Update: Income from Gold and Silver

investment income from precious metalsHere’s an update to the post I wrote last August on Income from Precious Metal Investments. In that post I mentioned that one possible strategy for deriving income from gold and silver was to write covered calls against investments in GLD and SLV. Well, it looks like someone else was thinking the same thing.

Since October 2012, gold and silver prices have gotten hammered (I wonder what Ron Paul’s portfolio looks like now!).  During this negative environment for precious metals, Credit Suisse launched a couple of exchange-traded notes (ETNs) that employ a covered call strategy to provide an income yield for underlying gold and silver holdings. GLDI was launched in January with a strategy to sell covered calls against GLD, and SLVO was launched in April to do the same for SLV. Although performance of these ETNs has been less than stellar so far, these products are still new and probably worth watching as possible investments for income.

My personal view is that these products are still unproven, and their risks should be considered carefully by potential investors. In addition to the concern I mentioned in the previous post about GLD and SLV being able to accurately reflect the price changes for the metals in all market conditions, there is also the uncertainty of Credit Suisse being able to back up the ETNs in all market conditions. I’m also a little concerned that the timing of these product launches may not be the best. Covered call strategies that involve selling and then buying back out-of-the-money calls from month to month are usually optimal when the prices for the underlying securities are flat or slightly bearish. In times when prices are rising significantly, the strategy gets tricky. Simply owning the underlying securities and foregoing the call income would usually maximize overall returns in a bullish situation, but of course then you would receive no income.

Over the past month (May 2013), we’ve seen long-term interest rates starting to creep up. If this turns out to be a precursor to the long-awaited inflationary cycle, then a covered call strategy for precious metals may not be the best strategy to pursue right now since gold and silver prices would also be expected to rise substantially. If, on the other hand, you believe that prices for gold and silver will remain relatively flat for some time, then these ETNs may prove to be smart investments for your income portfolio.

Are MLPs the Perfect Income Investment?

MLP Master Limited PartnershipMaster Limited Partnerships (MLPs) have been popular investments for income portfolios for the past couple decades, but over the past year there has been a noticeable push to promote these investments to a greater number of individual investors.  Everyone from Jim Cramer to Barron’s to the Motley Fool seem to have concluded that owning partnership units are the closest thing to a perfect investment as one can make for an income portfolio.  But are these investments too good to be true?

The basics of MLPs are explained pretty well at Investopedia and others websites.  The MLP world consists primarily of groups engaged in natural resource activities, notably oil and gas pipeline operations.  Because of the way they are structured and the tax-favored treatment they receive, MLPs are able to offer investors attractive high-yield returns.  Unlike regular dividends, the distributions from MLPs are treated as a combination of income and return of capital.  Many investors (myself included) are turned off by the paperwork and recordkeeping needed for tax purposes.  Partnerships are considered pass-through entities, so, as a unitholder, you are obligated to pay your share of the taxes for a partnership’s income.  Instead of 1099s, you would receive K-1 forms annually for your holdings.  The recordkeeping becomes even more involved if you hold these investments in a retirement account.  Understand the tax implications before investing in these entities. 

MLPs have bounced back nicely from the 2008 debacle, and earlier this month they actually looked overpriced.  Over the past week though (I’m writing this in late-May 2013), there has been a significant correction in the sector, so prices appear a little more palatable.  As with any high-yielding investment, these investments are sensitive to interest rate changes, so I would advise watching these investments closely going forward.

One way to bypass the tax headaches for these investments would be to invest in an MLP fund or ETF like AMLP or EMLP.  Before investing, I would run the numbers to make sure the fund expenses and fees are worth the return and income you are seeking.  If they are, then these may be smart investments for your income portfolio.

Smarter Bond Investing With Defined Maturity Funds

Defined-maturity fundsTwo popular ways to hold bonds in a portfolio are 1) to hold a collection of individual bonds or 2) to own shares of one or more bond funds. There are advantages and disadvantages to both approaches. Holding individual bonds guarantees return of your principal when a bond matures (assuming no defaults), but also requires a large amount to invest if you are to adequately “ladder” a portfolio to mitigate interest rate risks. If you have smaller amounts to invest, you can achieve better diversification with traditional bond funds or ETFs, but there is no guarantee that your initial investments will be returned at any time.

Defined Maturity Funds Make It Easier

Over the last year or so, new bond investment products have become available which combine the advantages of individual bonds with the advantages of funds. These so-called Defined Maturity Funds (mutual funds and ETFs) allow income investors to structure an income ladder that reduces interest rate risks while not requiring balances as large as would be required for individual bonds. Defined maturity fund products are currently available from Fidelity, iShares, and Guggenheim.

To explore more about these products and what can be done with them, check out these articles:
Build a Bond Ladder
Defined Maturity Fund Basics
Pros and Cons

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.