The Income Method: How 'High Dividend Opportunities' Succeeds

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Includes: AMZN, ARCC, BAC, BIP, GE, GOOG, GOOGL, KNOP, NFLX, RF
by: Rida Morwa
Summary

Income investors are one of two types of Chicken Farmers.

Unrealized Gains are fools gold unless turned into realized gains and reinvested into high-yield income stocks.

Low Yield, dividend growth stocks often stop retirees from succeeding.

Our investment strategy at "High Dividend Opportunities".

Co-produced with Treading Softly and PendragonY for High Dividend Opportunities

Investment Thesis

Investing for in high yield securities for immediate income is readily becoming a necessary step for many individuals. This type of investing requires additional diligence to avoid sucker yields and weakly covered dividends that pose great risks, however this style of investing is also highly rewarding.

The Two Types of Investing

Investors or investing styles can be typically broken into two camps. Those who invest for dividends/distributions and those who invest to see the value of those investments increase - than sell them to unlock those gains. Dividend investors receive their returns immediately as cold hard cash.

One easy illustration is a chicken farm. Chickens can be raised for meat or eggs. Dividend investors raise their chickens for the eggs - a consistent flow of immediate return versus value-oriented investors who have to kill their investments to receive the gains.

The risk that the farms run on depending on their chickens for meat is that sickness, weather, etc. that may come outside of their control can reduce the value of their chickens - leaving them with the larger potential for complete loss. Meanwhile an egg focused farmer has received a return already - before any outside impact could bring a loss.

While hybrid farms exist - mixing egg and meat chickens, they're simply trying to split the odds and get the best of neither type.

Unrealized Gains are Just That

Often when speaking of "total returns" investors throw this terminology around having never invested in the security, or having never sold it yet. Investors in Amazon (AMZN), Netflix (NFLX) and Google (GOOG) (GOOGL) have all seen fantastic unrealized gains.

Chart Data by YCharts

But a key difference between the rise in these stocks values is that those gains aren't locked in until an investor sells - thus without dividends, no total return has been actually achieved. They're counting their chickens before they're hatched, raised and slaughtered.

Chart Data by YCharts

The last financial crisis revealed just how quickly unrealized gains could be completely whipped out. Investors in General Electric (GE), Bank of America(BAC) and Regions (RF) are sound examples of this. Those investors who had no dividends were left being forced to sell additional shares to fund their retirements - or to delay their retirement all together.

Its normal for investors to hold on to their best performing stocks and imagine those unrealized gains will never go away - but this is a trick of the mind and not a part of reality. The only gains you've actually achieved are realized gains and dividend/distribution payments received.

Our Focus - High Yield, Immediate Income

We have chosen to focus on gathering our eggs, and not killing our chickens. Why? Because we recognize as the market and business cycle will move from a bull market to a bear, or boom to bust, that strongly covered, high yield options will provide a steady income and steady return - regardless of the price.

But what about dividend growth investing? Doesn't that benefit from this also? It does, but for most retirees, its not the best choice. Lets talk about why.

The average American family has only $95,776 saved for retirement. According to the CDC, Centers for Disease Control and Prevention, the average American lifespan is 78.8 years. Rounding to 80 years, this retirement savings would provide $6,385.06 per year spread over their 15 years of retirement. This means that investing in low yield, slowly growing stocks can starve a retiree from much needed income.

Immediate Income Investing: 10 years, no reinvestment, 10% yield

Capital Invested

Dividend Yield

Total Dividends Received

10,000

10%

1000

10,000

10%

2000

10,000

10%

3000

10,000

10%

4000

10,000

10%

5000

10,000

10%

6000

10,000

10%

7000

10,000

10%

8000

10,000

10%

9000

10,000

10%

10,000

After 10 years, a total of $10,000 worth of dividends have been received. Achieving a total yield of 10% is possible through careful screening and diligence. Knot Offshores Partner LP (KNOP) or Ares Capital (ARCC) for example offer approximately a 10% yield, and have no immediate plans of growing their dividend. The dividends are solidly covered.

Dividend Growth Investing: 10 years, no reinvestment, 5% yield, 8% annual dividend growth

Capital Invested

Dividend Yield

Total Dividends Received

10,000

5%

500

10,000

5.4%

1040

10,000

5.83%

1623

10,000

6.30%

2253

10,000

6.8%

2933

10,000

7.35%

3668

10,000

7.93%

4461

10,000

8.57%

5318

10,000

9.25%

6243

10,000

9.99%

7242

After 10 years of focusing on dividend growth investing, a total of $7242 worth of dividends have been collected. While this is nothing to scoff at, it is over 25% worse after 10 years than immediate income. We used Brookfield Infrastructure Partners LP (BIP) as a phenomenal model for dividend growth investing, currently it yields about 5% and offers a goal of 8% dividend growth per year.

The Market Misses the Point - You Don't Have To

The market has been fooled into thinking that total return is the only metric that matters, but for a retiree, their cash flow from their investments matter more than the price movements underlying their stocks. To live from the yield without selling is a key goal for many investors. But mandatory drawdowns or believing that selling off a portion of your investments annually continue to persist in normal retirement thought. Why? Because many invest in stocks that are yielding too low, with too little saved to truly meet their needs. But this equates cutting off your foot and thinking you'll run just the same. Shrinking your total portfolio value to live means you have less to benefit from next year.

This is where High Dividend Opportunities makes a difference. Our portfolio targets a yield of 9-10% from highly covered, safe positions. We have a team of authors committed to doing the heavy lifting so your retirement or investing life is as simple as possible.

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Disclosure: I am/we are long ARCC, KNOP. 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.