, you would have received $3,375 in AT&T income. Had you taken that $3,375 and put it into Coca-Cola stock, you would now be sitting on $7,300 worth of Coca-Cola.

In 2005, AT&T raised its dividend to $1.29, generating $3,483 in annual income. If that check got put into Procter & Gamble, it would have grown to a little over $6,600.

By 2006, the AT&T dividend grew to $1.42 per share. This would have created a $3,834 dividend check, that if put into Johnson & Johnson, would have grown to a little over $8,000.

In 2008, AT&T jacked up its dividend to $1.60 per share, and then raised the quarterly dividend by a penny per share every year since then. If you would have repeated the process in the order of the stocks I mentioned above, you’d have ended up with: $11,000 worth of Disney, $8,600 worth of Nestle, $7,300 worth of ExxonMobil, $9,000 worth of Chevron, $6,600 worth of Pepsi, $6,500 worth of Colgate-Palmolive, $5,500 worth of McDonald’s, and $4,400 worth of Wells Fargo.

Over a ten-year stretch, you just built a blue-chip stock portfolio solely from AT&T dividends. In 2004, those 2,700 shares of AT&T would have been worth $62,000. Someone just taking a cursory look at a stock chart would have noticed a $10 or so price gain, and a dividend that grew from $1.25 per share to $1.84 per share. Yes, it’s super nice seeing that $3,375 dividend check grow to $4,968 each year.

But look at what you did: In 2004, you essentially had a $62,000 portfolio that was 100% AT&T stock. Now, you have those AT&T shares worth somewhere between $90,000-$100,000, depending on the market fluctuations of the day. But you also created your own blue-chip portfolio that is worth over $80,000 in its own right, generating about $2,000 in dividends of its own. Now, AT&T is only 55% of your portfolio, and you’ve been gradually diversifying without selling any shares. And that is only with ten years of this strategy under your belt. Imagine what you could create if you spent 25 years replicating the strategy of using AT&T dividends to create your own blue-chip dividend portfolio.

Of course, that could be too slow for some, and if your allocation would make you miserable in the event that you stopped receiving dividend income from a single company—I don’t care which company—then it makes sense to scale back. But you can also use time and selective deployment of dividends to diversify a portfolio, so you can continue to receive ongoing benefits from the original cash cow while opening yourself up to new streams of high-quality revenue coming your way each year.

If you were able to make fresh investments from your job, you could further dilute the AT&T influence even faster.

For investors starting out, I’ve often discussed how nice it is to get a block of Coca-Cola, Nestle, Johnson & Johnson, or Colgate-Palmolive under your belt at an early age, because you know the company will be around for decades and you will always have some money coming your way each year.

But that’s not the only way to do it—there’s also something to be said about getting your hands on a couple hundred shares of something like AT&T, BP, Royal Dutch Shell, Conoco Phillips, Philip Morris International, Altria, or GlaxoSmithKline at an age in which you could spend decades taking their dividends and using them to create a mini blue-chip dividend portfolio from them alone. Using cash cows as the base of creating another blue-chip portfolio is an underrated, autopilot way to diversify your way into high-quality wealth.

Originally posted 2014-11-24 08:00:28.

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