Investing for capital appreciation vs income

[hyten1]

I have been thinking about this on and off for a while now. I know when most people think about investing and making money from investing, they think about the capital appreciation part.

 

However, one thing that i have been trying to do is generate enough passive income where the passive income can both satisfy my living needs as well as have enough passive income to obviously put back to be invested again.

 

my point is not to say which is better or worst and I understand if you have enough capital (even if you don't focus on investing for income)  the power of large number will take care of the income part automatically.

 

I was wondering anyone have any insight/trick/color on the best ways/places to invest for income. Any one have experience in this regard? Just curious.

 

EDIT: not sure what i am trying to get from everyone, i understand all the typical investment you can get income (bonds, equity with dividend, real estate as rentals etc etc.)

 

 

 

[DTEJD1997]

I think this could be the beginning of a great thread, good start hyten1!

 

I love to invest in income stocks. 

 

One thing I've never understood is that a lot of "financial advisors" will frequently speak of income stocks and "dividend champions".  Inevitability, these companies are paying 1% or maybe 2%.  Most of the time, these companies are good, solid companies.  They also grow dividends too.  HOWEVER, the problem is that even with stability & growth, when you start at 1%, you have to wait SO LONG that I would argue it might not be worth it.  Year 1 you get 1%, the dividend then grows 10% a year.  15 years later you are then getting about 4% income.  OR if you invest in a 2% payer, growing at 10%  a year, 15 years later you are then getting about 8%.  8% is good, but you had to wait 15 years to get it!

 

I find the best "income" stocks don't necessarily start out that way.  For example, I bought income some nano-cap community bank stocks.  SBFG re-initiated a dividend, and then raised it up 20%.  I suspect it will be raised for many years as they are paying out LESS than 12% of their net income.  I also suspect that net income will increase as earnings are retained and re-invested in the bank.

 

Another way to get good income is to write covered calls.  I have had positions where over a period of a few years, I've recovered my initial investment from writing covered calls.  Add to this dividends you receive and you are doing well.  Unfortunately, these are fairly rare, and I hope to do more of this in the future.

 

Lastly, a great way to get income is to buy into stocks that have STOPPED paying dividends.  A perfect example of this is Ark Restaurants.  At the peak of the financial crisis, ARK suspended it's dividend.  They did this not because of financial weakness in their company, but that they wanted to marshall cash in case good opportunities to sign leases in NYC came about.  A year passed and I think they got one new location.  They started up the dividend AND made a special dividend to make up for the lost payments.  If bought near the low, you could have gotten almost a 10% dividend yield.

 

 

[constructive]

From a tax perspective, having control of when you take gains (either for liquidity or investment reasons) is a lot more efficient than being forced to take gains regularly.

 

Probably over 90% of income investors don't understand the significance of this issue.

[constructive]

And also, you have to make more reinvestment decisions with income generating assets (even if it's just reinvesting dividends in the same security). Limiting the number of investment decisions seems better to me.

[Guest deepValue]

MLPs, REITs, etc when they are cheap. You basically need to perform the same analysis that you would if acquiring the entire business, except your universe shrinks substantially because you require large dividend payments. It will be difficult to find good opportunities while interest rates are at record lows.

[Guest deepValue]

On the other hand, you could just buy a stable company like Berkshire and start selling a part of your position after one year to create a synthetic dividend taxed at the long-term cap gains rate.

[Palantir]

Large Cap tech buddy. I think REITs could be good for nontaxables, and MLP's for taxables, but those are pretty high right now, so not yet.

 

IMO, everybody wants yield, so I don't think you should do the same, perhaps look for quality companies that are not paying a large dividend (or any div), and a dividend could be a catalyst. I agree with the poster who said that dividend growth is not a great strategy, but at this moment, I think div growth could be good if they have a lot of cash and have just started paying out (AAPL).

 

Some talking head on TV said, "People are looking for bonds that act like stocks, and stocks that act like bonds!". So true....

 

Personally, I don't view income investing as separate from growth, I just like to view dividends as a catalyst that can unlock returns. (AAPL, MSFT)

 

 

EDIT: Writing options IMO is one of the best ideas. Just pinpoint a value you'd buy at, and sell a put so that after you net out the premium, you end up buying if the option is exercised, either way you win.

[ericd1]

Why not look for both at the same time?  There are times when traditional income investments make excellent capital appreciation investments. For example when interst rates on bonds are very high investing in long duration bonds can produce terrific returns when rates decline. The '08-'09 financial crisis provided lucrative opportunities in financial preferreds that produced very high interest rate returns and superior capital agains. As previously mentioned REITs and MLPs can provide good returns if purchased at the right time. I'm sure there are other examples. 

[Shane]

It seems to me income investing in the public markets is a tough game to play.  If I wanted to generate income off of relatively small amounts of capital I would buy residential real estate when valuation was appropriate.  The tax breaks are outstanding and the yields can be much more rewarding.  I would only look at the markets for income if I had so much that it didn't make sense to go for private deals.

[ItsAValueTrap]

EDIT: Writing options IMO is one of the best ideas. Just pinpoint a value you'd buy at, and sell a put so that after you net out the premium, you end up buying if the option is exercised, either way you win.

I would respectfully disagree.

 

[CorpRaider]

I'll throw out some names for fun.  CHY, CHI: (Calamos Convertible closed end funds). PCL, RYN: Timber is fantastically beloved in the tax code, but expensive right now imop.  ARCC, OAK: (leveraged finance guys who did well through the recent financial armageddon), GAB, RVT: Leveraged closed end funds that pay you back some capital and income each year.  GAB aims to pay back 10% of NAV.  I think the theory is a 1.2 times leveraged value portfolio should beat 10% over the long term but gives the holders some liquidity.  Gabelli and Royce are both getting older though.  I would be interested to hear thoughts comparing the next cash flow yield that could be expected from mom and pop rentals versus primo reits in a normal environment.  Seems like owning rental houses might give you a lot more upside because of the cheap mortgage leverage, but a lot more headaches too.

[boilermaker75]

EDIT: Writing options IMO is one of the best ideas. Just pinpoint a value you'd buy at, and sell a put so that after you net out the premium, you end up buying if the option is exercised, either way you win.

I would respectfully disagree.

 

Could you expand on exactly what you are disagreeing with and why?

[SharperDingaan]

The smartest approach is to buy a utility just after a dividend cut. Media pisses all over the name, income investors panic & all dump at the same time, share supply greatly exceeds demand, & you get to lock in a nice low cost base. 5 years out the dividend will usually be close to what it was, & you'll have a 10-15% cash yield plus an unrealized gain. Buy & forget.

 

Boilermaker: If you get exercised on, your strategy failed. You mitigated the failure through a willingness to actually buy in the position, & forfeited the possibility of being able to buy it in at a lower price. While that may be desirable if it is a lot of shares of a difficult to obtain stock, it is a rare exception.

 

[ItsAValueTrap]

EDIT: Writing options IMO is one of the best ideas. Just pinpoint a value you'd buy at, and sell a put so that after you net out the premium, you end up buying if the option is exercised, either way you win.

I would respectfully disagree.

 

Could you expand on exactly what you are disagreeing with and why?

 

Options is a zero-sum game if there were no transaction costs.

 

If they are mispriced, then either the buyers or sellers of options will win out.  I don't see why one side would be better all the time.

 

Of course in the real world there are transaction costs (hidden and explicit).  A hidden cost is when somebody has inside information and suddenly buys a lot of put options.  Those with inside information tend to buy more options than they sell them.  So there's an asymmetry there that you have to be careful about.  It's a lot simpler to deal with common stock, as stock is less complicated and has significantly lower transaction costs.

[Palantir]

Options may be a zero sum game....but how do you know that the expected value for the seller = 0?

[ItsAValueTrap]

Expected value might be positive and it might be negative.  Who knows?

[boilermaker75]

Options may be a zero sum game....but how do you know that the expected value for the seller = 0?

 

The seller of the option is writing an insurance policy. A good job of underwriting and the put seller has a positive expected value.

 

Options are a zero sum game on the day of expiration, but I don’t view that as the end of the game. Being assigned, paying out on a policy, is not a loss as it is when paying out a claim on a wrecked car--as long as you are writing puts on positions that are selling dollars for much less than a dollar. As examples, I have had to pay claims by purchasing WFC under $20 and BRK/B under $70, positions I still have.

 

[Palantir]

Exactly, if anything, it should be statistically a very profitable strategy given that you're selling depreciating assets with skewed payoffs, and assuming you've done the valuation, you have a better understanding of the underlying's intrinsic value.

[ItsAValueTrap]

Clearly there is some price where puts are so cheap that it would make sense to buy them.  And there is some price where they are so expensive that it makes sense to sell them.

 

Let's just... agree to disagree.

[DTEJD1997]

Hey all:

 

One of the best income strategies I've used has been to write out of the money calls on volatile stocks that I have large capital gains in.

 

You are protecting your gain, and you are also harvesting volatility.

 

The percentage you earn on your original investment can be truly enormous.  Heck, the return you get on your current position can still be pretty good.

 

The buyer of your option has to be correct on BOTH the direction of the stock and the time frame in which it will achieve it.  Kind of like betting trifectas at the track or "parlays" in sports betting.  You have to get everything right to make money.

 

I would argue the smart money is in selling (writing) them, both options & parlays.

[hyten1]

folks, thanks for everyone's input, all very interesting and good things to think about

 

i guess i was wondering for the folks who have done it, meaning have achieve "passive income that can support themselves and then some"

 

would love you here your experiences, what are your income distribution look like (10% dividend, 20% rental income etc.)?

 

i know eric retire and live off his investments, was wondering how do you eric pay the bills? is it mostly just selling or take a X amount out from your equity portfolio per year to cover your expenses? and/or some other asset that generate income?

 

i am still trying to achieve "passive income that can support themselves and then some"