Picking up Nickels in Front of a Steamroller

Picking up Nickels in Front of a Steamroller

Income investing is hard.

Let’s say you buy twenty bonds. Each of them yields 5%. Nineteen out of twenty mature at par and you get your money back, with interest. One of them defaults. You are back where you started!

It is said that income investing is a negative art. Your goal isn’t to pick the winners—it’s to avoid the losers. You want to pick winners, invest in stocks. Have you seen a chart of Beyond Meat? Bonds generally don’t do that.

It is also said that income investing is like picking up nickels in front of a steamroller. You’re earning a 4-5% coupon, and you could get whacked pretty much any day, just like what happened at Toys “R” Us. It is a bit like selling puts.

My friend Jason Brady wrote the book on income investing. No really, he did write the book on income investing: Income Investing: An Intelligent Approach to Profiting from Bonds, Stocks and Money Markets. I have done a pretty good job summarizing it so far, but if I were you, I’d take the time to read the whole thing.

As a negative art, bond investing has become more and more difficult. Yields are slender, and they are not what I would call “safe.” We are at the peak of the cycle, the default rate is virtually zero, and getting 3% on XYZ high grade corporate bond fund does not sound like a great idea. This is one reason why there has been such a historic rally in municipal bonds, pension nonsense notwithstanding.

Bond investors allegedly think about what could go wrong. I am a dour/pessimistic person, so I was always a bit out of place on the ETF desk.

What Could Go Wrong

I am far from the first person to worry about the corporate credit cycle. Nine months ago, people were flipping their lids about the preponderance of BBB credits and the potential ginormous migration to junk.

Never happened.

I know a few smart hedge funds who bet against all the paranoia. They did quite well.

The credit cycle will turn eventually. It will take a skilled portfolio manager to avoid the turds.

I think last Friday was the first day I seriously considered the possibility that we were headed towards a recession, with two, three, and five year note yields plunging below two percent. Corporate debt issuance has been historic. Up until this point, there has been near-limitless demand for it.

By the way—if you’re also starting to seriously consider the possibility that a recession is on the way, you should really sign up for a webinar being held on June 24 by my colleague, Mauldin Economics’ resident income expert Robert Ross. That blog I pointed you to last week? Robert got so many worried questions from readers that he is going to take a full hour to share exactly what he does to recession-proof his portfolio.

You can save your seat for Robert’s Any-Weather Income Strategy webinar right here (and I recommend that you do). If you’re an income investor, or just worried about the R-word, it will be more than worth your time.

I suspect most income investors reading this are dividend investors. Dividend investing is similar to bond investing. High dividends are good, but they can also be bad, if they are signaling a future dividend cut. Anything much over a 5-6% dividend in a stock should be viewed with some suspicion.

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With regard to dividend investing, the key is not necessarily to buy big, fat dividends, but to buy growing dividends. Most people have it all wrong—they go yield hogging and end up paying the price.

Believe it or not, Apple is one of my favorite stocks. Not because it is a growth stock, but because it is a dividend stock. It has a decent yield, but one that is likely to grow, as it will one day have to figure out how to more aggressively return cash to shareholders.

The Key to Investing

I am going to tell you the secret to investing. Are you ready?

Invest in companies with dividend growth, and reinvest the dividends on a regular basis.

That’s it.

Say you had a million dollars. Buy 20 stocks with dividend growth. Set up the dividends to reinvest. Look at the P&L once a year. Make some adjustments. Repeat.

It really is that simple.

Of course, trading is more fun, and gives me stuff to write about.

My guess is that this growth phase we’ve had in the stock market for so long is getting down to tag ends. Recent history has demonstrated that it has paid to buy stocks without dividends. I have never understood why you would buy a stock without a dividend. Making enough extra cash to give some to you is how a company demonstrates that it’s profitable.

I have written before about the 35/55/3/3/4 portfolio. But I have never spent much time talking about the composition of the component parts.

The 35% in equities should all be invested in stocks with growing dividends, across all sectors.

The 55% in fixed income should be split between treasurys (including TIPS), corporates, mortgages, municipal bonds, and a handful of international bonds.

Then you have the 3% commodities, the 3% gold, and the 4% REITs.

The blended yield of this portfolio is probably around 3 to 3.5%. You could retire on that!

Yield hogging is a pejorative term, and it should be. The whole financial crisis started because people decided to reach for another 30 basis points. Rule number 42: don’t be dumb.

Tonight’s the Night

If you’re in NYC, please come out to the party at Hotel Chantelle at 92 Ludlow Street. It gets going around 8pm. Tickets here. Proceeds go to charity.

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In the sage words of Jermaine Stewart, we don’t have to take our clothes off to have a good time. Besides, we’re old.

Jared Dillian


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