Dividends are the forgotten heroes that have made countless investors rich.
When people talk about the massive gains common stocks have racked up over long holding periods, what they're really talking about is the phenomenal juggernaut effect of dividends.
Look at the history of Coca-Cola. It went public in 1919 at $40 a share. By 1998, a single $40 share was worth $250,000. But with its growing dividends reinvested, that one share grew into many shares worth a stunning $6.7 million.
My hope is to show you just how important dividends are to your portfolio, and also give you the base you need to become a successful income investor.
To start, I ask you to do one thing: Take a deep breath and relax.
It’s time to forget about the rocket scientists with their black boxes... the PhDs with their Greek formulas... and the high priests of Efficient Market Theory.
The most important investment decision you’ll ever make pivots on something far more basic -- how you treat the overlooked stepchild of Wall Street, the lowly dividend.
Although little respected and often ignored, more than 100 years of data point to the inescapable conclusion that owning hum-drum dividend-paying stocks…and then reinvesting those dividends…beats all other investment approaches hands down. So if dividend-paying stocks make you yawn, it’s time to wake up and smell the cash.
Since 1926 dividends have contributed 40% of the total return delivered by the S&P 500. This makes a massive difference over the long haul. A $1,000 investment in the S&P 500 in 1935 would be worth $2,294,681 today with dividends reinvested, but a mere $78,624 without the dividends. Underestimating the awesome edge income-paying securities gives you is the biggest mistake you can make in your investing life.
This course will give you everything you need to start investing for income yourself. If you're already focused on income, you're in luck, too. My 5-part course will give you the tips and tools I've discovered over the years that will help you become an even more successful investor. I'll even share some of my favorite picks for today's market.
But first, I want to show you exactly why I think dividends should be any investor's best friend.
The Unreal Math Behind Income Stocks
Conventional wisdom says that if you take on more risk you’re repaid with more reward. Yet that’s not always true. The Nasdaq, known for its aggressive dividend-less technology stocks, actually underperformed dividend-heavy utility stocks over the 30-year run from 1971 to 2001. Even with the Nasdaq's spectacular run in the 1990s, utilities still came out on top -- while incurring about half the volatility along the way.
The odds are so kind that it’s hard not to come out ahead when you invest this way. I am constantly amazed that more investors don’t help themselves to this delicious free lunch.
Maybe it's that the growth stories get the front page -- not the stodgy dividend payers. But what's lost in the shuffle is that dividends are a sign of financial strength, of a real business making real profits. Philip Morris (now renamed 'Altria'), which most investors dismiss as a stodgy -- even boring -- company, is a perfect example of this phenomenon.
There’s nothing fancy about making cheese, coffee and cigarettes. But with its high dividends and years of +15-20% growth, 'Big Mo' has thrown off some of the best long-term returns of any investment of the past two decades.
While $10,000 invested in the S&P 500 in 1988 grew into a substantial $83,975 by 2008, that same $10,000 put into Philip Morris exploded into $347,715. You can attribute the bulk of that remarkable 34-fold gain to Philip Morris’ 20-year record of high and rising dividends.
But that’s just the start of the story. Anyone who bought 200 shares back in February 1988 (then costing $17,350) was receiving $17,922 every year in dividends alone by 2008. That’s more than their initial investment!
To top it all off, Altria then spun off its Kraft subsidiary, awarding our original 200-share buyers with 4,078 new shares of Kraft worth $125,806. And believe it or not, these Philip Morris investors incurred 22% less risk than the market during their 20-year ride. Talk about enjoying the best of both worlds!
Years of Experience Studying This Niche Market
I think that most investors ignore dividends because they think 'they don't really matter.' Given that a lot of the most famous names on the market either pay no dividends, or only pay 2-3%, that's understandable.
But what most people don't realize is that there is an entire niche of the market -- which I call the 'High-Yield Universe' -- that offers tremendous yields. Payments of 7% annually are average in this niche... yields of 12-15% aren't uncommon.
I've spent years following this segment of the market, learning the ins and outs of its stocks, bonds... and a few securities I doubt you've ever heard of... to bring them to our readers at InvestingAnswers.
The yields in this arena are spectacular. And their impact on a portfolio is considerably greater than the 2-3% most 'normal' stocks pay. Take a look for yourself...
The Importance of Compounding
The dividend payments generated by a modest investment might seem to be inconsequential. But if you up your yields, it won't take long before they can begin to make a dramatic impact on your portfolio -- especially if you reinvest your dividends.
When you reinvest dividends, your dividend payments can be used to purchase more shares, leading to even larger dividend checks. These larger checks can then be used to buy even more shares and so on. In time, even a small stake in such stocks can grow into a tidy sum.
For example, suppose an investor buys 1,000 shares of stock in XYZ Corp. at a purchase price of $10 per share (for an initial investment of $10,000). Next, let's assume that XYZ pays a steady annual dividend of 10%, and the shares rise at an +8% annual rate going forward.
The very first quarterly dividend check would be worth just $250:
$10,000 x 10% = $1,000
$1,000/4 payments = $250
While that amount will certainly not go very far on its own, it is enough to purchase 25 more shares at the initial $10 per share price. Of course, those 25 shares would then generate dividend payments of their own. As the chart below shows, this steady compounding process can yield amazing results over the long haul.
After 30 years, the initial 1,000 share stake in XYZ would have grown to 17,449 shares! At the same time, assuming a conservative +8% compounded annual growth rate, those shares would have soared from $10 to more than $100. As a result, the beginning $10,000 investment would have swelled to more than $1.7 million dollars, without ever adding another penny!
It's also worth pointing out that at the end of the 30-year period, the portfolio would be generating annual dividend payments in excess of $170,000.
In other words, the investor's annual dividend income alone would amount to more than 17 times his or her initial $10,000 outlay!
No wonder John D. Rockefeller once quipped that the only thing that gave him pleasure was to see his dividend coming in.
But what if you don't want to wait years and years to grow your dividends?
You're in luck. Want regular income? You can simply select how much cash you want to earn from your portfolio and let the market do the rest.
Say you want to earn an extra $15,000 per year from dividends to help out with your bills. If your portfolio is $250,000, you simply need to average a conservative 6% yield from your investments.
If you wanted to earn a little more, you simply need to raise the average yield from your investments. I like to call it the simplest want to get a raise!
Of course, that leaves just one question: Where can you find yields of 6%... 8%... or even 10% or more? I told you earlier about my expertise in the 'High-Yield Universe.' In the sections that follow I'll teach you more about a few of the sectors I found in this field that can shower income investors with surprisingly high yields like these.
Wish You Could Own a Toll Bridge? Here's the Next Best Thing
Where can I find the highest and safest yields? It's usually one of the first questions I'm asked by my subscribers.
My research consistently points to one sector that, until a few years ago, was all but invisible to the majority of investors. But thanks to their high yields, the word is leaking out about master limited partnerships (MLPs).
Master limited partnerships couldn't have become the income powerhouse they are today if it weren't for a company many of us loathe -- Enron.
The day before Thanksgiving in 1996, Rich Kinder left his post at Enron. He was disappointed that Kenneth Lay had passed him over for the CEO job. Soon after, an old college buddy, Bill Morgan, approached Kinder with a business proposition.
Morgan had just bought some assets Enron had no use for: a couple of small pipeline systems and a coal terminal. He needed someone like Kinder to run the business. Kinder agreed, and the partnership was christened Kinder Morgan Inc. in February 1997. Kinder doubled the company's market capitalization to nearly half a billion dollars by watching costs and shipping more volume through the pipelines. He did all of that in just seven months. Today, Kinder Morgan Energy Partners (NYSE: KMP) is a $18 billion business, operating more than 25,000 miles of pipeline throughout the United States.
Master limited partnerships had already been around for decades, but it took someone like Rich Kinder to transform this asset class from a passive holding company into a dynamic investment vehicle. In the mid-1990s, Kinder Morgan was one of only a handful of master limited partnerships, which together totaled roughly $2 billion in market value. Today, there are dozens of actively traded MLPs with a total market cap of roughly $100 billion.
To understand why master limited partnerships have become so popular, it helps to have a better understanding of what they are.
An MLP is a publicly traded limited partnership. Shares of ownership are referred to as units rather than shares. MLPs generally operate the pipelines and infrastructure used to transport petroleum and natural gas around the United States. Unlike a corporation, a master limited partnership is considered to be the aggregate of its partners rather than a separate entity. The most distinguishing characteristic of MLPs, however, is that they combine the tax advantages of a partnership with the liquidity of a publicly traded stock.
MLPs allow for 'pass-through' income. This means that they're not subject to corporate income taxes. The result is that more cash is available for distributions than would be available if the company had incorporated.
Why have MLPs gained in popularity so quickly? It may have something to do with their enticing yields. Or maybe it's their exceptional track record for raising dividends an average of +8-9% a year for the past ten years that has endeared them to income investors. Their solid gains during the past decade haven't hurt their popularity, either.
Master limited partnerships have steadily churned out double-digit gains, even despite volatile commodity prices. In fact, this group of about five dozen securities, represented by the benchmark Alerian MLP Index, returned an +19% per year from 1999 through 2009. And the best news of all is you can still find attractively priced MLPs with rich yields.
Safety and Growth -- A Rare Mix
MLPs are required to pay out most of their cash flow to shareholders. As a result, the group carries an average yield of
High-Yield Investing Tip: MLPs
Taxes may be confusing to some, but they are also important to overall returns. That's why my research isn't finished until I know how the income paid by an investment will be taxed.
Most MLP distributions are comprised of about 20% net income and 80% return of capital (which is really just an allowance for depletion or depreciation). The income portion is generally taxed at your ordinary income tax rate.
You don't pay taxes on the return of capital portion until you sell the security, making MLPs ideal for long-term investors. Return of capital distributions lead to a reduction in your cost basis. If you pay $50 a share for an MLP, for example, and receive a $5 return of capital distribution this year, then the cost basis of your shares declines to $45. If you sell the shares next year for $55 a share, you'll be taxed at your ordinary income tax rate on the $10 in capital gains ($55 less $45).
If the owner of the security dies, the reduced cost basis is stepped up to the current share price. That makes MLPs good for estate-planning purposes, as they don't trigger a tax liability for your estate.
There is one glitch with MLPs. Individual MLPs aren't suitable for individual retirement or other tax-deferred accounts because they generate a type of income called 'unrelated business taxable income' (UTBI). If your retirement account earns more than $1,000 of this income, then you'll end up paying taxes on it. As a result, you probably want to hold MLPs in a regular brokerage account.
You can skirt around this tax issue by opting for a closed-end fund that invests in MLPs, such as the Kayne Anderson Energy Total Return Fund (NYSE: KYE). These funds handle the complexities of K-1 forms, Schedule E and out-of-state returns that may be required for owners of individual MLP securities.
These funds don't throw off unrelated business taxable income. They generate dividend income that is reported on a simple 1099 form instead of the somewhat more complex K-1 used by an individual MLP. They also offer the benefits of holding a basket of MLPs with diverse income sources. Management expenses can be much higher than with other funds, though thanks to their tax and diversification benefits, MLP funds remain an excellent choice for many investors.
- Carla Pasternak
about 7% -- about three times the puny yield offered by the average stock in the S&P 500 Index.
But their healthy yields aren't even their main attraction. Rather, it's the rare mix of safety and growth that make MLPs a must-have asset class for your income portfolio.
Most MLPs process and ship oil and gas, so it's only natural to think they would be affected by commodity prices. But the reality is far different -- their cash flows depend primarily on product volumes, not commodity prices. As a result, they offer some of the most stable distributions around. People need energy, regardless of its costs.
MLPs that own interstate pipelines enjoy even safer revenue from government-regulated rates. The rates they can charge may vary depending on where their pipelines are located, but one thing is for sure -- their rates are not pegged to commodity prices. Kinder Morgan operates the longest petroleum products pipeline system in the U.S., and it gets the same amount to ship a barrel of gasoline whether oil prices are $35 or $120 a barrel.
But with most of the profits going to shareholders, what will drive this sector's growth in the months and years ahead? Most MLPs make money by delivering natural gas and petroleum products to the market. The more pipelines, gathering systems, tanks, barges or royalty interests they own, the more cash flow they can generate.
Their key to growth is buying or building the infrastructure that will ramp up their product capacity. And this group has been doing just that. MLPs are spending billions on major projects to increase the nation's ability to move energy where it is needed.
Furthermore, U.S. energy demand is expected to grow a steady +1% annually for the next 20 years, just as it has during the past 20 years. As a result, energy MLPs should continue to see plenty of demand for their services and provide investors a growing income stream for years to come.
Years ago I became interested Magellan Midstream Partners (NYSE: MMP). This partnership operates one of the largest pipeline systems in the U.S. for refined petroleum products and ammonia. Its pipeline network is connected to 40% of U.S. refining capacity.
Since the company's inception in 2001, MMP has never reduced the distribution and has raised the payment by an average of +15% per year. Today, it yields close to 7%, offering a nice stream of income for investors.
But it's just one of the MLPs I like. In fact, I'm so fond of MLPs that I have an entire section of one of my High-Yield Investing portfolios dedicated to the asset class. But sorry... it's reserved only for my subscribers.
Be a Landlord... Without the Hassle
I'll admit it, I love MLPs.
The income... the stability... what's not to like? But I also understand that no one should invest solely in one asset class. That's like going to the movies and only watching films with Tom Hanks!
That's why I also want to tell you about real estate investment trusts, or REITs. No doubt you've heard about them. Maybe you've shied away because their fat dividends seemed too good to be true in a down housing market. Or maybe you already hold some REITs in your portfolio but want to identify which ones will provide the best long-term returns.
For those that are unfamiliar, REITs are dividend-paying securities that invest in real estate. Most own land or buildings and make their money by renting these spaces to individuals or businesses. Some REITs also earn interest on real estate securities, such as mortgage bonds. Others earn their keep by simply funding various real estate ventures.
Most investors buy REITs for their rich dividends. The average diversified property REIT offers an annual dividend yield of about 6%. That's money in your pocket.
Even better, the cash usually keeps coming in regardless of whether a particular REIT's share price goes up or down. That's because to preserve their unique REITs, REITs are required by law to pay out 90% of their income as dividends to shareholders. In return, REITs are not subject to corporate income tax.
On the downside, since REITs don't pay income taxes, their dividends are usually fully taxable. In other words, the dividends you receive will be taxed as ordinary income, up to 35%. Most REIT dividends don't qualify for the reduced 15% dividend tax rate.
But even after the extra taxes, the yields most REITs pay are far higher than the taxable equivalent yield you'll get from most other common stocks. And savvy investors can avoid these extra taxes entirely by holding REITs in a tax-advantaged account like a Roth IRA.
Put Tangible Value Behind Your Dividends
Owning shares in a REIT is an economical way to purchase real estate. And as we all know, real estate has 'real' value that investors can touch, feel and understand. This tangible value combined with the limited supply of high-quality real estate make REITs one of the most established income investments around.
REITs give people interested in real estate an economical and risk-reduced way to invest in it. Without REITs, an investor would have to invest large sums of money (often borrowed) to be able to buy properties. The investor would have to personally guarantee the loans and would be liable for whatever happened to the property. With a REIT, the only risk is the amount invested.
Most people buy REITs for their rich dividend yields. But investors who focus exclusively on a stock's yield could be making a huge mistake. That's because corporate dividend payments are by no means guaranteed. Even though a company might be paying a healthy 10% dividend yield now, it might not be able to sustain such a rich payout if its business model isn't solid.
Investors who buy a REIT based on its high dividend yield, without gauging its earnings prospects, could be setting themselves up for a similar disappointment. The most profitable stocks are those that generate the greatest total return: That is, dividends and share price appreciation. If total returns are what you're after, then looking exclusively at yield would be a foolish, short-sighted strategy.
REITs with long track records of steady dividend and share price growth are your best bet. But even if you can find a REIT with a reasonable price and a good dividend, one additional factor is paramount, and that's property type. It's important to know what exactly the REIT owns.
Everyone knows the old line about the three things that matter most in real estate: Location, location and location. But when choosing a REIT, there are a few more items for investors to consider. To get a feel for the income stream from which your dividend payouts are drawn, you should always pay close attention to the type of property each REIT owns.
High-Yield Investing Tip: REITs
If you're an income investor, you've likely heard of a 'payout ratio.' This figure simply takes the dividends per share paid by a company and compares it to earnings per share.
For instance, if a stock pays $1 per share over the year and earns $2 per share, it's payout ratio is 50%. The lower a stock's payout ratio, the safer its yield is considered.
Instead, I like to look at a REITs funds from operations (FFO), which give a more accurate reading of how much the trust has available to pay investors.
- Carla Pasternak
Many REITs specialize in a property type, such as offices, apartments, warehouses, regional malls, shopping centers, hotels or healthcare centers. Others, like Duke Realty (NYSE: DRE), own a mix of retail, industrial, and office property. A few others invest in specialty properties, such as Entertainment Properties (NYSE: EPR), which owns movie theatres.
Each real estate sector is affected by different economic factors. If the job market is booming, for instance, then office REITs could be attractive because more people are working and more space is needed to accommodate them. If consumer spending is on the decline, then a shopping center REIT like Regency Centers (NYSE: REG) might find itself headed for challenging times as retailers feel the pinch.
Property type can also tell you how predictable a stock's income stream might be. Thanks to the fact that they often require tenants to sign 10-year leases, mall REITs usually generate more predictable income than apartment REITs, which tend to lease for shorter periods of time. Knowing the quality and diversity of its tenants also will give you a sense of the reliability of the REIT's income.
Larger, diversified or geographically dispersed REITs are less exposed to regional weakness and major economic cycles. These REITs tend to be more stable over the long haul. A company such as Equity Residential (NYSE: EQR) owns apartments in various markets across the United States and is less sensitive to various local economic conditions. On the other hand, smaller, more specialized REITs often provide the greatest growth potential. A niche-player like SL Green Realty (NYSE: SLG), which owns offices solely in and around New York City, is positioned for success if that particular market does well.
The SAFE Income Security Overlooked by Most Investors
If you ask the average investor (i.e. one who hasn't read my course!) about a good income security, they might mention some stocks in the Dow 30 that pay yields of 3-4%.
I don't even blink at stocks paying 3%. And I've also found that some of the best income securities aren't common stocks at all.
There's an old saying that if you want a stable friendship, get a horse. Well, perhaps an investing version of that saying would be if you want a stable stock, buy a preferred one. In uncertain economic times it's often wise to hedge your bets with stable investments. Preferred stocks (and their closely related cousins exchange-traded bonds), a somewhat overlooked asset class, might be that safe investment you're looking for.
In the most basic sense, a Preferred stock is a fixed-income vehicle that offers set dividend. Preferred shares represent ownership in a company, similar to common stocks. However, they do not have voting rights. In return, preferred investors have a claim before common shareholders for a company's assets should it go bankrupt.
This precedence and safety, combined with a set dividend (usually ranging from 6-10%) that doesn't fluctuate means preferreds are dramatically less volatile than common shares. In fact, they resemble bonds more than stocks!
However, when comparing the advantages of preferred stocks to bonds, preferreds have an upper hand due to liquidity. Investors essentially get the best features of both stocks and bonds -- preferreds are as simple to buy as common stocks since they trade on major exchanges, yet offer the stability commonly found in bonds.
What About The Yields?
The other main difference between preferred and common shares relates to dividends. Although dividends paid on common stock are not guaranteed and can fluctuate from quarter to quarter, preferred shareholders are usually guaranteed a fixed dividend paid on a regular basis. In addition, many preferred stocks pay monthly income, and almost all pay at least quarterly.
Like bonds, preferred shares are rated by credit agencies such as Standard & Poor's and Moody's. An investment-grade credit rating of 'BBB-' or higher from Standard & Poor's or 'Baa3' or higher from Moody's gives you some assurance that your income is secure, and there's little chance of the company defaulting on the payments.
To check out the tax treatment or credit rating on a preferred share issue, you can ask your broker or visit a free online site like QuantumOnline.com before you make a purchase decision. Remember -- these credit ratings are helpful, but not foolproof. Some preferred stock issues may be equally secure as others, but have no credit rating.
You also can measure the company's ability to cover payments by looking at its earnings, cash flow, and cash reserves on the latest financial statements available on the firm's website or on free financial sites such as Yahoo! Finance.
Preferred stock dividends come as either 'cumulative' or 'non-cumulative.' With non-cumulative shares, if a company suspends dividend payments, they won't be paid later. In contrast, cumulative shares mean that if the dividends aren't paid, they accumulate from year to year until payment. Say the company faces a cash crunch and has to suspend all of its dividends. If they are cumulative, the firm can't pay dividends to the common shareholders until it has first paid all the dividends that it missed to preferred shareholders.
Preferred stocks can also be convertible. That means the shareholder has the option to convert a company's preferred shares into common shares at a preset conversion rate. For instance, shares of Capstead Mortgage Preferred B Series (NYSE: CMO-PB) are convertible into common shares of Capstead Mortgage (NYSE: CMO) at a rate of roughly 0.60 common shares for each preferred share.
The closer a preferred stock trades to the value of the converted common shares, the more they will follow the price movements of the common stock. In contrast, the higher the conversion premium, the less the convertible preferred shares follow the common stock.
With most preferreds, the issuer has the option to buy back the shares from you on or any time after a pre-set call date. If the company decides to do that, they would pay you the issue price in cash for each share you own.
Call dates can be tricky. If you purchase the shares for $26 each and they're called a year later for $25 each, total returns could suffer. But when the call date is a few years out, this risk factor is low. As well, companies don't call their preferreds very often since they have to come up with the cash to do it.
High-Yield Investing Tip: Preferreds
Found a common stock with an attractive yield? Before you buy, make sure there isn't a more attractive preferred offering.
While most preferreds don't offer the same upside potential, they will offer more stable (and higher) yields.
To find if your stock has more enticing preferred shares, simply follow these steps:
1. Visit QuantumOnline.com and do a 'Quick Search' for the common stock symbol of the company in question.
2. Underneath the company's profile, click the link that says 'Find All Related Securities'
3. This option brings up all the securities related to the parent company. Clicking the linked ticker symbol will take you to a page with more information on that security.
-- Carla Pasternak
Some preferred shares may also have a maturity date. When the shares mature, the company gives you back the cash value of the shares when issued. Maturity dates give you some downside protection, since no matter how low the price goes while you're holding them, at maturity you will get back the issue price (unless the company goes bankrupt or liquidates).
Taxes also play a role in what type of preferred stocks an investor should choose. Preferred shares usually fall into two camps -- either 'traditional' preferred or the more common 'trust' preferreds.
Traditional preferreds are considered equity, and the dividends qualify for the lower 15% dividend tax rate. Uncle Sam takes a bigger tax bite out of the more common 'trust' preferreds, which are considered debt. Payouts on those are taxed as ordinary income -- up to a 35% rate.
The tax advantage of traditional preferreds is useful if you hold your investments in a taxable brokerage account. Otherwise, payments on trust preferreds are somewhat more secure.
While bank stocks have experienced a roller-coaster ride, one of my favorite preferreds is the Wells Fargo 8.625% Enhanced Trust Preferred (NYSE: WCO). While the name is a mouthful, it doesn't take much to say the dividends are rock-solid.
In the middle of the financial crisis, Wells Fargo's common shares had their payments slashed from $0.34 per quarter to a nickel. However, the payments on the preferreds never wavered, throwing off $0.54 every quarter. That's because these payment are required, unless the bank goes bankrupt.
The preferreds can sometimes rise above their $25 par value, but investors who can enter at lower prices should do well, even if the shares are called.
But that's not all. You see, I also like exchange-traded bonds. They're basically bonds that trade like stock on the NYSE, making them easy to buy and sell. With their liquidity and safety, these bonds are very similar to preferred stocks. The Delphi 8.0% Senior Notes (NYSE: DFY) are of particular interest with their $0.50 per share quarterly dividends adding up to a hefty 8% annual yield.
Truth be told, I think preferreds and exchange-traded bonds are the best spots for income investors. That's why I've identified about a half-dozen for inclusion in my High-Yield Investing portfolios. Together, this group of holdings yields about 8.5% -- making them a subscriber favorite.
The 5 Rules Every Income Investor Has to Know
You've seen the impact dividends can make on your portfolio. You've also learned the details of three of my favorite hunting grounds for high yields.
But it could be the tips I'm about to share with you that prove to be the most profitable.
Through decades of my own research and experience, I've selected five of my top income investing tips. These tools help guide my portfolio choices.
Think of these as a gift from me to you to help you become a more accomplished income investor.
1. Look off the beaten path: I mentioned earlier how many investors think of the 2-3% yields thrown off by common stocks when it comes to income investing.
The truth is that there is an entire niche of the market that caters to income investors by throwing off 6%...8%... even 10% yields or more.
But you won't find these yields by focusing on common stocks. You have to look into the special classes of securities built for income investors. My years of researching the income field have uncovered even the most rare of these assets, including securities like STRIDES, ELKS, and even exchange-traded bonds. This is where you'll uncover truly mouth-watering yields.
2. Dividend safety is key: For us income investors, nothing should be held in higher esteem than the safety of our
dividends. After all, what's the use of a high dividend if it's only going to be cut a few weeks later?
That's why I always dive into dividend safety before profiling a stock for my readers. As well, an amazing thing happens when you follow my first tip and look off the beaten path for income investments.
Common stocks are under no obligation to pay a dividend; they can cut their payments at any time if they please. But I've found a few securities -- such as the preferred stocks mentioned earlier -- that can't change or reduce their payments. A number of other little-known securities have the same restrictions, all but guaranteeing you'll be paid a stream of income you can count on.
3. Use market downturns to find higher yields: Most investors look at a market downturn as a bad thing, and in fact, I would rather the market rise than fall. But I also appreciate the opportunities that appear in a downturn.
You see, a stock's yield is a function of its price. If a stock pays $1 per share and trades at $20, it's yield is 5%. If the same stock dips to $10 per share, the yield has risen to 10%.
That's one reason why I bought heavily during the recent market downturn -- the yields became too high to ignore! The result is that my portfolios are heavily positive, why I locked in unnaturally high yields for my subscribers.
4. Don't be afraid to take a loss: Subscribers always ask me about when to sell their holdings. And for good reason -- when you sell is just as important as when you buy.
I'm personally never afraid to take a loss. Many investors continue holding losing stocks and hoping for a rebound, only to watch them sink further. I've seen this countless times, so I'm always sure to look at the reasons a holding is falling and if I should sell.
If the stock in general is falling with the market, I may not be worried. However, if a change in the company's operations mean it could see rocky times ahead, I don't want a part of it.
5. Taxes matter: When is a lower yield more attractive than a higher yield that's just as safe? When the lower yield is taxed at a lower rate.
Consider this: An investor in the top federal tax bracket is invested in a municipal bond that pays 6%. Because the income from this bond is tax-free, the taxable-equivalent yield is actually 9.2%! In other words, if the same investment were in a fully taxable security, our investor would have to earn 9.2% to have the same income after taxes.
Pay special attention to how an investment is taxed before putting in a dime. I always review the tax implications of every investment before I make it.
After reading these five important rules above, I hope you're better equipped to start using dividend-payers to make your portfolio work for you. Good investing!