Here’s How COVID-19 Made Income Investing Easier
Over the July 4th weekend, I spent an afternoon tubing on the Potomac River with my sister. In a moment, I’ll share with you the ideal investment portfolio for a retiree seeking maximum income that I shared with her that day.
When you spend a couple of hours drifting down a river with someone, you have a lot of time to talk. And since my sister is less than a year until retirement, eventually the subject turned to investing.
Specifically, she wanted to know what I would do to generate a high level of income if I were retiring today. “That’s easy,” I said, “I would follow the advice I gave my readers a few years ago.”
In February 2018, I wrote a two-part series on “How to Avoid Outliving Your Money in Retirement.” In Part 1, I related the story of a friend who needed to generate a 6% annual yield from his mother’s investment portfolio to cover her living expenses.
My advice then was to use “an even mix of MLPs (master limited partnerships), BDCs (business development companies), and REITs (real estate investment trusts).” That would still be my advice today, and the good news is the distribution yield of this portfolio is much higher now than it was then.
That is due to uncertainty caused by the coronavirus pandemic:
- Most MLPs operate in the energy sector. Historically low oil prices has reduced demand for midstream services.
- Small businesses are bearing the brunt of social distancing restrictions. So, the loans made by BDCs to them are perceived as riskier.
- Many companies are requiring their employees to work from home. That may mean REITs will have fewer tenants to collect rent from in the future.
As Easy as 1-2-3
Those concerns are valid, but overblown in my estimation for the following reasons:
- As the old saying goes, the cure to low oil prices is low oil prices. The energy sector is notoriously cyclical and MLPs will get through this rough patch just as it has all the others.
- The small companies suffering the most from COVID-19 are not the type of businesses that borrow money from BDCs, which primarily lend to high-growth companies in the health care and technology sectors.
- Certain types of REITs will undoubtedly suffer from the coronavirus pandemic, particularly those that own shopping malls, restaurants, and small retail locations which you can avoid.
You don’t need to know which ones to buy and which to avoid. Instead, you can use three exchange-traded funds (ETFs) to provide diversification and professional portfolio management for you.
Here are three ETFs that pay an average annual yield of 13.1% (that’s not a typo) and pay dividends quarterly.
VanEck Vectors BDC Income ETF (BIZD) – This fund owns 26 BDCs and has a distribution yield of 12.2%.
JPMorgan Alerian MLP Index ETN (AMJ) – This is an exchange-traded note with a distribution yield of 12.0%.
VanEck Vectors Mortgage REIT Income ETF (MORT) – This fund owns 25 REITs and has a distribution yield of 14.9%.
Yields that high suggest that there may be dividend cuts in the near future. Their share prices already reflect that expectation. Over the first half of this year, these three funds have fallen by an average of 34%.
A temporary dividend cut by each of these funds is possible. But even if they were cut by a third, the average yield for these three funds would still be 8.7%.
Swapping Growth for Income
Of course, you don’t need to put all your money into a portfolio like this. But even putting a third of your money in these three funds would raise the average distribution yield of your portfolio considerably.
Bear in mind, the 10-year Treasury note is paying less than 1% and nobody but Bill Gates can live on that. After paying income tax and adjusting for inflation, the real rate of return on all U.S. Treasury securities is negative.
With so much attention being paid to mega-cap tech stocks, income vehicles are being ignored. After all, why get excited by a 13% annualized dividend yield when Tesla (NSDQ: TSLA) has is up nearly 400% over the past twelve months?
The answer, of course, is that Tesla does not pay a dividend and probably never will so long as Elon Musk is in charge. The same is true for Jeff Bezos at Amazon.com (NSDQ: AMZN), which is up 50% so far this year.
At the moment, the stock market has very little interest in value or income stocks. If you believe in the Wall Street adage to buy low and sell high, then now may be the perfect time to swap overvalued momentum stocks for undervalued income payers such as MLPs, BDCs, and REITs. Paradoxically, the coronavirus pandemic has provided a cure for the retiree’s dilemma.
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