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Summary

  • In order to maintain overall portfolio yield at 5%, some high yield stocks are necessary.
  • Investment in mREITs, and MLPs do not provide significant diversification in high yield stocks.
  • PSEC has a good history of paying consistent high yield dividends.

On the commencement of my second 15 years of retirement, I will be purchasing Prospect Capital (NASDAQ:PSEC) for the income portion of my portfolio. My goal is to maintain 5% yield on my total portfolio and this requires a maximum of 25% in high yield securities to balance the 75% invested in lower yield dividend growth stocks (such as AT&T (NYSE:T), Caterpillar (NYSE:CAT), Comcast (NASDAQ:CMCSA) and Procter & Gamble (NYSE:PG)). With my dividend growth stocks averaging 3% yield, the high yield portion must average 11% yield in order to maintain the 5% overall yield. Current growth in stocks such as CAT, CMCSA, and PG has brought my overall yield below 5%.

Four years ago when I first started investing in high yield stocks, such as American Capital Agency (NASDAQ:AGNC) and Linn Company LLC (NASDAQ:LNCO) I did not venture into Business Development Companies due to the Great Recession debacle that many of them had faced. However, after hearing about PSEC from many of my friends here on Seeking Alpha (Plow Jockey, Miz Divy Dogs, and Fredrik Arnold) I have finally decided to start channeling new funds into this stock. I will hold it in my IRA, due to the fact that the dividends are not qualified for tax preference and are pass-through instruments which are taxed at one's normal tax rate. I have found this to be true of the mREITs (AGNC and MTGE) also.

The main difference that I find between a BDC and an mREIT is the maximum debt-to-equity ratio of 1:1 for the BDC. This limits the leverage and holds the yield down when compared to a mortgage REIT. In order to better understand the risks involved, I recommend the following article by BDC Buzz Prospect Capital Vs. Fifth Street Finance. To better understand the prospects of PSEC, the following article is helpful Prospect Capital: With The SEC Issue Resolved, The Stock Has 50% Potential Return by Portfolio Management 101.

Prospect Capital has a Tweed Factor (yield + 5yr dividend growth rate -P/E of 6.74) which puts it in my buy range. The 12.55% yield will bring my portfolio yield back up to 5% quickly. I have looked at the 5yr chart,

(click to enlarge)

and the long term chart:

(click to enlarge)

It appears that there is no price appreciation. However, with 12.55% dividends reinvested monthly, one can obtain good price appreciation. In order to demonstrate this, I have prepared a spreadsheet of the past 5 years of dividend reinvestment. Note in 2009 and the first quarter of 2010, the dividends were paid quarterly.

Date of reinvestDiv Rate# SharesDividendDrip price# Shares purTotal ValueCurrent Yield
$0.1101,979.90$9,880.00$10.49921.70$20,769.1112.58%
06/26/14$0.1101,959.35$215.53$10.4920.55$20,769.1112.58%
05/28/14$0.1101,937.97$213.18$9.9721.38$19,534.7213.24%
04/28/14$0.1101,918.39$211.02$10.7819.58$20,891.3012.24%
03/27/14$0.1101,899.00$208.89$10.7719.40$20,661.0912.26%
02/26/14$0.1101,880.09$206.81$10.9418.90$20,775.0312.07%
01/29/14$0.1101,861.26$204.74$10.8718.84$20,436.6112.14%
12/27/13$0.1101,843.22$202.75$11.2418.04$20,920.5411.74%
11/26/13$0.1101,825.56$200.81$11.3717.66$20,957.4011.61%
10/29/13$0.1101,808.08$198.89$11.3817.48$20,774.8511.60%
09/26/13$0.1101,790.63$196.97$11.2917.45$20,413.2311.69%
08/28/13$0.1101,773.05$195.04$11.0917.59$19,858.1311.90%
07/29/13$0.1101,755.43$193.10$10.9617.62$19,432.6012.04%
06/26/13$0.1101,737.48$191.12$10.6517.95$18,695.3212.39%
05/29/13$0.1101,719.65$189.16$10.6117.83$18,434.7012.44%
04/26/13$0.1101,702.40$187.26$10.8517.26$18,658.2612.17%
03/26/13$0.1101,685.45$185.40$10.9416.95$18,624.2112.07%
02/26/13$0.1101,668.82$183.57$11.0416.63$18,607.3511.96%
01/29/13$0.1101,652.62$181.79$11.2216.20$18,724.1711.76%
12/27/12$0.1101,635.76$179.93$10.6716.86$17,633.4412.37%
11/28/12$0.1021,620.11$165.25$10.5615.65$17,273.5811.59%
10/29/12$0.1021,606.27$163.84$11.8413.84$19,182.0610.34%
09/26/12$0.1021,592.13$162.40$11.4914.13$18,456.0310.65%
08/29/12$0.1021,578.27$160.98$11.6113.87$18,484.6910.54%
07/27/12$0.1021,563.87$159.51$11.0814.40$17,487.2211.05%
06/27/12$0.1021,549.87$158.09$11.2914.00$17,656.1210.84%
05/29/12$0.1021,535.44$156.61$10.8514.43$16,816.0911.28%
04/26/12$0.1021,521.29$155.17$10.9714.15$16,843.7311.16%
03/28/12$0.1011,507.29$152.24$10.8714.01$16,536.4311.15%
02/27/12$0.1011,493.42$150.84$10.8813.86$16,399.2611.14%
01/27/12$0.1011,478.99$149.38$10.3514.43$15,456.9111.71%
12/28/11$0.1011,463.28$147.79$9.4115.71$13,917.2912.88%
11/28/11$0.1011,447.12$146.16$9.0416.17$13,228.0813.41%
10/27/11$0.1011,432.47$144.68$9.8814.64$14,297.5012.27%
09/28/11$0.1011,415.45$142.96$8.4017.02$12,032.7614.43%
08/29/11$0.1011,399.91$141.39$9.1015.54$12,880.6213.32%
07/27/11$0.1011,385.46$139.93$9.6814.46$13,551.1812.52%
06/28/11$0.1011,371.54$138.53$9.9513.92$13,785.3212.18%
05/26/11$0.1011,359.62$137.32$11.5211.92$15,800.1110.52%
04/27/11$0.1011,348.15$136.16$11.8711.47$16,138.6510.21%
03/29/11$0.1011,337.05$135.04$12.1711.10$16,406.939.96%
02/24/11$0.1011,325.82$133.91$11.9211.23$15,937.6310.17%
01/27/11$0.1011,314.41$132.76$11.6411.41$15,432.4910.41%
12/29/10$0.1011,302.21$131.52$10.7812.20$14,169.3411.24%
11/26/10$0.1011,288.99$130.19$9.8513.22$12,826.7712.30%
10/27/10$0.1011,275.91$128.87$9.8513.08$12,696.5812.30%
09/28/10$0.1001,262.98$126.30$9.7712.93$12,465.6412.28%
10/27/10$0.1011,249.63$126.21$9.4513.36$11,935.1812.83%
07/28/10$0.1001,236.88$123.69$9.7012.75$12,121.3812.37%
06/28/10$0.1001,224.53$122.45$9.9212.34$12,269.8012.10%
03/30/10$0.4101,184.53$485.66$12.1440.00$14,865.8113.51%
12/29/09$0.4091,144.97$468.29$11.8439.55$14,024.8013.82%
10/06/09$0.4081,103.66$450.29$10.9041.31$12,480.2314.97%
07/06/09$0.4061,058.20$429.63$9.4545.46$10,429.6217.19%

From the spreadsheet, it can be seen that $10,000 with dividends reinvested for 5 years grew to $20,769 for an average annual growth of 15.7%. I have graphed these results below:

(click to enlarge)

Conclusions: In these times of volatile markets with considerable global turmoil along with Federal Reserve tapering of the purchases of mortgage bonds and treasury bonds, it is difficult for retirees to get sufficient cash flow to live on. Coupled with this is the ongoing needs of extended family, including education expenses. I have found that it is better to take a long time in studying an investment and then sticking to it during the downturns rather than jumping from stock to stock as the market moves them. When you are retired, there is no monthly paycheck to fall back on. However, without sufficient yield from some portion of your portfolio, you will not be able to help out those you love. PSEC is a high yield, risky investment and one should be careful if selecting it for their retirement portfolio. I do not allow my high yield stocks to exceed 25% of my portfolio!

Disclosure: The author is long AGNC, CAT, CMCSA, LNCO, PG, T. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I will be purchasing PSEC this month with dividends from my income portfolio.

Source: Prospect Capital Is The BDC For Me