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By Lawrence Meyers
| November 16, 2016
Once the Federal Reserve decided that interest rates should be as low as possible for as long as possible, every income investor groaned. Where could they find dividends and yield if they couldn’t find it in bonds? Bonds offered decent yields at relatively low risk. Instead, income investors piled into anything that paid big dividends, especially stocks, which meant higher risk.
In some cases, higher risk does yield big dividends. There are also ways to generate big dividends by taking on comparatively lower levels of risk.
As with everything, you have to pick and choose carefully, which is one of the things I go into detail about in my forthcoming stock advisory newsletter, The Liberty Portfolio.
You cannot simply grab at whatever thing pays the highest dividends, but always assess if that security meets the level of risk you are truly comfortable with. Here are seven ways to pick up big dividends that carry varying degrees of risk.
Mike Mozart via Flickr
One of my personal favorites when it comes to finding big dividends are preferred stocks. These babies didn’t get much coverage until about eight or nine years ago.
They are stock-bond hybrids, issued by a company to raise capital. They don’t have any voting power, but trade in narrow ranges like bonds and pay big dividends. Those dividends can only be cut after a cut in the common stock dividends. Most, but not all, preferred stocks have cumulative dividends, so that if the payout is reduced or cut then all the accrued payments must be paid before the common stock dividends can be reinstated.
They are also ahead of common stock in terms of recovery if the company files bankruptcy. Preferred stocks generally pay anywhere from 4.5% to 9%. One choice to consider is Public Storage 6.375% Series Y Preferred Shares (symbol PSA-Y), which currently yields some 6%.
Courtesy Qwest Corporation
Baby bonds, also known as exchange-traded debt, have become increasingly popular as well. Rather than issue a massive bond offering in the hundreds of millions or even billions, baby bonds are generally smaller capital raises.
In addition, rather than trade on bond exchanges, they trade just like ETFs on stock exchanges. They are usually issued at $25 per share, have 30-year maturities, sit behind secured bonds in the capital stack and ahead of preferred stock, and most are investment grade.
Yields run from around 4% to 8%, but payouts are considered, and taxed as, interest and not as dividends. You might consider Qwest Corporation 7.5% Notes due 2051 (CTW).
Master Limited Partnerships, or MLPs, are special investment vehicles that must derive 90% of revenues from some form of natural resource or real estate activities.
The trick with these is that most of them are related to energy, and the oil price collapse hurt many of them badly. However, many have clawed back some ground after hitting their lows and may represent some value.
Their dividends will vary, but the average as represented by the Alerian MLP (AMLP) is about 9%. The risks to be watching for are those that are still near their lows and have liquidity problems, and that oil prices still have not stabilized, although we appear to be getting close.
Divulgação Petrobras / ABr - Agência Brasil via Wikipedia
Royalty trusts are quite odd when you examine them. They have no employees, own no land or any other hard asset. All they do is collect revenue from some asset that somebody else owns in the form of a royalty. Royalty trusts also have a finite lifespan which is usually some long period of time or when a certain amount of natural resource it is mining is pulled from the ground.
Thus, you want to completely avoid any such trust that is near that expiration event, because eventually it becomes worthless to own it. There are only a handful of them and they pay between 7% and 11%.
Again, because these are usually tied to energy, the amount extracted will depend on demand, and thus so will your dividends. Marine Petroleum Trust (MARPS), a trustee of private company Southwest Bank, yields 9%.
Closed-end funds are very similar to ETFs but have a few major differences. CEFs also pool the money of numerous investors, but they issue a limited number of shares. Thus, the fund can trade like a stock on the exchange. That money is raised via an IPO.
The fund itself will, like many ETFs and mutual funds, be restricted to certain types of investments and will be actively managed. The funds are of all different stripes and rarely have much more than a few hundred million in assets. Their dividends can also vary wildly, from as little as 1% to 22%.
Choose these carefully, though. Make sure you know what your fund invests in and weigh those risks. One ETF that gives you diversification is the YieldShares High Income ETF (YYY).
Business Development Companies, or BDCs, are a mix of all these different dividend plays. These are vehicles that are required to invest in only certain types of businesses, and must pay out 90% of their net income as dividends.
BDCs will raise capital using debt, and often at very low cost. They will then turn around and lend that same money to “middle market companies” at rates that are 7%-12% higher than what they are borrow at.
BDCs can do this because middle market companies are growing quickly and need capital to keep up with the growth, but have either exhausted bank credit lines or aren’t eligible yet for them. ETRACS Linked to the Wells Fargo Business Development Company Index ETN (BDCS) yields 8.7%.
Buy-write ETFs are the oddest choice of the group, I think. These ETFs select a certain index and choose certain stocks from that index to sell covered calls against. By selling calls, they generate premiums from options contracts and pass much of that on to the investor.
The risk is that the overall value of the fund will drop even if your dividends are pretty solid. Yields are all over the place so choose wisely, but the Star Global Buy-Write ETF (VEGA) is one to consider.
This article is from Lawrence Meyers of InvestorPlace. As of this writing, he has no position in any stock mentioned.
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