How To Earn 8% Per Year Without Equity Risk
There are many different paths one can take to make money investing. For most people, they invest either using an investment manager who actively picks components just for you or more typically advises you about what kinds of mutual funds to buy. Mutual funds themselves are either actively managed by teams, or they track market or sector indexes. The components of the indexes are determined by established third parties, such as Standard and Poor’s which, e.g., is well known for the S&P500 large capitalization index.
How do you make money with mutual or index funds?
The simple answer is that most of the funds largely bank on you making most of your money through capital gains, and a smaller amount through income. The often quoted benchmark long term return for the market of “8-11% average/year”, is comprised of about 2% of income and the other 6-9% for capital gains. Historically, income has accounted for a larger percentage of long term gains, but more recently the amount of income has gone down (the dividend yield for the benchmark S&P500 index is about 2% today).
So then, what is a Capital Gain? That’s a fancy word for getting someone to pay you more for your shares than you did. If they pay your more for your shares you have a gain, if they offer you less (and you sell), that’s a capital loss.
When is comes to traditional company stocks (which when combined together makeup the typical mutual or index fund), an investor will want to pay you more because of the companies earnings. If the investor believes that they will earn more in the future or if those earnings have actually materialized they might want to pay you more.
How Well Did this Work the Past Ten Years?
If you invested in broad indexes or diversified mutual funds, you didn’t do too well compared with the previous ten years. It’s not because the companies themselves were performing poorly, in fact in many cases just the opposite. Consider a company such as Paychex (PAYX). Paychex as a company has performed very well by expanding its business and increasing its earnings. It’s just that if you bought the stock 10 years ago you simply would have paid too much.
So, there wasn’t anyone willing to pay you more because the stock was too expensive. The company did deliver results. So, after ten years you would have earned some dividend income, but the stock price has gone nowhere. This is how it sometimes goes when investing for ‘capital gains’.
There are 3 main variables to consider, if you are looking for capital gains:
- How much you initially paid.
- How well the company performs.
- How much a future investor will be willing to pay you.
If you get all these variables right you may make money, otherwise not.
If you invest in a mutual or index fund, it will expose you not to a few investments, but a bunch of investments. How it performs over time will be the average of all the investments;some will perform better than average, while others will perform worse than average.
As discussed above, earning an ‘average’ return does not offer a lot of certainty for getting the long term average return of ‘8-11%’ because the typical mutual fund is placing a large bet on capital gains, which has a fair amount of uncertainty. Note that this uncertainty also includes the possibility of doing much better than average.
How about finding the ‘above average’ candidates and investing in them? That can work if you can identify a strategy to find them, or hire someone to do it. It’s worth trying with some of your money, as we will attempt to do in the microPort.
Another Approach – Investing For Income
How about earning the low end of the long term stock market average – say 8% – consistently, in exchange for giving up potential higher returns through capital gains?
The IncomePort contains a few investments that offer the potential to earn 8%/year over the long term. No more, no less. These investments are a type of stock called preferred stock. It’s a bit of a misnomer to call these investments ‘stock’. This is what they have in common with typical common company stock:
- There is the word ‘stock’ in the name.
- They can be bought/sold just like stocks on exchanges.
That’s it. These investments have more in common with bonds, which are loans made to the company. Preferred stocks work the same way:
- Investors loan the company a bunch of money.
- The company periodically (typically quarterly) makes a fixed interest payment.
- The loans can go on for many years (30 years or more), sometimes never expiring because they can be renewable.
- The investment can be ‘called’ (closed out) as determined by its underwriting rules.
While the word ‘stock’ may be misplaced, the term ‘preferred’ is important; from the investor point of view it means ‘first in line’. When the company pays out its income, the preferred investor get paid first near the top of the list.
Understanding The Risk
Preferred stocks are tied to the company that issued them and their fate. Preferred stocks are not as safe as other bonds, such as Treasury Bonds which are virtually risk-free. However, the selections in the IncomePort are very good quality stocks that have paid interest for many years, and throughout the 2007 Great Recession without any interruption. There is good reason to believe that they will continue to pay going forward.
Like any investment it is not recommended that you put a large percentage in anyone single investment. However, putting some of your money in preferred stocks can be a good strategy to attain a stable and predictable return with lower exposure to the risks and uncertainty of regular stock investing. The potential to earn a market matching (or even market beating return) so easily shouldn’t be passed up.
A Sample Portfolio – Earns 7-8%
The portfolio below will earn 7% or more per year, depending of course on the price you pay for the preferreds. Click on each stock symbol to get quotes and other info. The dates next to each stock indicates which date the investment pays interest for the 1st quarter of each year (a similar date applies to all the other quarters of the year). When combined, this simple portfolio will pay income every two weeks throughout the year.