I Prefer Income Blog 3-12-19

I started investing when I was around 18.  The father of one of my good friends was a broker at Dean Witter Reynolds.  One day I went with my friend to visit his dad at his office in downtown, Portland, Oregon.  I was a little star struck as so much was going on around me.  People sat or stood around watching the prices roll across the big electronic ticker tape screen on the wall and making notes and talking to each other.  It was exciting, but the best part came once I talked do my friend’s dad.  He talked a bit about the market and some of the companies he was excited about. He didn’t realize it, but his enthusiasm convinced me to dip my toe in the water.  I ended up buying GAF (General Aniline and Film) before I left his office.  Do you remember the little View Master that displayed pictures of Disney and other characters into view one after another?  That little gadget is long gone, but during this period, it was a big deal.  I eventually doubled my small investment after a relatively short period of time.  This was my initiation into the wonderful world of investing.

Like many new investors, I have made a lot of mistakes.  After years of trying to hit home runs from buying stocks at low prices and riding them to the mountaintop, I was lucky to hit a single or double.  I say I was lucky because all too often, I struck out or hit foul balls.  This became very expensive; not only because I was rarely successful on a consistent basis, but the cost of every transaction was high.  Most trades came about by phoning my broker.  That took time and cost a percentage of the total amount invested.    

Investing has never been quite as rewarding as that first investment, but through “trial and error investing”, I have found a way to invest that I am comfortable with and enjoy.  Knock on wood, as it now provides a nice income that is relatively safe, reliable and continues to grow.   I consider myself an “income investor”.  I focus 99.9% of my efforts into investing in securities that provide a minimum of 6% yield.  This focus has come about from realizing that I was not successful enough to make money consistently from stocks that appreciate in value.  I slowly began to see the value in investing in companies that paid a dividend.  As this change took place, I started to recognize the different ways to invest for income and in the many classes of companies and securities that paid dividends or interest.   I feel that there are 2 basic ways to invest for income. 

Higher Yielding Securities.

These securities generally do not generate dividend growth, nor do they provide an opportunity for long term appreciation. 

The benefit of investing in securities with higher yields is that you receive more income – immediately.  You don’t have to wait for companies to increase their dividends over several years.  The good news is that there are a lot of options available.  The bad news is that the risk level is generally higher than lower yielding investments.  There is additional good news as there are many exceptions where investors can obtain higher yields with lower risk.

Lower Yielding Securities

These securities generally have the ability and willingness to pay and increase dividends.  And because of this growth, they also provide an opportunity for long term appreciation.

The benefit of investing in securities with lower yields that grow dividends is that over time, these companies will generate increasing income and increasing appreciation.  The bad news is that it could take a long time before the results are high enough to meet your needs.  More bad news is that not all low yield, dividend growth companies are successful.   

Yield and Risk

In general, as the yield increases, the risk also increases.  The lowest yield class are those companies that have a history of increasing their dividends for 25 and more years in a row.  That is quite a record.  They deserve to be classified as low risk.  At the other end of the table are the companies that have the highest yield, the mortgage REIT companies.  That top spot does not come easily.  Investors have voted with their dollar.  Investors have said that the only way they will invest in them is if the yield is high enough to compensate for the risk.

Each of these classes provide benefits to investors; however, as an income investor that invests on higher yielding securities, I have built my investment portfolio on a foundation of securities that yield more than 6%.  As an admitted “Yield Chaser”, I have learned the hard way that risk must be taken into account.  Yield and Risk are the 2 sides of my investment scale.    

Preferred Stocks & ETD Securities

I found that over the last 10 years, I gravitated to companies with high yields that provided reasonable risks for safety and the ability to pay their dividend or interest on a sustainable basis. The good news for me is that there are a lot of choices especially when I focused my search on Preferred Stocks and ETD securities.  Yes, I do own securities in all the classes with yields above those of preferred stocks & ETD securities, but they are harder to find, and I tend to own them for a shorter period of time.   It is interesting that many of the stocks in the higher yield classes have issued preferred stocks where risks are lower.  As an example, there are 8 cREITS, 14 mREITS and 29 BDC that have issued preferred stocks or ETD securities.

I have discovered that there are over 600 preferred stocks & ETD securities with a par value of $25 (I do not count convertibles).  These include 168 ETD securities, 278 traditional preferred stocks, 135 traditional preferred non-cum stocks and 18 trust preferreds. 

I now consider preferred stocks & ETD securities as my investment foundation.  The majority of my portfolio is built on this foundation and from there I work my way higher with selective higher yielding securities.  There are several reasons why I feel comfortable owning preferred stocks & ETD securities.  First, I consider myself to be a long-term investor.  I do not trade.  I buy for the long haul.  Preferred stocks are safer than the common stock of their parent company and ETD securities are safer than the preferred stocks.  Next, preferred stocks cannot stop paying the dividend unless they are in real trouble and not before they stop paying the dividend on their common stock.  That is very important as it provides a buffer or hurdle that must be crossed before the parent company can stop paying the dividend.  Then, most preferred stocks have the benefit of being “cumulative”.  This means that if they are forced to stop or delay paying the dividend, they must accumulate those missed payments and pay them back to the investor within a certain period of time. 

That is not all the benefits, but it gives you an idea of some of the beneficial features of owning a traditional preferred stock.  Yes, there are preferred non-cum stocks, but those are issued by companies that are generally considered stronger than the traditional preferreds. There are also ETD securities, which are even safer than preferreds as they are a debt and debts are higher on the list if it comes to the company being liquidated. 

Interest Rates & Preferred & ETD Securities

One of the issues that many investors point to for not investing in preferred stocks & ETD securities is that they are sensitive to interest rate fluctuations.  If interest rates rise, then market prices have a tendency to drop.  I recognize that this relationship is true, but many have missed out on this great class of investments for many years only to find that most preferreds & ETDs are currently at or above par.  If you are a long-term investor, the key is income, not the price.  Interest rates fluctuate just like the economy does.  If interest rates increase today and into the future, they will eventually change direction and fall once the economy falters.  Learn to take advantage of those changes. 

Yes, interest rates have increased, but many analysts feel that interest rates have peaked or stabilized.  We can see this trend in the 10-year treasury rate.  During 2018, it increased to over 3%, but has now dropped to around 2.65%.   These are sweet words for the preferred stock investor as stable rates means a stable market for interest sensitive securities. 

Here is one other thing to consider.  Have you ever thought of buying an annuity? If you are 70 and purchase a Single Premium, Immediate Annuity, you can probably receive about 6 to 6.5% yield for the rest of your life.  That doesn’t sound too bad until you realize that when you are gone, the principal is also gone.  However, if you were to invest the same amount in a preferred stock or ETD security, you could probably earn a higher yield.  The difference is that 100% of the principal would be maintained and available to your heirs.    

This article will be continued with articles such as the financial metrics I use to determine safety, reliability and dividend sustainability.  I will also present the various portfolios I maintain, such as the “Hot & Spicy” portfolio, the “Meat & Potatoes” portfolio, the and the “Investment Grade” portfolio.  Each of these contain specific securities that match the portfolio name.      

Thanks for reading,

Rich Hill
I Prefer Income




2 replies
  1. Donald Twary
    Donald Twary says:

    A great and well written blog. Reading thru the blog you can find some really important info for any investor who may use the Preferred stocks & ETD investing style for their portfolio. Looking forward to the next chapter to this Blog.

    Reply
    • Richard Hill
      Richard Hill says:

      Donald,

      Thanks for the nice comment. There is a lot to learn about preferred stocks & ETD securities and I believe that our website and spreadsheet provide a lot of tools for the investor. Thanks again. Rich Hill

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