Don't Book Your Summer Holidays Yet: The Income Method

Summary

• An old adage advises leaving the markets for 5/12ths of the year.
• Historical returns show May through October underperform the rest of the year.
• Income investors have additional considerations to take into account before even thinking of following this adage.
• We recommend some additional securities for your income portfolio that you may have overlooked recently.
• Looking for a portfolio of ideas like this one? Members of High Dividend Opportunities get exclusive access to our model portfolio. Get started today »

Co-produced with Treading Softly

Whenever May comes rolling around, we hear about the old adage, "Sell in May and go away". We often get asked why people like to use this saying and what validity it has. Here at High Dividend Opportunities, we look at things through the lens of our Income Method. This means we do not look at the market like total return junkies or day trading fanatics, but as long-term income investors who carefully craft their portfolios for long-term success via immediate income investments. We sprinkle in value investing principles to help generate additional alpha - which, through portfolio rotation, we capitalize into more income generation.

We are like the landowner who sells trees to International Paper (IP) or Enviva Partners (EVA). We realize that rotating our matured investments for new opportunities can generate additional growth and income when carefully practiced. We're not burning down our portfolio on hopes and dreams, but rotating via meticulous research.

So today, we wanted to look at this adage from the lens of an income investor.

A Little Backstory

This saying hails back from England, when higher-class individuals would leave London in May to summer in the country before returning in mid-September. Essentially, the upper crust - and their spending - moved off to other locales for a span of time.

This means the major wheels of investing and commerce went with them.

As the stock market took hold in America, this adage became focused on May through Labor Day or often May through the end of October. This span of time was the most common vacationing time for those actively involved in the market, and volume decreased accordingly. Usually, when buyers are off vacationing, shorting increases and lower volume allows for faster price drops.

How Does This Hold Up in the Markets?

Overwhelmingly, the November through April periods have outperformed May through October. According to a 2017 Forbes article:

According to Almanac data, since 1950 the Dow Jones Industrial Average has had an average return of only 0.3% during the May-October period, compared with an average gain of 7.5% during the November-April period.

Looking at the S&P 500 (SPY), the trend seems to hold up as well:

May 1, 2019 through October 31, 2019 performed admirably but still underperformed the prior November 1, 2018 through April 30, 2019 time frame.

But we must ask ourselves if there is a real benefit to sitting out of the market during May through October. In 2019, there was no benefit from sitting it out, as you simply missed out on approximately 4-5% returns. Since 2012, selling out in May resulted in missing some serious returns from the S&P 500:

(Source: LPL Research)

While often the November through April span produced greater returns, the overall picture shows that consistent negative returns in May-October have not been seen in recent years.

Right now, as investors looking at this pattern, you would have forfeited a large portion of your capital gains by selling out during this portion of the year. As income investors, we need to think long term and not fall for gimmicky sayings. If you held a monthly-paying security, you would be skipping out on five of its 12 dividend payments, so your total capital would be diminished if you had to make up those dividend payments by cannibalizing your total money pile.

Consider the PIMCO Dynamic Credit Income Fund (PCI), for example, from May 1 through October 31, 2019, it provided a total return of 11.15% and a price return of 6.56%.

Now, take into consideration that during this time it would've paid out $1.0242 per share in distributions. See the chart below for the distributions during that period

(Source: Seeking Alpha)

On May 1, 2019, PCI had a share price of $23.49 per share. The missed distributions equal a 4.36% return on your investment during that period. If you held $10,000 worth of PCI on May 1, instead of it rising in value, your cash pile would diminish in value if you had to compensate for lost dividends. Now you walk away with only $9,564 to reinvest after taking out the equivalent loss to your investment income.

Timing the Market vs. Time In the Market

The idea of selling out in May and returning when the snow has fallen again - or November, depending on where you live - is an aspect of market timing. Essentially, you feel that playing the market by not remaining in it is the best route to achieve your goals.

Income investors use their dividends to soften the blows of market drops and supercharge the returns of market recoveries. Right now in this bear market, some preferred securities have rallied from their bottoms by more than 100%. Dividends invested into those opportunities have already produced outsized returns versus those simply sitting out of the market if they timed it right.

Income investors also need to factor in their reliance on dividends for daily spending. Retirees, especially those who use their portfolios as a way to augment their income streams, need to understand that sitting in cash does not mean preserving value versus the market if they are still pulling from that cash to supplement lost dividend income. For income investors, placing your funds into securities that pay reliable steady dividends or distributions is the best means to a sound and safe retirement income stream. Gamification of the market has led many to chase a day trader's dream of the next big score. Don't be a gambler. Be an investor. Time in the market for income investors vastly outperforms timing the market when it comes to developing a steady dividend income stream.

Consider These Securities For Your Income Portfolio

The Reaves Utility Income Fund (UTG) is a CEF that invests in utilities and infrastructure companies. These are two of the most defensive sectors because we all need electricity, water, heating, and Internet in good and bad times. Regulated utilities are steady stable income producers, and wrapping them in a Closed-End Fund allow you to get instant diversification in the sector with high yield. UTG is actively managed by Reaves, the most renown manager in the utilities space, and works to maximize your returns. UTG also offers monthly distributions versus quarter of most utilities This makes budgeting easier and reinvestment opportunities come more often. UTG's yield was at 7.3% on 05/04/200.

Newtek Business Services Corp., 5.75% Notes Due 8/1/2024 (NEWTL) is a baby bond offered by one of the most solid "business development companies": Newtek (NEWT). NEWT is a major beneficiary of the Paycheck Protection Program (PPP) and SBA loans, having already taken a larger-than-traditional role in aiding their portfolio companies with payroll services. NEWT is in a very sweet spot to outperform, and the bonds offer a great conservative way to take advantage of that. The baby bond NEWTL yielded 5.8% as of 05/04/2020.

Conclusion

As investors, you will hear various adages or myths from the investment community timed with various parts of the year. We've tackled some of them before, and again we've seen this yearly myth rise up from the ashes.

We have seen where, historically, the back end of the year outperforms the middle as far as overall gains. This doesn't mean an income investor or retiree should sit out 5/12ths of the year over the chance it will not perform as strongly as the rest of the year. Furthermore, income-reliant investors need to consider the effect of cannibalizing their portfolio cash value while waiting to reinvest. This alone makes the hard task of making up for lost time even more insurmountable.

If you are an income investor, focus instead on our task at hand: developing a strong income stream that provides the steady cash flow you desire and want. You can use this cash flow to live, to reinvest in mispriced opportunities, and to impact your world that otherwise would not be possible without the power of dividends. Majoring on the minors often outweighs cashing the myths and ghosts from the past.

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Analyst’s Disclosure: I am/we are long NEWT, NEWTL, PCI, UTG. 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.

Comments

[dvan69]

Why was my comment deleted when I asked asked you opinion on KBWD a monthly payer at 15 percent?

[MtBudmoreView]

Since apparently 2019 never happened and certain commodities may have evolved yet to be decided, to the next reality. Nothing about the future is overwhelmingly accepted as widely believed. We're between doomed and glory with experts for everything in-between. I'll take your PCI and Newt avoiding Dante's inferno by adding a PDI and ARCC etc. I like your take!

[The Value Portfolio]

During times of uncertainty, when the market prices it in by dropping prices, that's potentially the best time to invest.

[Donggle]

@The Value Portfolio too bad the last 3.5 years was wasted.

[huskers123]

Doesn’t the Capital preservation method rule over the income method? Many of your divided recommendations have been cut, suspended. And the values halved.

[Donggle]

@huskers123 give me the details of the Capital preservation method, timing the markets is the only thing that would seem to work, but we all know you cannot time the market.

[huskers123]

I’ve timed the market pretty well. Get out when the 50 DMA is 2 STDs above the mean . Did in all the last take downs except this last one and I should have kicking my self . You can hedge or you can choose investments that are not all that correlated to the economy like biotechs. The biotechs I’ve owned have almost made up for the losses I’ve incurred from this latest takedown. It will take about 8 years of dividends in the accounts I setup with the income method to recover, that’s if they don’t appreciate. I’m hoping they will of course. Which would shorten then break even time.

[Donggle]

@huskers123 I think you pointed out the problem with any plan, if you dont stick to it, it makes no difference if you have a plan. You get many whipsaws with the 50DMA ? Take a look at the 5 yrs charts of biotech. You needed something to save you from the hedge. The non correlated sounds good in theory only, the market sinks all ships, non correlated is not being in the market.
I think the income method is better for people that need income and take the dividends, not try to get cap gain by reinvestment. If dividends are 100% of your income when retired, good luck.

[Longbottom]

Thanks for the write up. I currently have pci, utf, thw and oxlc for my monthlys (although I think oxlc will suspend its divvy for a bit). What do you think about etg?

[jrloma]

I’m in NEWT, USAC, ARCC, NMFC and EPD. Feeling cautiously optimistic after they have all reported first quarter earnings. I will probably buy more NEWT. I’m of the belief that a good dividend is coming due to their involvement with the PPP and SBA loans. I recommend listening to the conference calls for all of the above mentioned stocks.
Thank you Rida for all of your valuable advice. With your help I’m keeping grub on the table!

[Donggle]

What is UTG defending against, had close to a 50% drop in principal about 2 beta on the downside and .5 beta on the up so far. Now that is volitility.

[Anarchy99]

What about EPR? MAC? SPG? NLY?

[ShankaSwingTrades]

I've been watching MAC too

[ShankaSwingTrades]

Rida,
Thank you for your articles
Always great info.
Obviously I'm doing my own DD..
But do you like $NEWT at it's current price?
I've been following now and hoping to scale in..

[The Value Portfolio]

I would start with MAIN. Almost the same dividend but much larger and with much more stability.

[Arsenal26]

Rida - when did you say to sell OXLC?

[Rida Morwa]

@Arsenal26 I have never said to sell OXLC.

[Ta0]

I currently own a relatively large chunk of PCN. Should I sell the entire holding and purchase PCI instead?

[Rida Morwa]

@Ta0 PCN is a more conservative sister fund of PTY. I would consider swapping it for PTY or simply holding it as it is also run by PIMCO.

[Ta0]

@Rida Morwa Thank you for your answer. :)

[PaulY2]

PCN is funny right now, its premium is back to 30% such that the share price now matches the Nav from before the crash, which hasnt recovered due to the wider credit spreads.

[bobholt]

@Rida Morwa

Thanks you. As always, another good article with sound advice. I'm shifting some equity (especially ETFs) to income (PCI) and some lower yield ETFs to UTG.

What do you think of PONAX/PIMIX?

[Rida Morwa]

@Holtgraver

I generally do not invest in mutual funds due to their added fees and restrictions. I would much rather hold a CEF that is easier to trade in and out of and does not include load fees etc.

[dvan69]

What do you think of KBWD? It is a monthly payer

[Rida Morwa]

With KBWD, Their top holdings contain $ORC - which had large forced losses due to MBS prices shifting as we've seen with other MREITS - and $PSEC which has large CLO positions that are bound to be hurting during this time. generally for these sectors prefer to hold high quality individual securities vs an ETF where you get a basket of good and bad.

[Ethan Roberts]

Rida, you raise some very interesting points in this article. I particularly like your thinking about sustaining income throughout the year. A few observations that I have:

With the market indexes still a long way below their peaks in February, many solid companies who have pledged to maintain their dividends, now have 4-5% dividend yields or more. If stocks do begin to decline again, I will simply use some cash to sell naked puts and either generate premium income if prices don't hit my strikes, or be "forced" into buying some favorite dividend stocks at discounts to today's prices which are already 10-20% below their highs.

Second point: Re: UTG, one doesn't have to buy a stock or fund that pays monthly dividends to garner a monthly dividend. You simply buy a number of quarterly paying dividend stocks whose payouts are in different months, thereby insuring that you are receiving dividends every month. For example, T pays their dividend in January, April, July, and October. Meanwhile, CVX pays out their dividends in February, May, August, and November. And MO pays their dividends in March, June, September, and December. So if you owned those three stocks, you would receive a dividend payment every single month, even though those stocks pay quarterly dividends.
Have a good weekend!

[Rida Morwa]

@Ethan Roberts That is an interesting plan with your puts for companies you prefer. I have a long standing that you should never sell a Put for a firm you don't want to own at the strike price. There is a risk present with selling puts if the security falls rapidly, but accepting that risk is part of the process.

I usually like to keep things as straight forward as possible.

As for your second point, yes I know you can vary your pay dates by picking various securities, but often you are locked into different sectors paying at different times which can create extremely lumpy income payments from a monthly perspective. While I dont recommend only funds - as any regular reader of mine knows - I do think it is a benefit when a well run fund allows you to covert quarterly payments into monthly ones.

[Donggle]

Does anyone really want to own the stock when selling a put? Not in your life just the premium. Owning the stock means you are now holding the bag with a chunk of your cash, probably lower now then your put price. One bad trade eats up all those little premiums you banked. Now you are stuck do you sell a covered call possibly lock in your loss at a higher level?

[Ethan Roberts]

Yes, I can see that last point you made. BTW, I do own Realty Income to smooth out the lumps!

[kbaba]

Dow is trading higher than at any time in history before 2018. That's insane when one considers the effect of COVID-19 which aren't going to disappear overnight. Beware of normalcy and optimism bias. This is unsustainable. Invest or don't but have very serious hedges

[Rida Morwa]

If you feel a market crash is imminent, are you mostly holding cash? @kbaba

[kbaba]

I'm playing chicken with the market a bit because I think the down side is going to take a number of weeks to sink in. I'm super hedged instead. Big big position in a small but profitable gold miner with low P/E RNKLF (up 20% friday) Big cruise line put positions and some negative funds like DWSH and VXX.

On the long side, Very large positions in Agency MREIT preferreds mostly NLY and AGNC (which I bought very much lower) and some of their common (Thesis credit risk back-stopped by government at a very high priority) and some preferreds in companies like TGP and HMLP, with long term contracts not heavily exposed to COVID.

Been selling the long positions to boost liquidity lately. I'm contemplating more sales but every time the market goes down, my portfolio does up, and when the market goes up, the same, so feels like the right balance for now. Thesis is the Cruise lines are weaker with their lack of government support and being at the highest risk of reopening late, while the MREITs are stronger as GSE protected housing is the first thing to be protected.

Also have quite a lot of Alternative energy commons and preferreds, BEP, BEP-A, AY, TERP and CWEN-A but have been trimming them lately as they ran back up again.

this could admittedly backfire but so far have booked more capital gains during the pandemic than my whole investing career combined so I'll have to contribute to the governments economic needs at unprecedented levels at tax time, a welcome but painful side effect.

[Moats and Income]

Agree completely, Rida....we see so many other chasing the pot of gold...like a dog chasing its tail...the opportunity cost of time is forever lost for those in that mode.

Not saying some spec isn’t okay (and fun)...I do it to with a limited part of portfolio...and in areas where my expertise lies...

I’ll take a look at the baby bond. Thanks.

And, our Saturday paper delivery in the states was heavier than normal. Return of print ads due to reopening...:). We still hold onto the local print paper...something about reading from paper vs electronic that’s comforting...but, in this historical instance, the weight of the paper meant more to those that understand...;)

[BULRUN100]

@Rida Morwa don't you find PCI's expense ratio too high at +2%? Looking for monthly paying ETF's, do you follow others that you recommend at a lower cost ratio?

[Rida Morwa]

@BULRUN100 PCI is an ultra-active bond CEF. Expense ratios operate are calculated from leverage costs and management costs. Those management costs are like a CEOs pay, if the CEF is performing well and a reliable income producer, then management is earning their payment.

[sme20]

As the end of the fiscal year comes for PCI(6/30), what level of income/distribution cut are you anticipating for July and forward? How are you factoring this into purchasing plans? Thanks.

[Rida Morwa]

@sme20 PCI and PTY have a long history of stable distributions. I expect PIMCO to do everything possible to maintain that history and not cut. PTY had a very slight distribution cut in 2007, maintained it through all of that global recession and raised it after. If anything were to occur, it would likely be similar.

[sme20]

@Rida Morwa - I'll reserve further discussion until the UNII report for April 30 comes out, that should be very telling. I know they raised last year, but this is a whole new ball game for credit market investments, one that no one could see coming, but that fact remains, is this something you would want to invest in until some clarity is gained? Covered calls in the QQQ for me.

[jzwmnb01]

@sme20

What dates and prices are you looking at for the QQQ covered calls?

thanks and good luck.

[John Vellema]

Rida,
Thanks for your comments about timing the market and the fact that with an income portfolio, dividends continue even if the market drops (except of course in some cases in unusual times like we are now in with the Covid-19). As you have pointed out several times that when the market drops, many times it provides a buying opportunity.

[Rida Morwa]

@John Vellema
You are very welcome! We are living through unusual times indeed. Often the overlooked aspect of going to cash is the big question of how to you replace the income you need to live off of. Often that causes going to 100% cash to be a net-negative plan. Picking the right places to park cash is a must - so we've been focusing on preferreds and baby bonds.

[Only6greens]

Only if you raised cash before hand!

[usiah]

Definitely will not be selling in May, Mr. Morwa.

Have been accumulating UTG lately. Possibly buying PCI (or PTY or PCN) this summer to replace the income from a called taxable muni in the IRA.

Thank you for the write up.

Retired income investor

[Rida Morwa]

@usiah You are very welcome. Buying up PCI, PTY and UTG will provide you with multiple strong monthly income streams, I personally hold them all.

[jzwmnb01]

I just bought some IP a couple of weeks ago and so far, so good, as it is up almost 15% since then plus it pays almost 6% on current price. Too bad I didn't buy more but too often, greed kills.

All the best.

[Rida Morwa]

@jzwmnb01 I understand that feeling. The market has been quick to change prices. I have long held allocation rules that keep myself from being overly greedy on any transaction.