Anyone with money to invest in 2011 already knows that putting the money into a bank account will provide safety but no return. CD’s are paying very little, and money market funds pay even less. Five year US Treasury bonds pay just a bit over 2%. So that leaves us with the question of where to get return on your money for 2011. Here are a few choices together with their plusses and minuses.
First, buy stock in Business Development Companies (known as BDC’s). These are companies that make loans to lesser credits and get compensation other than just interest in return. For example, some borrowers provide equity interests as well as interest on the loans. Companies like Apollo Investments (AINV) and Ares Capital (ARCC) pay dividends in the area of 8-10%. In addition, the stocks have options, so their yield can be increased and their risk reduced through the sale of covered calls. Ares close on Thursday at $16.73 and it pays a dividend of 35 cents per quarter. (Note that these are unqualified dividends and they change over time more frequently than industrial corporations.) Selling the February 17 calls would probably take in 45 cents, a move that would up the return on the stock by another 15% while leaving a small bit of room for further capital appreciation as well.
A second place to invest is in mortgage REITs. The best of breed here in my opinion are Annaly Capital management (NLY)and Invesco Mortgage Capital (IVR). The companies borrow mostly using short term funds and buy mortgage backed securities (mostly from agencies backed by the federal government). I would stick only to those companies which buy only agency debt – there is no need to take the risk on the mortgage backed securities. Since short term rates are unlikely to go up in the short term (unless the Fed has a major change of heart), the biggest risk to these companies has been almost eliminated. Another risk for these companies, a spike in the refinancing of mortgages, has also been greatly reduced due to the recent rise in longer term rates. Again, both NLY and IVR have options, so covered calls can be used to increase yields and reduce risk. The premiums on the options are a bit less than those on the BDC’s, but they are still worth using. For example, with NLY at 17.85 at the close on Thursday, the April 18 calls would bring in about 48 cents.
A third place to generate yield is by investing in Municipal bond closed end funds. I wrote about these funds – called Muni CEFs – on September 30 and November 12th. You can get the full discussion there. With the recent rise of the fear of defaults by certain municipal borrowers, rates have increased to a point where these funds now yield 7-8% tax free. One caveat: unless you buy a state specific fund (of which there are many), the return is tax free from federal income taxes but not state or local income taxes. Also, for anyone who is subject to the Alternative Minimum Tax, some portion of the return could be hit by that tax, so you need to check out the characteristics of the fund that you are buying before you purchase it. For someone in the 25% tax bracket, 7.5% tax free is the same as 10% on a taxable investment. My favorite Muni CEF at the moment (and it changes daily) is the Invesco Van Kampen Trust for Investment Grade Municipals (Symbol VGM). It is paying 8.09 % and it is selling at a discount to net asset value. Of course, if the municipal market really does get hit by many defaults this year, this area could see a decline in the value of all muni bonds to take the increased risk of default into consideration.
A fourth place to generate yield is in natural resource royalty trusts. Examples of these are San Juan Basin royalty Trust (SJT) which gets royalties on the production of certain natural gas wells and BP Prudhoe Bay Royalty Trust (BPT) which gets revenue from the production of oil on the North Slope of Alaska. These are currently paying about 8% and they come with substantial tax benefits that make current income either totally tax deferred or close to it. Of course, when the trust stock is sold, the tax will be due at that point. These trusts also have options which can again be used to increase yield and reduce risk.
One more place to get yield is by buying stocks which have been paying dividends consistently for years while increasing the amount of the dividend over time. My favorite in this category is a stock that anyone who reads this blog has heard much about: Armanino Foods of Distinction (AMNF on the Pink Sheets). Armanino is selling at 74 cents per share and it pays a regular dividend of 4 cents per year for a yield of 5.4%. Almost every year, however, the company also pays a special dividend which further ups the yield. In addition, the company is on a winning streak, setting records for earnings and revenues almost every quarter. Over the last year, the stock price has gone up by more than 50%.
There are, of course, many other options for getting increased yield from one’s portfolio. These are just a few that I like. It is important to keep in mind that none of these methods are meant to be used exclusively. You want to employ a mix of many different types of methods in order to use diversity to reduce risk. In addition, these are investment methods that require one to pay attention to them every day. These are not like CD’s; things change, and you need to react appropriately.
Disclosure: I have used all of these methods myself over the years. At the moment, I am invested in all of them except for the natural resource royalty trusts which I do not use since my energy and metals investments are through other vehicles.
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