Currently, there are many people, especially baby boomers, who are retiring or approaching retirement. Many of these people may be looking to supplement their incomes. One way to do this is investing in selected income stocks.
There are different types of income stocks. Most of them periodically issue new shares to help fund the growth of the companies they represent and usually pay dividends or distributions on a quarterly basis. As with any other stocks, all of them involve some risk, which should be considered before investing in them. Everyone should do their due diligence and not rely on word of mouth.
REITs (Real Estate Investment Trusts)
REITs are one type of income stock. They are highly leveraged but not as much as banks and are required to pay out at least 90% of taxable earnings, not GAAP earnings. One type of REIT is equity or property REITs, which derive income mainly from rents from such sources as apartments, office buildings, shopping centers, hotels, restaurants and health care properties. In addition, there are mortgage REITs, some of which which utilize commercial (business properties) loan spreads and some of which depend on residential loan spreads for earnings. Due to the recent sub-prime crisis, housing crisis and general credit crisis, most residential mortgage REITs have either gone bankrupt or ceased to pay out quarterly dividends entirely. This illustrates the need to do due diligence when deciding on what income stocks to invest in.
BDCs (Business Development Companies)
BDCs, like REITs, must pay out at least 90% of their taxable earnings. These income companies are much less leveraged than REITs and invest mainly in small and medium-sized privately-owned companies. In addition to providing loans to these companies, BDCs aid these companies’ growth. The companies that the BDCs have equity positions in may be sold at some point in the future, hopefully as a profit. The sales of these companies result in a realized profit or loss. Commercial loan spreads also contribute to the profitability of BDCs.
Shipping companies
Some companies dealing with shipping pay out quarterly dividends. These are mainly foreign companies, some of which are listed in major U.S. stock exchanges such as the NYSE, AMEX and NASDAQ. These companies deal with dry bulk (coal, grain, etc.), crude oil tankers and refined product tankers (gasoline, propane, etc). In addition, shipping companies may have spot contracts which vary day to day, in long-term charters (one to ten years at a predetermined set daily rate) or a combination of both. These companies depend on shipping rates in general for their earnings. Although they do not have to pay out a specific amount in dividends, some of these companies elect to pay out most or nearly all of their cash flows as dividends.
CANROYs (Canadian Royalty Trusts)
CANROYs are Canadian companies which pay out distributions based on their earnings from oil and natural gas found on their properties. Many of them have U.S. stock listings on major exchanges. One CANROY also has a refinery. The CANROYs occasionally acquire new oil/natural gas properties in order to offset eventual declines in the oil/natural gas production on their current properties. Most CANROYs pay monthly distributions rather than quarterly distributions. It’s to be noted that there is currently a 15% foreign tax on distributions to U.S. owners of these stocks which can be recovered as foreign tax credits at the end of the year. In addition, there is currently a distinct possibility that proposed tax laws to be put into effect in 2011 by the Canadian government will pass and adversely affect distributions paid out by CANROYs.
MLPs (Master Limited Partnerships)
MLPs derive their earnings from various sources: Oil/natural gas sales from their properties, transportation of natural gas and fluids through their own pipelines, and sales of coal from their properties. In addition, there are MLPs which derive their income from other areas such as shipping and propane retailing. Instead of shares, investors who own MLPs are referred to as having units. MLPs pay out quarterly distributions from much of their cash flows. Most MLPs have GPs (General Partners) which aid them in their growth and which receive up to 50% of the distributions from an MLP, depending on the size and growth of the MLP. A few MLPs have no GP, which allows them to pay out distributions entirely to their unit investors without having to pay distributions to a GP.
Because of tax laws, MLPs are generally considered less suitable for tax-sheltered accounts, such as IRAs, as those accounts will be taxed if UBTI (Unrelated Business Taxable Income) from MLPs is one thousand dollars or greater for any given year.
ETFs (Exchange Traded Funds)
ETFs are basically funds consisting of a basket of stocks. They are closed-end; that is, they don’t issue new shares to help fund their growth. Some ETFs pay dividends on a monthly basis rather than quarterly and a few ETFs may pay dividends twice a year. While some ETFs relate directly to domestic stock indexes, such as the Russell 3000 index, other ETFs also invest in foreign stock indexes, in such things as commodity and energy stocks and may also use some vehicles, such as derivatives, for their earnings. Most ETFs are operated by large brokerages such as Vanguard, Schwab, etc. There may be management fees for investing in ETFs, which must be considered as part of the expense when investing in them.
In summary, there are several types of income stocks available for investment which pay much higher yields than CDs from banks, many of which pay double-digit annualized dividend or distribution yields. As with any other stock however, there is some risk involved. All potential investors in any of these stocks should do their due diligence in investing in them, including utilizing professional help such as full-service brokerages and financial advisors for those who are inexperienced in investing.
Bruce Supranowicz is a former software engineer who has earned a living from income stocks for the past seven years. He is also a member of a worldwide social network which can be viewed at http://profiles.zenzuu.com/profiles/investor.htm
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