Some Things Get Better With Age

Some things get better with age. Wine, whiskey, a properly humidified cigar…

Other things… not so much. Take my knees and rotator cuffs, for example. Against all better judgment, I joined an over-40 men’s basketball league, and we had a game last night. We won… and it was a blast. But I’m really wishing I had iced my knees and shoulders after the game. I’m feeling it this morning.

It was worth it. But rather that focusing on my decrepit knees, I’d rather add other item to the list of things that actually get better with time: dividend growth stocks.

I enjoy a high yield as much as the next guy. But focusing exclusively on yield exposes you to the very real risk of losing ground to inflation over time.

The Fed’s goal is to keep inflation at around 2%. Now, we could split hairs about their calculation methods, and I think it’s fair to say that the “real” inflation rate experienced by most Americans is significantly higher than that. But let’s be generous and pretend the Fed’s 2% inflation target is reality.

Like interest, inflation compounds. So, over 10 years at 2% inflation, your purchasing power will decline by 22%. Over 20 years, it’s nearly 50%.

We’re talking about losing half your purchasing power over 20 years… even under a wildly conservative estimate of inflation.

So, bonds, preferred stock and high-yield (but no-growth) dividend stocks might pay you a fantastic income stream today. But over the course of a retirement, you run the real risk of having your retirement standard of living degraded.

Now, let’s compare that with a proper dividend growth stock.

Realty Income (O) is a REIT specializing in high-traffic retail. Think the local gas station or pharmacy.

The REIT generally raises its dividend 4% to 5% per year, and it’s working on a string of 89 consecutive quarterly dividends hikes.

Realty Income is not a particularly high yielder at today’s prices. It’s dividend yield is a modest 3.8%. But let’s imagine you bought the REIT five years ago. Your yield on cost (or the annual dividend today divided by your original purchase price) would be a much more attractive 5.7%.

Now let’s pretend you bought Realty Income 10 years ago. Your yield on cost would be a whopping 11.9%.

Now let’s get really crazy and assume you bought Realty Income 20 years ago. Your yield on cost would be a gargantuan 22.4%.

Yes, you’d be making more than 22 cents per year for every dollar you invested in Realty Income. That’s the power of dividend growth.

I’m not recommending you go run out and buy Realty Income today. Personally, I think the shares are a little too expensive to justify buying with new money. I’d recommend waiting for a significant pullback.

But I bring this up to show you that there’s more to income investing than simply grabbing the highest yield you can find. I even have a name for that. I call it “yield whoring,” and I consider it a vice that’s detrimental to your financial health.

A good income portfolio should have a mix of high-yielding investments and lower-yielding but faster-growing dividend stocks. Ultimately, it’s the only way you’ll stay ahead of inflation in a long retirement.

10 High-Yield Monthly Dividend Stocks to Buy in 2020

The following is an excerpt from 10 High-Yield Monthly Dividend Stocks to Buy in 2020, originally published by Kiplinger’s.

The typical American’s life tends to be organized around monthly payments, yet somehow, monthly dividend stocks are the exception, not the norm.

Your mortgage, your car payment, your phone bill … even your Netflix payment is on a regular monthly payment plan. That’s perfectly fine when you’re working and are used to getting one or two paychecks every month. Budgeting is simply a matter of making sure your regular monthly income covers your monthly expenses with a little left over for emergencies.

But once you retire, the situation changes. Sure, the Social Security check still comes monthly, and if you’re lucky enough to still get a pension, your income generally comes in monthly as well. But the payout from the vast majority of your investments tends to be a lot more sporadic. Most stocks pay their dividends quarterly, and most bonds pay interest only semiannually.

“Cash flow mismatch is a common problem for recent retirees of all income levels,” says Mario Randholm, founder of alternative investments specialist Randholm & Co. “And the cash drag from keeping more cash on hand to compensate for erratic income reduces long-term returns.”

High-yield monthly dividend stocks can be part of the solution. Stocks that pay monthly dividends better align your income to your spending.

You shouldn’t buy a stock simply because it pays a monthly dividend, of course. That would be as ridiculous as choosing a mortgage bank based on the specific day of the month your payment would be due. Clearly, the stock needs to meet your criteria for yield, quality or growth prospects. But if a stock checks all the right boxes, why not also enjoy a monthly payout?

Here, we’ll look at 10 high-yield monthly dividend stocks to buy in 2020.

Let’s start with Main Street Capital (MAIN), a blue-chip business development company (BDC). Main Street provides debt and equity capital to middle market companies that are generally too large to go to the local banks for capital, but not quite large enough to do a proper stock or bond offering.

The capital Main Street provides typically is used to support management buyouts, recapitalizations, growth investments, refinancings or acquisitions.

BDCs are similar to real estate investment trusts (REITs) in that they are required to pay out substantially all of their earnings in the form of dividends. This is good news for income investors, of course, as many BDCs end up being high-yield dividend stocks, some of which pay monthly.

But there is one downside: It can be difficult to maintain a steady payout when you can’t keep extra cash on hand. For this reason, many BDCs end up having to cut their dividends after a slow quarter or two.

That’s obviously upsetting to investors. However, Main Street avoids this problem by keeping its regular dividend comparatively low and then topping it off twice per year with special dividends that can be thought of as “bonuses.” This makes it among the most conservatively managed high-yield monthly dividend stocks to buy, but shareholders aren’t complaining.

At current prices, Main Street yields an attractive 5.7%. The special dividends over the past 12 months have added an extra 1.2% for a total yield of about 7%. That’s far from shabby.

To finish reading, please see 10 High-Yield Monthly Dividend Stocks to Buy in 2020.

Rules for a Trade-Up House

I’ll admit I have houses on my mind these days.

After seeing my friend Alan’s new home – complete with its four-car garage and Hugh Hefner grotto – my wife is bugging me to upgrade. And while I’m not crazy about taking on a major new expense, she makes valid points. Our two boys are the proverbial bulls in a China shop, and they’ve pretty well trashed our existing place. So even if I don’t buy a new house, I’m probably looking at tens of thousands of dollars in repairs and remodeling. And a little extra square footage wouldn’t be a bad thing.

We’ll see. If the right house comes along at the right price, I’ll likely join the millions of my predecessors that got suckered in the trade-up game. Or, I might resist the urge and continue on in my broken-down hovel for another couple years.

This brings up some questions on when and how to trade up. Last week, I really drove home the point that your house is not an asset. It’s an expense and should be viewed as such.

So, today we’re going to continue this conversation. We’ll call it “The Rich Investor’s rules for upgrading your house.”

Rule #1: Retire with a Paid-Off House

I consider this rule the single most important to your financial wellbeing. You do not want to start your retirement with the responsibility of a mortgage.

Once you’re retired, your income stops. You no longer have the ability to work overtime or earn that year-end bonus that helps you wipe the credit card balance clean. You have to live off of Social Security and off of whatever dividends and income your portfolio throws off.

Your expenses in retirement will be higher than you planned. It’s inevitable. And if you let your expenses get out of control early in retirement, you risk depleting your assets and then being forced to move in with your kids later. So, do whatever you need to do to ensure your mortgage is paid off before you retire. That potentially frees up several thousand dollars per month and gives you more flexibility.

So, if you’re thinking of upgrading, do the math. If you’re 45 and planning to retire at 65, will you be able to pay off your trade-up home in 20 years?

If that’s not realistic, then don’t upgrade or do so with a cheaper house. That beautiful home with the perfectly manicured lawn might be a trophy at 45, but at 65 it will be an albatross around your neck.

Rule #2: The Three-Year Rule

This rule is a bit more extreme, but I like it. I have a colleague in Houston that runs a large wealth management practice, and his rule for a trade-up home is simple: If you can’t pay it off in three years, don’t buy it.

The Three-Year Rule is obviously unrealistic for the young couple struggling to save for a down payment on their starter house. But that’s just it. We’re not talking about your starter house. We’re talking about an optional upgrade that you might want but that you certainly don’t need.

It’s important to note that you don’t necessarily have to pay off the house in three years. You just need to be able to pay it off in three. If you choose to keep the mortgage and invest your cash somewhere more profitable or stash it in a 401(k) or IRA, that’s perfectly fine. The Three-Year Rule is more about setting a practical spending limit than on keeping a specific timeline.

Rule #3: Watch Out For Taxes and Expenses

Let’s say you’re disciplined and get your mortgage paid off. Good for you! That’s a major financial milestone.

But your homeowner expenses don’t stop with the mortgage. You also have to pay property taxes, insurance, maintenance and possibly more frivolous things like HOA dues and landscaping.

So, consider your neighborhood closely. If your kids are already out of high school, paying the property-tax premium for a house in a good school district might not be necessary.

Likewise, some houses are far more expensive to insure than others due to their proximity to flood zones. And some neighborhoods have outrageously high HOA dues that are used to pay for services you might not want or need.

You might be able to skimp a little on maintenance, cleaning and landscaping. But once you’re moved in, you’re stuck paying taxes, insurance and HOA dues for as long as you own the property. So, be sure to take those numbers into consideration before you buy.

There’s nothing wrong with splurging on your dream home. It’s your money, and you only live once. But if you bite off more than you can chew, that dream home is going to end up being a financial nightmare for you.

Best Stocks for 2020: Energy Transfer Is Poised for an Epic Rally

The following was originally published on InvestorPlace as part of the Best Stocks for 2020 contest.

They say lightning never strikes twice. But that’s exactly what I’m betting on in InvestorPlace’s Best Stocks for 2020 contest.

Four years ago, in the 2016 contest, I recommended leading midstream pipeline operator Energy Transfer (ET). It was a controversial pick, as the energy sector was in free fall at the time. The fracking boom had created a surge in domestic oil and gas production, and the resulting drop in prices showed just how fragile the industry was.

As Warren Buffett once said, it’s not until the tide goes out that you can see who was swimming naked. And once energy prices crashed, it became very obvious that a good chunk of the energy infrastructure industry was swimming in its birthday suit. 

Today, as in late 2015, Energy Transfer finds its shares under attack.

Energy Transfer’s share price is nearly 40% below its post-oil bust highs and is trading at levels last seen in 2013.

To finish reading the article, see Best Stocks for 2020: Energy Transfer Is Poised for an Epic Rally.

Don’t Chase Yield

When looking at low-priced stocks, how can you tell the difference between solid value stocks and the dreaded value traps?

The answer: value stocks eventually recover, while value traps do not.

I realize that my answer is no more useful than Will Rogers’ advice — “Buy stocks that go up; if they don’t go up, don’t buy them” — and that is precisely my point.

Identifying value traps ahead of time isn’t easy.

Value traps are stocks that look cheap on paper. But rather than eventually recover to a “normal” price, they just perpetually stay cheap, or even get cheaper.

There are any number of reasons why a company becomes a value trap.

The Change into a Value Trap

Perhaps the company has an entrenched board of directors that is eroding company value.

Or perhaps a founding family has a stranglehold on the company and won’t let go.

More often than not, stocks become value traps due to crumbling fundamentals. The stock price may look cheap, but that’s only because the lousy financial results haven’t been released and the price is accurately anticipating the worst.

In the income world, value traps tend to take a very specific form, and it’s only gotten worse after nearly two decades of exceptionally loose monetary policy.

I’m referring to yield chasing.

If a 5% yield looks attractive, then surely a 10% yield is twice as attractive!

Well, it could be.

Those kinds of opportunities do pop up from time to time, and I look for them in Peak Incomeevery month. But if something looks too good to be true, you can bet that it likely is.

The numbers back this up.

Dartmouth Professor Kenneth French broke the market down into six sub-portfolios: stocks that don’t pay a dividend and then five quintiles ranked by dividend yield. He calculated the returns on each of these six buckets going back to 1928.

No DividendLowest Dividend QuintileSecond Lowest Dividend QuintileMedian Dividend QuintileSecond Highest Dividend QuintileHighest Dividend Quintile
Annualized Return8.49%8.90%9.82%9.60%11.53%10.54%
Standard Deviation33.14%22.62%19.14%20.57%20.97%23.81%
Growth of $1 $1,671 $2,546 $4,580 $5,117 $21,610 $9,757

Not surprisingly, stocks without dividends had the lowest returns and the highest volatility. Non-paying stocks are often garbage and have garbage returns.

This is where it gets interesting…

The best-performing stocks aren’t actually the highest yielding ones. That distinction belongs to the next quintile down.

The highest-yielding stocks actually had lower returns and higher volatility than the next quintile down.

So, high-yield stocks — but not highest-yield stocks — tend to be the best performers over time.

Why Is the Yield So High?

As investors, we’re drawn to high yields like moths to a flame.

But incredibly appealing high dividends are generally only made possible by one of the following scenarios:

  1. The stock pays out substantially all of its income in dividends and there is no possibility of significant growth. This is often true of tobacco stocks.
  2. The stock is highly leveraged and, thus, at risk to any unexpected shifts in Fed policy. Closed-end funds and mortgage REITs can fall into this trap.
  3. The stock is paying out a “return of capital” in addition to the regular dividend, or simply returning your original investment back to you. This is common with certain oil and gas trusts.
  4. The market is pricing in a steep dividend cut and the current high yield you see is about to go up in smoke. This is a typical red flag for companies in distress.

The first, second, and third situations aren’t necessarily bad so long as you know what you’re getting into. You’ll likely lose ground to inflation over time, and that is a legitimate concern. But it’s not philosophically different than a bond.

It’s the fourth situation you really need to watch out for.

When you see an abnormally higher dividend on a stock… beware. There are times when the market just flat-out gets it wrong and a high-yielding stock is a bargain. But, more often than not, a high and rising yield is a sign of distress.

So, if you question whether a company’s dividend yield might be too high and signaling trouble ahead, a quick-and-dirty first step of your analysis should be to simply look at its dividend yield over time. If the current yield is significantly higher than in years past, something is likely amiss.

You should also give the dividend payout ratio a look.

The dividend payout ratio is the percentage of the company’s profits that it pays out in dividends. For example, if a company earns $1.00 per share and pays a dividend of $0.80 per share, its payout ratio is 80%.

As a general rule, the lower the payout ratio the better because it means the company has more of a cushion. A company payout out 100% of its earnings as dividends leaves no cash on hand for growth projects or for emergencies.

As a general rule, I like to see a payout ratio of 70% or less.

There are some caveats to this, however.

Sometimes a company has larger-than-usual write-offs that cause its earnings to get depressed in the short-term. This can make the payout ratio look abnormally high.

So, if you’re evaluating a company and you see that its payout ratio is getting awfully close to 100% (or even higher than 100%), do a little extra digging to see if the company had some sort of temporary setback. If it looks reasonable to assume that earnings will be high enough in the coming quarters to more than cover the dividend, don’t sweat it.

Also, certain types of stocks have quirky accounting that makes the payout ratio meaningless. For example, REITs and MLPs both have exceptionally high depreciation charges that depress their earnings on paper but don’t actually burn any cash. When analyzing these kinds of stocks, you’ll need to do a little extra digging. But for your typical stock, the dividend payout ratio is a simple metric to gauge how safe the dividend is, and the ratio is usually calculated for you on popular financial sites like Yahoo Finance or MarketWatch.

There’s a lot to digest here. But here’s the gist of it: Ignore the siren song of high yields when it comes to mainstream stocks and look for sustainable and, preferably, growing dividends instead.

It requires a little patience, but it’s more likely to give you safety in retirement.