by Richard Band | March 31, 2009 4:32 am
These are perilous times for retirees and other folks who rely on investment income[1] to cover living expenses. On one side, we’ve got the Federal Reserve trying to hammer interest rates into the ground. Who can make ends meet on Treasury bills paying 0.2% a year?
At the same time, corporations are slashing dividends and defaulting on bonds at an alarming pace. It’s no fun swapping out of Treasuries only to find that the “higher yield” you thought you were earning elsewhere has suddenly evaporated.
Here’s the solution I’ve worked out: Divide your income-producing assets[2] into three buckets:
Your primary goal here is to make sure you get your principal back, whenever you need it, with a modest income cherry on top.
For this purpose, I continue to give pride of place to FDIC-insured bank money market accounts. Some smaller local institutions (credit unions, in particular) offer excellent rates.
For most of us, though, the best option is to open an account with an Internet-based outfit like GMAC Bank (www.gmacbank.com[3] or 866/246-2265). GMAC Bank’s online savings account is paying 2.5%. Minimum deposit: $1. (Discover more ways to profit despite the gyrating Dow[4] here.)
You might be wondering how safe I consider the FDIC to be.
Answer: Very safe. It’s true, of course, that a rash of large bank failures could deplete the agency’s reserves. However, Congress is well aware of the FDIC’s crucial role in preserving confidence in the banking system. Sen. Christopher Dodd, chairman of the Senate Banking Committee, recently introduced a bill to let the FDIC borrow up to $500 billion from the Treasury in a pinch. I think the bill would pass in a heartbeat if the necessity arose.
Get six tips for weathering the financial storm[5] here.
Your second bucket should be at least as big as #1 and bigger than #3.
Here, you’re taking a bit more risk in search of higher income and some capital appreciation as well. Over time, companies that steadily increase their dividends tend to be rewarded with a rising share price, creating a favorable total return.
The trick, as we’ve been vividly reminded of late, is to pinpoint businesses that will live up to their billing as dividend champions. McDonald’s (MCD[6]) is certainly one with a 3.71% yield. Procter & Gamble (PG[7]) is another with a safe 3.38% yield, while Sysco (SYY[8]) is paying 4.21%. (Get details on 5 recession-proof stocks to buy now[9] here.)
The third bucket is reserved for aggressive investments (7%, 8% and higher yield) that can help furnish life’s little extras — the Caribbean cruise you’ve been hankering for, the car with the leather interior, the sparkling new kitchen.
In today’s market, a yield above 7% for a stock (or a bond[10]) often signals some kind of distress. Not always, though.
A few investments feature what I call an “outsized” yield because of a misunderstanding. Wall Street is confusing them with other, superficially similar investments that carry much greater risk.
Right now, for example, investors are skittish about real estate. The average real estate investment trust (REIT) has cratered almost 75% since February 2007.
Is this enormous markdown justified?
In many cases, yes. However, I know of one conservatively financed REIT whose preferred shares are yielding close to 10%.
These preferreds are entitled to their full dividend before the common shareholders of the REIT get a penny of dividends.
Furthermore, if financial problems should force the issuer temporarily to suspend the preferred dividend, all back dividends would have to be paid to the preferred shareholders before the common shareholders could receive anything.
Best of all, the REIT is generating enough cash flow to pay the preferred dividends four times over. To me, that’s a very substantial margin of safety.
The REIT I’m talking about is Public Storage, which owns and operates the ubiquitous self-storage centers with the orange sign.
Founder/Chairman B. Wayne Hughes, in charge since 1972, insists on low levels of debt — an important source of security for both common and preferred shareholders. Self-storage is also a fairly recession-resistant business[11]; occupancy at Public Storage’s facilities held at 87.8% on December 31, 2008, down only 0.6% from a year earlier.
Public Storage has 17 different series of preferred stock outstanding, but all enjoy the same priority claim on the company’s cash flow. Thus, you should generally buy whatever issue happens to be priced at the highest yield on the day you place your order.
(For a list of all the Public Storage preferreds, visit www.publicstorage.com[12] and click on the Form 10-K under Investor Relations.)
Join Profitable Investing risk-free today[13], and read the April issue immediately online. Inside, you’ll get complete details on all of the income-generating investments covered today, including the Public Storage series preferred with the most active trading market that Richard is recommending to his Profitable Investing subscribers. Plus, you’ll also receive immediate online access to Richard’s newest stock report, 5 Top Income Stocks for 2009[14].
Dividend Stocks[15]
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