I
write this blog because I want to share a simple income investing approach. Retirement
account portfolios built for income can maximize yield to the account holder
when they use these three securities:
When using this approach in a taxable account, taxes
will reduce the yield of the portfolios tracked in this blog.
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Corporate
Bonds:
If you could put all your money in a portfolio of laddered,
government guaranteed bonds and have enough money to live on, you would own the
perfect low risk income stream.
In today’s market, that is not feasible unless you can live on about a three
percent yield. A million dollars will generate $30,000 per year. Therefore, if you need more yield, you take
on more risk and therefore the yield from your corporate bonds must beat the 10
year U.S. treasury and yet he coupon must be very safe, and the principle must
be very safe.
Five Bond Selection Guidelines
They key to corporate bonds is to buy at par or less. If you paid $100, which is typically par, for a bond with a 7 year maturity date, your $100 will be worth around $80 when the bond matures. If you paid $110 for the bond just to get more current yield, your $110 investment turns into a mere $80. This is not good investing.
Five Bond Selection Guidelines
- D/E ratio of issuer within industry average
- Bond Rating greater than C
- Price par or better
- Laddered Maturity Dates
- Yield greater than U.S. Treasury of similar maturity
They key to corporate bonds is to buy at par or less. If you paid $100, which is typically par, for a bond with a 7 year maturity date, your $100 will be worth around $80 when the bond matures. If you paid $110 for the bond just to get more current yield, your $110 investment turns into a mere $80. This is not good investing.
Ladder the maturities.
Interest rates will be increasing, and this could go on for 20
years. If you buy a bond today that
matures in 20 years not only will your principle erode due to inflation, your
yield will be fixed. Even the value of
your income will be less.
And, the value of your bond will not improve if new bonds
are issued with higher interest rates.
Keep the maturities in the 5 -7 year range and ladder them every 3-6
months.
Dividend
Stocks:
Dividend Stocks make up for the limitations from corporate
bond or U.S. Treasury bond income.
Dividend stocks can provide income, income growth and principle growth. Dividend stocks can also suffer losses of
both income and principle and that means you need to pick your dividend stocks
carefully.
I use a set of criteria to pick dividend stocks. No strategy is perfect but this one is
working out well.
Guidelines for Picking Dividend Stocks.
- EPS, earnings per share, greater than dividend paid out
- Dividend yield greater than 2 year U.S. Treasury
- Consistent Dividend Increases equal to or greater than inflation
- Positive Revenue Trend
- D/E, debt to equity ratio, less than 1 or within industry standard
Covered
Call Options:
Stock options are a derivative. I do not trade stock options. I do sell, also known as write, calls on my
dividend stocks. Selling call options on
my stocks obligates me to sell my shares at the strike if the call buyer so
desires. However, 90% of call options
expire without being exercised. That
means I pocket the money they paid me for the option to buy my shares.
Guidelines for Picking a Call Option.
Guidelines for Picking a Call Option.
- Strike price 8% greater than basis
- Call premium greater than 1% of basis
- Total Potential Gain greater than 10%
- Expiration Date after next ex-dividend date
Nothing is perfect, and it is not uncommon when the call
buyer does exercise their right to buy your shares, the stock price has moved
up and you get “seller’s” remorse because you you’re your stock at the time it
is a winner. This is called loss of
upside potential. It happens but not enough
to make the strategy of selling call options on dividend stocks worthwhile.
I also tracked some of my covered call portfolios, you can
find them in the “Portfolios” tab under 2016 and 2018 call portfolios.
Will you still feel financially secure in ten years?
My Strategy is based on a simple fact; to be financially secure you need income. When you need income, you should buy investments that pay income. I have tested this theory over time and I know that investments that create income should be the major portion of every income investors' portfolio.
Income from your investments must increase over time to keep up with inflation. Do not listen to inflation statistics. Think back to the cost of your first car or the rent on your first apartment and you will agree that to pay for your next car and your future housing, your income must constantly increase. Even when you own your own home free and clear the cost of maintenance, taxes, will go up over time. The point of The Money Madam’s strategy is to invest in stocks that increase your income over time. Sell calls on certain dividend stocks to pocket more income as stocks go up. Ladder your bond yields and maturities so your fixed income increases as your buy new bonds with higher coupons.
More Control at less cost.
Investors will reap other benefits by using this income investing strategy. When you manage your income sources by yourself, you have more control, more safety and it costs less.
With these principles in mind, I believe over time you will achieve income investing success if you buy dividend producing stocks, solid bonds, and for the more sophisticated investor, sell covered calls on these companies.
Will you still feel financially secure in ten years?
My Strategy is based on a simple fact; to be financially secure you need income. When you need income, you should buy investments that pay income. I have tested this theory over time and I know that investments that create income should be the major portion of every income investors' portfolio.
Income from your investments must increase over time to keep up with inflation. Do not listen to inflation statistics. Think back to the cost of your first car or the rent on your first apartment and you will agree that to pay for your next car and your future housing, your income must constantly increase. Even when you own your own home free and clear the cost of maintenance, taxes, will go up over time. The point of The Money Madam’s strategy is to invest in stocks that increase your income over time. Sell calls on certain dividend stocks to pocket more income as stocks go up. Ladder your bond yields and maturities so your fixed income increases as your buy new bonds with higher coupons.
More Control at less cost.
Investors will reap other benefits by using this income investing strategy. When you manage your income sources by yourself, you have more control, more safety and it costs less.
With these principles in mind, I believe over time you will achieve income investing success if you buy dividend producing stocks, solid bonds, and for the more sophisticated investor, sell covered calls on these companies.
M* MONEY MADAM
Municipal bonds, Real estate
investments and Preferred Stocks are not covered in this web/blog. Using
stock dividends, bond interest and covered call income to create income have
tax implications that make any qualified retirement account the account of
choice.
