How to Clean Up Your Dividend Portfolio (Without Panic or Regret)

Investors today face a paradox: the allure of steady dividend income clashes with the risks of corporate financial instability. As economic volatility persists, dividend traps—companies offering seductive yields but fragile balance sheets—threaten to derail income streams. The solution? A disciplined approach to portfolio cleanup that prioritizes forward-looking financial health, valuation discipline, and diversification. Let's break it down step by step.

Step 1: Identify Dividend Traps with Morningstar's Distance to Default (DtD) Score

The Morningstar Distance to Default (DtD) score is your first line of defense. Unlike backward-looking metrics like dividend yield or payout ratios, DtD uses market data (equity value, volatility) to predict a firm's risk of financial distress. A lower DtD score means higher default risk—and a higher likelihood of dividend cuts.

For instance, DtD flagged companies like Vodafone (which slashed its dividend by 40% in 2019) long before payouts were reduced. By screening out firms with DtD scores below the 50th percentile, you avoid companies that could destabilize your portfolio.

Step 2: Shift from Historical Yields to Forward-Looking Resilience

Dividend history alone is insufficient. A company's ability to sustain payouts during downturns depends on its balance sheet strength and competitive advantages. Morningstar's Economic Moat Rating complements DtD by assessing whether a firm's business model can withstand shocks.

Actionable Tip: Eliminate holdings where DtD scores are declining while dividend yields remain artificially high. Such companies are often masking weak fundamentals with unsustainable payouts.

Step 3: Use Valuation Metrics to Avoid Overpaying

Even financially healthy companies can become overvalued. Morningstar's Star Score evaluates whether a stock's price aligns with its intrinsic value, adjusted for uncertainty. The VanEck Durable High Dividend ETF (DURA) uses this metric to focus on stocks ranking in the top 70% of valuation.

DURA's approach ensures you're not overpaying for yield—critical in today's market where frothy valuations lurk even among dividend stalwarts.

Step 4: Diversify Across Sectors to Mitigate Concentration Risk

Sector concentration is a silent killer of income portfolios. Overweighting in volatile sectors like real estate or utilities during a rate hike cycle can lead to abrupt dividend cuts.

The VanEck DURA ETF exemplifies balanced diversification:
- Top sectors: Healthcare (23.8%), Energy (18.3%), and Consumer Staples (14.4%) as of September 2024.
- Large-cap focus: 91.8% of assets in firms with $10B+ market caps, reducing volatility.
- Top holdings: ExxonMobil, Chevron, and AbbVie—companies with decades of dividend growth.

Step 5: Model Your Portfolio After DURA's Criteria

The VanEck DURA ETF (DURA) is a blueprint for dividend portfolio cleanup:
1. Financial Health Filter: Only includes companies in the top 50% of DtD scores.
2. Valuation Discipline: Prioritizes stocks with Star Scores in the top 70%.
3. Cost Efficiency: A 0.30% expense ratio ensures more of your returns stay in your pocket.

While DURA underperformed its benchmark slightly in 2023, its focus on DtD and Star Scores helped it avoid steep drawdowns during the Q1 2024 banking crisis.

Caution: Avoid High-Yield "Traps"

A 7% dividend yield may seem tempting, but it could signal desperation. If a firm's DtD score is below 50 or its Star Score is in the bottom 30%, proceed with caution. Such companies are often masking weak cash flows or debt-laden balance sheets.

The outliers with high yields but low DtD scores are precisely the traps to prune.

Final Takeaway: Proactive Management, Not Panic

Cleaning up your dividend portfolio doesn't require drastic moves. By:
1. Using DtD scores to filter out financial weaklings,
2. Prioritizing valuation over yield,
3. Diversifying across sectors and companies,
you can protect income streams while positioning for long-term growth.

The VanEck DURA ETF (DURA) embodies this philosophy. Its blend of DtD rigor, valuation discipline, and sector balance offers a path to steady dividends without undue risk.

Investors who act now—methodically, not emotionally—will be rewarded when volatility strikes again.

Stay disciplined, stay diversified, and let the data guide your decisions.