Earn Double-Digit Yields Outside of the Stock Market?
October 6, 2020
These Little-Known Income Investments Pay Reliable Retirement Income
I know from talking with investors that many are struggling to generate enough retirement income.
The root of the problem comes down to a lack of savings. The slow extinction of corporate pension plans has put the burden of retirement planning on employees. But rolling recessions in recent years have made it next to impossible to save, as millions of Americans have struggled with mass layoffs, plunging home prices, and stock market volatility.
Rock-bottom interest rates have only made things worse. In a desperate bid to prop up the economy, the Federal Reserve has slashed its overnight interest rate down to basically zero percent. That means even a sizeable nest egg won’t generate much in the way of retirement income.
Thankfully, there might be a solution. For years, I have called this little-known investment the perfect source of retirement income. And for those willing to do a little bit of extra digging, it’s not uncommon to find safe, upfront yields as high as 7%, 12%, and even 15%.
Let me explain…
These Retirement Income Investments Yield up to 15%
Look; when most people think about an investment, they generally think of either stocks (which investors prize for their potential capital gains) or bonds (which generate safe, reliable coupon payments).
When you buy a bond, you’re making a loan to a business. If the company prospers, bondholders don’t get a better return. Instead, you get a predetermined interest payment for the duration of the bond, plus your money back at the end of the contract.
A stock, in contrast, represents an ownership stake in a business. If the business prospers, you can profit through dividends and a higher stock price.
Both come with trade-offs. Bonds, generally speaking, are a safer investment because lenders stand first in line to get paid. Shareholders, by comparison, usually earn higher returns, but their investments have more uncertainty.
Both can represent valuable tools in any income investor’s portfolio. But it turns out that you don’t always have to choose between these two options. There’s actually one area of the market where you can combine the retirement income potential of bonds with the upside of common stocks.
I’m talking, of course, about preferred shares.
Preferred stock represents a group of securities that have a higher claim to assets and dividends than common shares. And for investors, they come with a number of advantages:
- Preferred shares typically come with large, fixed payouts upfront. So, it’s not uncommon to see preferred shares to have dividend yields several times larger than the payouts on common shares at the same companies.
- Companies have a contractual obligation to pay their preferred investors before common shareholders see one red cent. In other words, a dividend-paying business would have to cut its common distribution to zero before it could even consider skipping payment to preferred owners.
- Most preferred shares are what’s known in the business as “cumulative.” This means that, in the unlikely event a company skips its preferred dividends, it has to make up any missed payments to preferred owners before resuming normal distributions to the common shareholders.
I often describe owning preferred shares as having gold status with a major airline. You get a whole bunch of perks (priority boarding, complimentary upgrades, access to the VIP lounge) that other travelers never get to enjoy.
Companies have a number of advantages in issuing preferred shares, too.
Because preferred shares are considered equity rather than debt, companies can raise the cash they need without leveraging their balance sheets. Better still, preferred shares are also more flexible to issue than traditional bonds.
Of course, investing in preferreds come with their own trade-offs, too.
While preferreds pay safe, high dividends, they have a lot less potential for capital gains than common stocks. That’s because the bulk of the securities that are issued are “callable.” This means the issuing company can buy back their preferred shares after some predetermined point in the future at a fixed price.
For instance, say a business issues a series of preferred shares at a price of $25.00 per share (often called the “par” value). During the life of the shares, the price of these preferred shares can swing up and down. But, by the end of a specific period (usually five years), the company reserves the right to buy back outstanding standing shares at the par value.
For this reason, it’s uncommon to see preferred share prices rise too far from $25.00. But most investors don’t worry about this problem too often. After all, we’re looking to collect large, safe streams of retirement income, not necessarily strike it rich through capital gains.
And while nothing is risk-free, preferreds hit a sweet spot between offering safer returns than stocks while delivering far higher yields than bonds.
How to Lock in This Stream of Retirement Income
But rather than investing in the preferred shares of individual companies, I often suggest prospective investors opt for a “one-click” preferred-shares fund, such as Nuveen Preferred & Income Opportunities Fund (NYSE:JPC).
JPC is a closed-end fund that owns a collection of high-quality, investment-grade preferred shares. These investments have produced a robust income stream, which explains why JPC can fund an upfront dividend yield that’s over seven percent.
But what really gets me excited is the unit price. JPC shares trade on the New York Stock Exchange just like a regular stock. And because units fluctuate in price, they sometimes trade at a discount to the net asset value of the fund.
And that appears to be the situation we have right now. Over the past few weeks, JPC shares have traded for as much as a 10% discount to the net asset value of the fund. Or, in other words, prospective investors can buy up a wonderful portfolio of preferred shares for $0.90 on the dollar—adding an extra level of safety to the investment.
If you haven’t considered investing in preferreds, a closed-end fund like JPC represents a great place to get started.
