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Subject:  Re: income generating strategies help Date:  12/5/2009  4:00 PM
Author:  BruceCM Number:  66533 of 76406

currently was reaching out to people with more history/experience in income investing and was looking for specific recommendations by individual Fools.

I have been an evolving income investor since 1999 when I retired from the military. DW and I had accumulated high 6 figures in RE sales over the years, and wanted it to start providing income that would sustain us through retirement years, along with extremely modest military pension, starting at age 48. Started research on asset allocation for sustainable 4 to 4.5% annual withdrawal rates, growing by 3% each year, and so on and so on.

But then as I looked at the stocks, I found that many of them were generating reliable dividend income of >4%, growing annually with inflation, and NOT consuming capital! Huh? Did I miss something? What isn't there a mountain of research on this approach? Why isn't this a topic in the popular personal finance media? Was I missing something in this seemingly simply bit of investment logic?

Ok, loooong story short......here are the income classes I've found, in order of the proportion I currently hold them.

1. Exchange traded equity REITs. The REIT act of 1960 created these income machines that do exactly what they were intended to do. But as we've recently seen, dividends can be cut. And REITs are not all the same...healthcare and storage are completely different than retail malls and apartments. Never non-exchange traded REITs.

2. C-Corp blue-chip dividend stocks of industries not prone to revenue fluctuations, to include household staples, tobacco and spirits, energy and discount retail.

3. Utilities...particularly retail distribution and residential service.

4. MLPs involved with pipelines, storage and retail.

5. Preferred stock of large companies with long common dividend histories, utilities and equity REITs. The dividends are enticing, usually at >8%. But there are multiple disincentives to preferreds, to include redemption at exactly the wrong time (very low interest rates), illiquidity, no dividend growth and with the small ones, risk of being mistreated if the company is taken over by a 'black night' (like Gorden Gecco). And if the parent company ever suspends the dividend, it is highly unlikely you'll ever get anything, as they almost always dissove into chapter 7. But I own many.

6. Exchange traded bonds. Same limitations as preferreds, but lower risk of default and usually better liquidity....but lower yield.

7. Bond ETFs. I'm relatively new to these, but so far so good.

8. Energy royalty trusts. I've disgourged myself of these, as their distributions are simply too volatile. I avoid shipping and Canroys for similar reasons.

9. I do not do open or closed end MFs. Almost all of them reduce their dividends over time or rely on capital gains for supporting their monthly/quarterly dividends...which is great when the market for their securities is going up...bad when its going down. And MFs have the wrong incentives....managers are rewarded for total return, not income reliability....which incentivizes managers to trade a lot and take capital gains risks....both work against reliable growing income.

I screen by current yield and then look at dividend growth at a minimum over the past 5 years. I then look at the tax character of past distributions...the danger signs here are growing capital gains or unrecaptured sect. 1250 capital gains, as this suggests high capital turn over is supporting the distributions....and return of capital in other than REITs and MLPs is always a bad sign. I then look at the company's free cash flow as a % of their distributions, avoiding anything distributing >90% of their operational free cash flow...and I monitor this every year.

And NEVER chase yield. High yields + difficult to understand company fundamentals = high risk that the company will cut or eliminate their dividend in market turmoil. Mortgage REITs, highly leveraged CEFs and Business Development companies are painful reminders of this.

Anyway, that's a rough overview.

Oh, and the reason I think you'll find almost nothing on this style of income investing is because middlemen have no way to make money on this approach. In fact, if you hold just the individual securities, in a year you neither buy nor sell anything, your annual expenses, direct and indirect, will be $ZERO

BruceM
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