Preview: The New Treasury Floating-Rate Note

floating-rate investment incomeFor bond investors who are  interested in variable-rate investments that increase interest payments as general interest rates rise, things should be getting a lot more interesting in the next few months.  The U.S. Treasury is scheduled to announce this month (November) the size of its initial January 2014 offering of new Floating-Rate Notes (FRNs). 

Overview

According to the Federal Register, the Treasury will be able to issue FRNs with maturities between one year and ten years.  The interest rate on these notes would effectively reset weekly based on the results from the weekly auction of 13-week Treasury bills.  The actual interest rates would be equal to the 13-week T-bill rate plus some “spread” amount.  Interest would accrue daily and be payable quarterly.  The Treasury is expected to issue no more than four FRNs per year.

Initial Offering

The initial January offering is expected to consist of $10-$15 billion of notes with 2-year maturities.  One of the key advantages of these notes is that they will have a minimum net yield of 0%.  This means that even if the Treasury allows T-bill auctions to result in negative interest rates, these notes will never be priced to reflect negative interest rates.  Individuals may purchase these notes through Treasury Direct with a $100 minimum. 

Outlook

I am expecting these notes to be very popular, especially if interest rates drift higher.  Banks (including foreign central banks) and corporate cash investors will be the dominant buyers, but individuals seeking a safe alternative to commercial floating-rate notes will also be buying.  Holding these notes will be a popular alternative to rolling T-bills, which may incur significant transaction costs.  The high demand for these notes will likely lead to relatively low yields (probably just slightly higher than the T-bills).  Like other safe, but lower-yielding products, these notes will be excellent vehicles in which to park cash or to use to ensure preservation of capital in a rising-rate environment.  Unfortunately, at least initially, the rates will still be too low to be attractive to most income investors.  When interest rates are a little higher, and the Treasury offers longer maturity floating-rate securities, those will most certainly be smart investments for income.

Income From Precious Metal Investments

gold silver investment incomeIn response to popular economic forecasts, many people are considering making investments in hard assets. A couple of weeks ago, PIMCO’s Bill Gross tweeted the following message to his followers:

Gross: w/ neg real intrest rates out to 20 yrs in US bond mkt, how wl investrs maintain purchasing powr? Stocks maybe. Real assets bettr bet

Real assets do sound good to me, but the question for income investors is whether or not there are viable ways to produce reliable income from real assets. Generating income from real estate and property investments is straightforward enough since they lend themselves to rental arrangements. But what about generating income from precious metal holdings?

Gold and silver holdings are often considered dead weight in a portfolio. They provide a good hedge against currency devaluation and inflation, but they do not produce income, and their financial benefits are not realized until after the hard assets themselves are actually sold. The next best thing to owning the physical metals would be to own securities that are closely linked to the value of precious metals. Even better would be to generate income from such securities. Be aware that various hair-brained schemes (and scams) to produce income from precious metal holdings have been attempted in the past (see here for example), but these have always ended with great disappointment and tears for investors. If you are interested in trying to squeeze some income from precious metal investments, consider these two more conventional ways of doing it.

Buy Gold and Silver Mining Stocks that Pay Dividends

As experienced investors will tell you, the price of a mining company’s stock is somewhat correlated to the price of the underlying metals that the company extracts, but the link is far from perfect. My own unscientific observation is that the share prices of mining companies are much more volatile than the prices of the metals themselves. Although the prices do not move completely in step with each other, shares of gold and silver mining companies should fare well during any period of inflation. A list of dividend-paying gold and silver mining companies can be found at this site.

Write Covered Calls Against GLD or SLV

The Gold (GLD) and Silver (SLV) ETFs track the price movements of their respective metals. Although bullion purists are skeptical about the ability of the ETF price-tracking mechanisms to continue to operate properly under extreme conditions, to date these ETFs appear to be working just fine. Both ETFs are optionable, and based on the open interest volumes and the relatively narrow bid-ask spreads, the markets for their options appear to be comfortably liquid for traders. If you have the required resources, and a conservative options income strategy appeals to you, you can generate monthly or weekly income by selling covered calls against these ETFs. I don’t consider this to be passive income since it does take some work, but it is better than no income at all. As with all options investing, do your homework and make sure market conditions are favorable for your strategy before acting.

Since generating income from real assets is a topic of increasing interest, I hope to update this post in the future as I discover other possible approaches that pass my “sensible and workable” criteria.

The Case for Equity Income Investments

Dividend incomeThe author Richard Stooker makes a compelling case for building portfolio income through equity investments. Although he comes down pretty hard against growth investing, the prudent investor will probably have no problem at all with the idea that at least some significant part of one’s portfolio should be devoted to current income production through equities. Stooker’s book is pretty good. Look for a link to it somewhere on this website. The following is from one of his articles:

Investing for Income — FAQ for Ordinary Investors

1. Dividends are so low, they’re a joke. Why should I invest for such a small return on my money?

If you buy only stocks in the Mergent index, you’ll get quality companies that have raised their dividends every year for at least 10 years — some of them for over 100 years.

Besides, dividends are no longer as small as they were during the peak of the dot com boom when the average S&P 500 stock paid under 1%. Thanks to the low stock market, you can pick up stocks that pay up to 8% or more.

2. What kinds of stock offer such high returns?

Brand name consumer stocks aren’t quite that high, but offer dependability and safety — such as Coca-Cola and McDonalds. Real estate investment trusts (REITs) are required to pay out over 90% of their cash. So are master limited partnerships (MLPs) — which transport oil and natural gas through pipelines. Utility companies are the traditional widows and orphans stocks, because they pay dividends and are so safe.

3. What if the economy goes into another Great Depression?

Every company would suffer, no doubt about it. And people would not be able to pay higher rents, they wouldn’t use as much electricity and they wouldn’t go out to eat as much. Companies that pay dividends might have to reduce them, or not raise them as much as they’d like.

However, unless a universal catastrophe sends the entire world back to the Stone Age (and if that happens, you won’t care about your stock portfolio’s performance anyway), people are still going to turn on electric lights, chew gum and buy hamburgers.

4. Everybody says that when you buy a stock and its price goes down, you’ve lost money. How can I avoid losing money?

Any stock you buy could go down in price at any time. Income investors don’t have to care, because they still receive quarterly checks.

5. Why shouldn’t I just put my money into an index fund?

If you insist on investing for capital gains, that’s the smartest way to do it. You can’t pick individual winners, so go with the broad market. However, index fund holders gained nothing from 1999 to mid-2008. And the future doesn’t look any better. Here’re some bad signs for the future:

1. Rising oil and other energy prices — with political unrest, war and possible war with Iran threatening to move the price of oil even higher.

2. Rising gold and silver prices.

3. The sinking U.S. dollar.

4. The baby boomer generation has started to retire, which will place enormous strains on the Social Security and Medicare trust funds, take experienced labor out of the economy and depress stock and bond prices as they sell off their portfolios.

5. Terrorists still want to convert the entire world to their version of Islam.

Index fund advocates say that in the long run the market will go up because our capitalist economy creates wealth. I support the sentiment, because I strongly support capitalism. I just don’t see any guarantees from God that capitalism will triumph, or that human progress has to continue.

We’ve seen a lot of scientific advancement, social progress and wealth creation over the past 500 years. But we’ve also seen periods of human history, such as the fall of the Roman Empire, where previous gains were erased — for hundreds of years.

If the terrorists succeed in setting off a nuclear bomb, it could be many decades before the U.S. stock market can rise above current levels.

I’m not going to say this is going to happen, but none of us has any guarantee it won’t.

6. Dividends are only for rich people who inherited a bunch of stock. I need to get rich in a hurry.

It’s true that you’re not going to receive a million dollars a year in dividend income unless you’re starting out with at least $20 million. However, investing is not — and never has been — a way to get rich quick. People who try it usually lose their money.

If you want to speed up the process, you must start a business of your own that solves problems for many people. If you think they’re shortcuts to such success, you’ll lose your money to the many con artists that prey on people like you.

7. The stock market is so low, and may go lower — I’m afraid of it. What should I do?

Realize that this is the best income investing opportunity to come along in a long time. Because stock prices are so low, there’re many opportunities to pick up brand names, utilities, Canadian income trusts, master limited partnerships and real estate investment trusts at bargain prices.

Now is the best time in years to lock in high — and ever-growing — dividend yields.

SUMMARY

With today’s financial markets as uncertain and unstable as they are, traditional buy and hold, and pick winning stocks, strategies don’t promise much return. You must rely on luck, and that’s not reliable over the long term. Stocks have gone nowhere since 1999. Yet people who invest for income have received regular quarterly dividends.

Best Ways to Get Income From Preferred Stock

preferred stock incomeJust as I don’t believe in holding the common shares of only one company in my portfolio, I don’t believe in buying the preferred stock of just one or two companies either. The more you rely on an income stream from preferred stock, the more reason you have to be mindful of diversifying to minimize risk. The down side of diversification for most individual investors, however, is the need to do a lot of research. I, for one, am willing to forgo a little (very little) return in order to save some personal time and not have to do so much research. If you are of the same mind, then maybe you should consider investing in preferred stock ETFs.

Unlike bond funds, which I generally don’t care for, the yields for some preferred stock ETFs are currently high enough that you actually do okay even after fund expenses are subtracted. If you can stand the high volatility usually associated with closed-end high-yield funds, you can start exploring these investment options by taking a look at these:

iShares S&P U.S. Preferred Stock Index (PFF), yield 5.89%

PowerShares Preferred ETF (PGX), yield 6.44%

SPDR Wells Fargo Preferred Stock (PSK), yield 6.3%

The holdings of all three of these funds are heavily weighted towards the financial sector, so if that makes your stomach turn, it’s probably a good idea for you to look elsewhere.

Alternative Real Estate Investments for Income

real estate investingSo you’ve designed an income portfolio containing a healthy mix of equity and debt instruments tailored to your personal situation and taking into account the current economic climate. Congratulations!

But wait – something is still bothering you.

After some thought you realize that all of the investments in your portfolio depend on the performance of the financial markets. Based on recent past experience you recall how these markets were actually quite correlated in their response to the financial shocks that hit a few years ago. Isn’t there a way to diversify a bit more and invest in income producing assets that are not so dependent on the financial markets? The answer is a resounding………maybe.

On the face of it, the price of real tangible assets like real estate and commodities would appear to be uncorrelated with stock valuations or interest rate fluctuations. However, common inter-market forces (e.g., significant changes to the value of the dollar), can affect both financial markets and the price of real assets at the same time. Assuming you find this bit of correlation acceptable, then real estate does present some possible income investments to explore.

Of course the most common real estate investment is to buy residential rental property (preferably at a deep discount) and generate income from the rent. The internet is full of resources to assist you in finding suitable properties. Here I want to mention some other types of real estate investments for income.

Agricultural Properties

Agricultural properties include farms that generate income. You can own and operate the farm for income yourself, or you can purchase property and just lease it to a farmer for the rental income. Good basic information on agricultural investments can be found here and here.

Forestry Assets

Forestry assets include timberland that provides raw materials for paper products, construction, and fuel. The primary driver for forestry investments is the fact that timber grows in physical size, giving owners exposure to financial growth that is independent of financial markets. In addition to income from timber sales, forest owners can derive additional income from hunting leases. Helpful information to jump start your research for these investments is located in Chapter 2 of this Forest Landowners’ Guide.  Forestry assets tend to be longer-term investments, but once established, the income is fairly secure.

Rural Land

Selective investing in rural land might also have potential income possibilities although much research is needed to make this kind of investment pan out. The most common way in the U.S. to derive income from raw land is to own property with a high probability of oil or natural gas reserves underneath, and to then lease the land to drillers. Another way to generate income is to buy rural land that has commercial potential (location, location, location!) and lease it. The website LandsofAmerica.com is a good resource for finding land properties.

Like every other investment class, these all come with their own sets of risks and rewards, so research is absolutely required, but a careful investor can be successful in diversifying an income portfolio by adding alternative real estate investments for income.