Friday, February 18, 2011

Dividend Machines, can you live on three percent?

If you have one million dollars to invest, you invest all of it for income, and that income is three percent, you will have $30,000 to live on. $30,000 income is probably not going to be enough to live on for most income investors.

Dividend machines alone will not make your retirement. As an income investor, you need a cash flow strategy that includes more than just dividend machines. Some of your investments will be in instruments that provide less than 3 percent cash flow but will have more income possibilities. For instance, covered call income can produce ten percent income streams or sometimes even more.

Bunge, symbol BG is a good example of income potential. In a previous post, I talked about buying BG and the price at the time was about $66.75. Today BG is about $74 a share. BG pays a 1.75 percent dividend yield therefore BG qualifies as an income investment. The real income comes from selling covered calls. Today you could sell a covered call that expires in April. The strike price is $80 and the call income is $1.20 per share. When you combine the income from the call, the dividend, and the gain you will receive if the call buyer takes your stock at $80, your return is nearly 22 percent.

Income investors need to figure out how much income they need from the portion of their investment portfolio dedicated to investment income. Once that chore is accomplished a cash flow strategy is developed that will include companies that pay income to its investors in the form of dividends and have a chance to get covered call income. Work backwards from this calculation. What percent of your investments can be in safe dividend machines at 3 percent? What percent do you need from the rest to create the cash flow you need?

Real estate is another idea. While real estate is beyond the scope of this blog, you can learn a lesson from an experienced income investor. Invest in real estate that pays you more in income than it costs to operate the investment. So many investors made the mistake of getting into too much debt buying property that did not give a positive cash flow. Now they are underwater and have to decide to walk away or put more money into the property until prices recover enough to either sell the property or find tenants that will pay enough that the cash flow is positive.

It all comes back to one of my most important rules. Invest in something that creates investment income. Dividend machines are one piece of the picture but not the only piece. However, investing for income means just that. Every investment should produce cash flow.

Remember this very important rule.

Very Truly Yours,