Chasing yield as some pundits suggest as taking on too much risk may consider the assets under consideration. Both BDCs and mREITs have yields four to five times the average blue-chip company stock and are not in the same classification for comparison. High Yield is normal for both types of investments since they must payout 90% of their earnings to avoid corporate tax and pass-on higher income to their investors. Both asset classes may have bottomed out in January and since then the cost of income has become more expensive. As I have suggested in all my articles this portfolio design is not recommended and contains a great deal of price risk. It is my belief this actual portfolio design will sustain my income projections well into the future reducing income risk.
Source; Google Search; images The Road Less Traveled
The one thing I cherish the most is the road less traveled where new discovery is a certainty. I never liked following the herd, but enjoyed new challengers both in failure and success all leading to knowledge and wisdom along the path to achieving my goal. When working toward your goal always focus on the finish line, what the end results will look like. This way when obstacles are thrown your way, you won't lose sight of your end-game. Think of the journey as a maze, you start down one path only to hit a wall, what do you do next, back up and start down another path that leads you further toward your final goal. That's how life is never a straight line, but always encountering obstacles along the way, persistence and determination will lead to success every time. A few years before retirement you need to come up with a plan making small moves along the way, always keeping sight of your final goal. For example; a few years ago I needed my portfolio to generate 75% of my current gross employment income before I retire. I took small steps buying investments over time always having my end-game in sight. Based on the size of my portfolio balance, I needed at least a 10% yield to achieve my 75% employment income by the time I retire. I original calculated retirement will take 4 years to begin December 2017. But the accelerated income from my investment method has exceeded my expectations to a point that I can now retire one year earlier December 2016.
What most investors didn't realize was over the past few years there were many opportunities to accumulate BDCs and mREITs at reasonable prices. These guys are selling for 20 to 30% under book and investors were throwing them under the bus because of price. I was accumulating them because I have a retirement plan based on cash-flow-income with the end-game always in sight. Since I have been purchasing them at such discounts, my original 10% yield goal has been around 12 to 14%. With the higher yield my income projection has accelerated to the point I can retire one year earlier as mentioned above. Since the middle of January 2016 both BDCs and mREITs have been on an upward trajectory (see Chart 3) and I have slowed down my purchases with the hope of some more doom-and-gloom hysteria. I can always count on human nature in providing such an environment ;-)
What Is High Yield Investing…
Let me break it down in simple terms. When you're investment method is high yield the focus should be income. The capital gains and/or dividend growth from your investments may not materialize and do not expect them too. That's not the purpose of high yield income investing especially in the BDC and mREIT space. If you're a DGI (Dividend Growth Investing) investor in a single company, expect low yield in the 2 to 4% range plus dividend growth between 6 to 7%. The big difference will be the expectation of capital gain and/or total return for the typical DGI investor. In retirement I wanted a portfolio to be designed that concentrates on income without the expectations of capital gain. Capital gain is a non-issue since I'm not going to sell shares for income. So when people lump these guys into the total-return classification they are not looking at the real purpose of both types of investments. Initially I explored the DGI method a few years ago and determined my path to retirement will be income focused just like my working career. With just a few years from retirement the low yield of DGI was not an option. For the record, there is nothing wrong with DGI, very sound investment method that capitalizes on compound growth. If I chose the DGI path the low yield would force me to live below my current standard of living. I'm already conservative with my living expenses, so doing the DGI method was not going to work. This is where necessity is the mother of invention, and I have chosen another path less traveled. I'm not suggesting anyone reading this article to invest in the assets mentioned, but I'm willing to forge a path that might be an alternative for income seekers. Adding small amounts to any portfolio may provide additional income, but do not expect them to perform as your typical Blue-Chip corporate stocks. If you have been an SA member for a while you might have noticed a few DGI investors have sprinkled some of these guys into their portfolio to juice up their income. There is nothing wrong with that, but they need to be classified differently.
As a side note it is my belief before retirement the investor should invest for capital growth. A good method is dollar-cost-averaging into your company 401k or ROTH and hopefully a good company match. Just the SP500 over the years has exceeded a 10% return. When you hit about 60 years of age you should begin to consider how you're going to replace your paycheck in retirement, and dividend stocks may be the answer. Your design will depend on your portfolio size and risk tolerance and will be unique to all others. SA articles and comments are a good source to start building your portfolio and expanding your knowledge base.
Near retirement my investment perception has changed toward the market. I now go to the market to buy income machines used in my business. I perceive the stock market no more than a store to purchase little machines I need to run my business. The machines when placed in service will help my cash flow and improve my bottom line. As any purchaser I want the cost of the machines to be as low as possible. This is why when the market drops I get in motion to purchase more machines to improve my cash flow. This continues on a perpetual basis since I'll always be on the lookout to increase my income. Some machines will break down and need to be replaced, some may slow down and need repair, but the continuous purpose in adding or fixing machines is to always improve business cash flow. Some of the income may be used to make payroll and some for expenses, but half will always be used to improve the business moving forward. In business what is the one thing you can't live without; cash coming into the business. The plant and equipment may be valued more or less, but the cash flow coming in each month make a company more valuable. Your business plan in retirement needs to be designed to replace your employment paycheck; that includes your portfolio dividends, social security and any other source of income.
SA Comment that reflects High Yield RIC Investments…
I follow some people that truly understand the concept of high yield investing. The perspective from some high yield investors is profound and completely illuminating. Knowing what these types of vehicles are and investing in them will take on a new meaning for income investing. I needed to change my perspective and come up with a goal of income cash flow instead of building wealth. With his permission please read a comment from Frank Ellis concerning high yield that may shed some light on these types of investments. His comment states the understanding of RIC (Regulated Investment Company) investments in a much better way than I could have. This comment was before the FED's first interest rate hike in December 2015. Notice Frank's prediction in the second paragraph where he states what will happen after the first interest rate hike. Since January of this year my yields have been declining because of price appreciation as Frank has predicted. Only a handful of people in the SA audience fully understand the concept of high yield investing and I want to give them my thanks in sharing to those willing to listen.
FrankEllis; "Like the risk adverse, I am much less focused on the current price of shares. Actually, I am happy with lower prices, which means that my reinvested distributions will purchase more high income yielding shares at the lower price. I am content to reinvest in shares of high income yield in RIC's rather that spending the distribution on low yield income taxed corporation shares. Price appreciation is not the goal. Retirement income is the goal, the very reason for investing in RIC's -- REITS, BDC's, and CEF's. The advantage of the 1940 Registered Investment Companies Law is favorable to the income investor less fearful of price swings, more focused on income yield. Eliminating the corporate income tax rate from the return on investment, the double taxation paid on the low yield corporate income of the "safe" companies, is advantageous to the income investor."
"In the long term, equilibrium will return. Fear of the Fed's 1/4% interest rate hike will dissolve into nothingness in the course of the long term. Prices will once again climb, reducing yield on reinvested shares. The lower present prices which offer higher yields for the present and all future are a wind fall of opportunity for the willing investor, fearful for the short sighted. I foresee no future in which I sell the shares, the golden goose laying the golden eggs. I do foresee a future of yield, income, and the desired goal, free of reduction in the capital that is yielding the 90 +% of taxable income of RIC's. Giving 40% of taxable income to the IRS, then giving a few percent to the stockholder, may meet the goal of price appreciation, but not the goal of income appreciation."
The benchmark I'm using is my Gross Employment Earnings since I'm still working. The purpose of building my portfolio is for income replacement, not capital gain, total return or matching the SP500. What does my portfolio balance have to do with my income since I'm not selling stock to pay expenses? This is one of the questions you have to ask yourself when building your dividend income generator. Are you going to sell stock for income or create a portfolio that generates enough dividend income to not only pay expenses, but to generate surplus income to reinvest back into the portfolio for growth. The only thing important to any soon to be retiree is INCOME-CASH-FLOW and how it's generated. This is why the GFI (Gross Financial Income) of my portfolio is compared to my GEE (Gross Employment Earnings) and is currently at 72%. If you think about it my human capital is approaching zero since this is my last year of employment in my unique field. Once I stop working and no longer collecting a paycheck my human capital is no longer of value and not generating income. So the purpose of working 45 continuous years was to provide a method of income replacement that will continue well into retirement. My basic plan is to withdraw 50% of my portfolio dividends and reinvest the remainder back into the portfolio for income growth. The 50% of dividends plus Social Security will cover my living expenses. The nice thing about this method is having the surplus dividends as a backup emergency allocation. A built-in safety net is a nice feature to any investment plan.
So what is your number? Are you generating a GFI of 25% or 50% or 75% of your GEE? I believe since we spend our whole life building up our gross income investing in education, switching jobs for pay increases we should adapt a benchmark we can all relate too. This is just an opinion of one soon to be retiree striving for independence from the necessity of employment to sustain one's existence.
Income, Projected vs. Actual, Chart 1:
I have normalized my actual monthly income from my portfolio to $100 for the 2016 year. As can be seen in chart 1, I have projected total income "blue line" for the entire year of 2016. I then divided it by twelve and plotted the accumulated value each month to keep it simple. This method will be used to determine future income into the following year. Now, I overlay my actual income "green line" each month, and I can monitor the accumulated income during the year. Big income months are January, April, July and October. The income is dependent on the investment's payment schedule and most pay on a quarterly schedule. All income for the current year will be reinvested back into the account to provide income growth. Actual payouts for the current month have been projected and included in the chart.
To calculate actual income from the chart; if your portfolio is generating $50K a year, you would simply use the formula (50,000/12/100) = 41.66 to create the multiplier. In the chart above, the December [Blue-Line] calculation would be; $1,200 * 41.66 = about $50K.
Income Allocation Target, Chart 2:
Chart 2 displays my income allocation for the first three months of 2016. Each bar color indicates the year of purchase in reaching my income target. My investment plan is designed for each stock to contribute 3.33% toward my income goal. In the year of 2014 I figured out how to generate my retirement income and the blue-bars indicate most of my stock allocation. The over allocation in American Capital Agency Corp (NASDAQ:AGNC) was because I purchased this asset in 2013 before I had my plan finalized. There is no point in selling any AGNC since it looks like it has bottomed and pays good monthly dividends. In 2015 notice the red-bars indicating my asset purchases. Last year my new investments were Arlington Asset Investment Corp (NYSE:AI), Blackstone Mortgage Trust, Inc. (NYSE:BXMT), FS Investment Corporation (NYSE:FSIC), Triangle Capital Corporation Co (NYSE:TCAP) and TriplePoint Venture Growth BDC (NYSE:TPVG).
The Start of the New Year I came up with an investment method for purchasing additional income generators, Bubble-Up-Yield Purchase Method. This method takes my existing holdings and allocates new cash dividends based on the highest yield on the premise that some stocks are undervalued. I have decided not to add any new companies to my portfolio this year and just balance out my income allocation. During the Doom-And-Gloom month of January 2016; I made most of my purchases in AI, BXMT, Medley Capital Corporation (NYSE:MCC) and Western Asset Mortgage Capital (NYSE:WMC). You can see by the green-bars I have moved the needle a little trying to reach my 100% income goal for each asset. It is noted that once I have completed this task I'll be receiving my 75% income paycheck replacement by the end of this year.
The Wild and Crazy Market, Chart 3:
Chart 3 displays the market value percent change from December 31 2015 closing date. I don't typically report market value, but this January was a wild and crazy time for high yield investments. While some were running from the market, I was running toward the irresistible sales with my eyes wide open like a child in a candy store. I've seen this before; the market is a manic-depressive-emotional glob of misinformation that changes on a dime. In the accumulation phase of any portfolio plan you want to buy when there is blood in the streets. That's when I came up with my BUY (Bubble Up Yield) method to purchase additional shares as stated under Chart 2. This January and the first week of February I was buying as soon as cash hit my account and at times I had under a dollar left.
Looking at Chart 3 the green line is the total portfolio market value percent change from the beginning of the year. The change from a positive 3% to a negative 12% in about two weeks was great for people looking to buy cheap high yield income investments. My portfolio design makes it easy to split both the BDC and mREIT investments to determine who is winning the race to capital gains. Both asset classes considered high yield are on a rocket ride that may not be sustainable. Who knows they are acting like undiscovered investments that are undervalued and all of a sudden they become hot? This makes my future cash flow income more expensive and might slow down my predictive income growth.
There are many roads leading to retirement. No path is any more or less correct, but ultimately leads us to that same point. I have chosen the one less traveled that includes perhaps more obstacles along the way, but I believe the rewards will be just as satisfying as any other method. As far as I know my investment portfolio is the only unique design to include only BDCs and mREITs with the hopes of surviving both a bull and bear market. My personal believe as an optimist is that all methods in the SA realm of existence are viable. Commentators in the past have told me this method will not work, but this only emboldens me to prove them wrong. I take destructive-criticism as a challenge and have prevailed more times than I can count. As a side note I have nothing but gratitude since becoming a member of the SA team. In a short period of time it has expanded my scope of knowledge and understanding in the investment field. I'm just an average Joe trying to prepare for the next step in life we all must engage. I'll keep you all informed as the year progresses and make available any applications I develop to improve your chances of success. Thanks; Joe HYI ;-)
Please note the stocks included in the 50/50 portfolio are not recommendations. They were personally selected by the author and contain a great deal of investment risk. The stocks in the portfolio are Business Development Companies [BDCs] and mortgage Real Estate Investment Trusts [mREITs]. Both investment vehicles are Regulated Investment Companies [RICs] and are required to distribute at least 90 percent of taxable income as dividends to investors. This is a live active IRA portfolio that I believe will withstand the markets' bull and bear movements based on my own research. The progress will be updated and tracked for feasibility of this investment method over the years. The article titled 50/50 Portfolio (BDCs And mREITs) Baseline 2014 details how the portfolio was constructed.
Disclosure: I am/we are long AGNC,AI,AINV,ARCC,ARI,BDCL,BXMT,CMO,CYS,DX,FSIC,GBDC,HRZN,HTGC,HTS,MCC,MFA,MITT,MORL,NLY,NMFC,NYMT,SCM,SLRC,STWD,TCAP,TCPC,TCRD,TPVG,TWO,WMC.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.