Tahoe-Truckee Market Beat: Investing risks vs. rewards
Investing for current income in this environment can be a difficult task given the record low interest rates.
Conservative investors have a very difficult time finding good yields without taking on too much risk. Stretching for yield or reaching for yield can produce some disastrous consequences if too much risk is taken on in doing so.
Many investors who would normally purchase bonds in times of normal interest rates have shifted funds into dividend paying stocks as a way to maintain their income.
There are many strategies investors can use to find good dividend paying stocks. A little research can help narrow the list to companies with solid fundamentals.
I think it’s important when scanning for dividend stocks to not just try to locate the issues with the highest dividend yield. If you do that you are likely to end with a list of companies that could very well cut their dividend in the future.
Another common strategy is to seek out companies who have a long term history of raising their cash dividends.
Standard and Poor’s puts out a list of stocks that have been raising their dividends for at least twenty five consecutive years. They’re called the Dividend Aristocrats; it’s a good group of companies, but it is a long term strategy.
Investors who purchase the Aristocrats should plan on holding them many years for capital appreciation and future dividend hikes. The current yield on the Aristocrats is not that high.
One metric worth considering when evaluating dividend paying stocks is the “price to free cash flow yield.” This way you’ll find stocks that have adequate cash flow to maintain or even increase their dividend payment.
By looking at the price to free cash flow yield you can calculate the “headroom” and determine how much cash they generate above and beyond the current payout.
A viable income strategy is to combine covered calls with dividend paying stocks and ETFS. There’s serious academic research that shows that call writing can enhance returns, provide cash flow and lower volatility. Options are not suitable for all investors and it’s important to understand how they work and the risks involved in using them.
Education is very important if you’re thinking about building a high income portfolio; understand the various risks and the potential rewards.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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