I’m Tim Plaehn.
And I’m here to guide you on the next step on your path to building a lifetime of income from a rock-solid dividend portfolio. You’re right on track to become a seasoned Dividend Hunter as part of my Dividends Forever Summit.
So let’s get to it…
First of all, most high-yield investments – like the ones in the Dividend Hunter portfolio – come from only a handful of investment sectors.
And I can tell from the questions that land in my inbox, most of you don’t have a thorough understanding of the different types of high-yield investments.
But before we jump into each one, let’s take a quick look at everybody’s favorite subject – taxes.
You should know… the types of businesses we like to own operate under special laws or rules that allow them to pay little or no corporate income taxes.
For a business to qualify, the company must “pass through” at least 90% of net income as dividends to shareholders. The pass-through structure is a great recipe for larger than average dividends and higher yields, which is whatattracts investors like us.
And one more thing…
Most of these companies prefer to invest in tangible assets like real estate, energy, infrastructure or other natural resources.
With that explained, here’s an in-depth look at each type of high-yield asset that we like to own:
Real Estate Investment Trusts (REITs)
In 1960, Congress passed a law to make it easy for investors to invest in commercial real estate. Simply put, REITs own income-producing real estate assets. The larger REITs fall into two distinct categories:
Equity REITs – specialize in properties like office buildings, healthcare properties, shopping centers, malls, apartments, hotels, self-storage, data centers, single-family rentals, cell towers, and warehouses. Each category has its own unique characteristics. You can diversify across business sectors with the different REIT categories. For example, the data center and cell tower REITs are closely tied to the technology sector. And returns will vary across sectors as well. You can find REITs with high current yields and steady dividends. Or others, where initial yields are low but offer guaranteed dividend growth.
Finance REITs – originate and/or own debt securities related to real estate. Finance REITs divide into two broad categories. Commercial finance REITs are companies that originate mortgages on commercial properties and hold the loans in their portfolio. Residential finance REITs usually own a leveraged portfolio of mortgage-backed securities (MBS), like those issued by Fannie Mae and Freddie Mac. Like any sector, there are some great companies and some real dogs in the finance REIT world. I’ll be right there with you along the way to identify which is which.
Business Development Companies (BDCs)
BDCs – provide equity and/or debt financing to small and midsized corporations. Congress passed the BDC Act to provide financial support for companies too small to access the public debt and equity markets and, at the same time, too risky for commercial banks.
There are about 45 publicly traded BDCs, ranging from tiny market caps up to $10 billion. Factors I like to consider include stability and growth of dividend payments, management structures, expenses, and price to book or net asset value (NAV).
Generally, I like BDCs that trade at a premium to NAV over ones trading at a discount. Quality BDCs yield in the high single digits. However, the COVID crash put certain high-end BDCs on sale with 10% plus yields.
Energy Midstream or
Infrastructure Companies
Midstreams – provide processing, transport, and storage services between the upstream energy producers (oil and gas drilling companies) and the downstream users, including refiners, natural gas liquids (NGLs) manufacturers and utilities. Energy midstream companies own pipelines, processing plants, storage facilities, and terminals for loading and unloading energy products.
Master Limited Partnerships (MLPs) – most midstream companies were once organized as MLPs when they provided tax-advantaged, pass-through features with attractive yields and dividend growth. But the 2015 energy sector crash blew up the MLP business model and many were converted to a corporate structure. About one-third of the companies in the midstream space continue to operate as MLPs. Most MLPs are simply no longer attractive to us as Dividend Hunters.
We like energy midstream companies because they have stable revenue streams from long-term contracts. Despite drastic price reduction over the last few years, there are many midstream companies with growing dividends. With stable, reliable businesses, lots of them are tremendously undervalued. Current yields range up into the mid-teens, so I believe total returns from this sector are likely to be outstanding over the next five to ten years.
Preferred Stocks
Preferred shares – get their name because they have priority over common stock for dividend payments. For example, a company might slash its common share dividend and still pay its preferred dividend. When the COVID shutdown forced RLJ Properties REIT (RLJ) to close its hotels, the company slashed its common stock dividend from $0.33 to $0.01 per share. But that token payout told me RLJ would likely continue to pay its preferred dividends. While the rest of the market crashed, I told Dividend Hunter subscribers to pick up RLJ preferred, racking up double-digit returns.
Most preferred issues feature a fixed dividend rate and $25 par value. Preferred stocks don’t have a maturity date, but most are callable at some point. As a result, most preferred’s prices will trade around $25. When shopping for individual preferreds, you want to pay less than $25 per share. Typical yields range from 5% to 8%. My list of preferreds for Dividend Hunter subscribers has an average coupon rate of 7.3%.
Closed-End Funds (CEFs)
CEFs – are similar to mutual funds. However, CEFs trade on a stock exchange and have a fixed number of shares. That means the price fluctuates with buying and selling, just like an individual stock.
With over 500 different funds, CEFs cover every nook and cranny of the investing world. Categories include individual state muni bonds, gold and silver bullion, high-yield bonds, international and domestic stocks.
But finding quality CEFs is the trick. I see lots of investors chasing hi-yield CEFs without understanding what they’re getting into. They’re simply swayed by the high yields, and don’t understand where those great dividends come from.
CEFs typically use significant leverage and can use managed dividend policies, where dividends have not been earned from the investment portfolio. They’re often simply a return of principal. That’s the main reason I have only one CEF on the Dividend Hunter recommended list.
Exchange Traded Funds (ETFs)
ETFs – own portfolios of investments from one of the investment categories listed above. For example, you’ll find the Dividend Hunter list recommends a preferred stock ETF and an MLP ETF.
Certain income-focused ETFs use covered calls – an options selling strategy – to boost the return from major stock market indexes like the S&P 500 or the Nasdaq 100. These are great funds because provide us with a combination of attractive income and investment exposure to the stock indexes.
There you have it! A comprehensive list of every type of investment you’ll find in my Dividend Hunter recommendations.
Keep this in mind…
When you jump into the world of high-yield investing, it’s crucial to know what type of security you are buying. Each stock or fund in each category has its strengths and weaknesses. It’s my goal for The Dividend Hunter recommendations to provide you a diversified portfolio, with high yields and a lifetime of income. I’ll be sending you regular updates so you’ll be learning more about each category, even after our Summit has ended.