Actual Passive Income: Dividends

People on the internet talk about "passive income" all the time. "It's not a get rich quick scheme," they say. But they then talk about how you can make a lot of money quickly without doing a lot of work. That's what a get rich quick scheme is. 

Billboard marketing, dropshipping, and MLMs can indeed make you passive income, but they involve work and are not passive. They also involve a decent degree of risk.

In reality, there are a couple way to get passive income. Dividends are the most accessible. This post will explore a few baskets of stock picks for consistent dividend income. 

Criteria: The stocks must all pay a dividend (obviously) and must be optionable. If a stock does not offer the opportunity to wheel, then it is not on this list.

tl;dr: Pick a handful of stocks off the Dividend Aristocrats list and buy shares. Buy O, PSEC, or ARR if you want monthly dividends.  Check out NLY and ET if you are hunting big dividends. Buy HDV or NOBL if you are too lazy to pick stocks.

Basket 1: The Classic

There is a group of dividend stocks called the Dividend Aristocrats that fit certain criteria that makes them reliable and worthwhile:

- Must be traded on the S&P 500;
- Must have increased dividend for previous 25 years;
- Must have at last $3bil market cap

Stocks that fit these criteria are aristocrats and make excellent choices for the income investor. As time ticks by, aristocrats will almost certainly continue increasing their dividends, resulting in potentially very high payouts down the road.

You can buy the whole index with the ETF NOBL, but this basket describes my current favorites. One of them is not an aristocrat, but it is getting there and I believe it is still remarkably reliable.

1) Prudential (PRU):
Price: $67.96
Dividend: $1.10/quarter
Yield: 6.5%

Technically not an aristocrat because it cut its dividend in 2013, PRU has increased its dividend every year since. PRU got beaten down during the March crash and its reduced price makes its dividend remarkably high. I do not expect these prices to last, so I am loading up while I can. PRU sells insurance and other investment vehicles and manages wealth.

My position: Long 100 shares, have 3x cash-secured puts to buy more if assigned.

2) Coca-Cola (KO)
Price: $47.80
Dividend: $0.41/quarter
Yield: $3.43

You can't go wrong with the undisputed leader in soft drinks around the world. KO is highly likely to continue increasing its dividend every year while growing its business. This is a buy-and-hold investment.

My position: Long 100 shares, may buy more shares with an ITM cash-secured put later this year.

3) AT&T (T)
Price: $30.02
Dividend: $0.52/quarter
Yield: 6.93%

T has caught some flack during the COVID-19 pandemic because sports coming off the air and a bunch of people finally cutting the chord has impacted business. But T's payout ratio is less than 60%, so the company has plenty of room to work with regarding dividend. Further, T has diversified its business since last year by purchasing WarnerMedia and luring customers with HBO Max streaming. Although T may not grow as fast as the new hotshots, it is a fantastic choice for the dividend investor.

My position: Long 101 shares, 1x cash-secured put expired Friday that will be reinvested into more shares, will likely open another $30csp this month.

Basket 2: The Minimalist

There is no reason to hunt specific companies when an ETF will work just fine.  There are ETFs for just about everything these days, including one specifically aimed at the strong financial health of its companies and above average dividends: HDV. Out of the many similar ETFs focused on dividend investing, I find HDV to offer the best balance of capital gains and dividend. 

1) iShares Core High Dividend ETF (HDV)
Price: $85.05
Dividend: Varies, about $0.85/quarter
Yield: Varies, about 3.3%

HDV is similar to NOBL, but NOBL only looks at dividend history when selecting holdings, whereas HDV also evaluates company financial health. As a result, HDV with reinvested dividends will usually outperform NOBL. However, keep in mind that HDV pays out quarterly with its underlying stocks, which may vary across quarters. Therefore, HDV will not pay the same amount each quarter even though its trajectory is certainly up. 

My position: No holdings or current plans to pick up shares, but will likely select this dividend ETF for a future investment.

Basket 3: The Monthly

There is intrinsic value in receiving dividends monthly instead of quarterly. It helps your budgeting if you are spending (i.e., living off) your dividends, and helps you build income faster by being able to reinvest rapidly. Plus, it feels rewarding. For that reason, some people may choose to focus on dividend stocks that pay monthly.

1) Realty Income (O)
Price: $62.72
Dividend: $0.234/month
Yield: 4.49%

O is my favorite stock. In addition to being a dividend aristocrat, O has shown an impressive ability to continue expanding business in any environment. An equity REIT, O may sound vulnerable to recessions and low interest rate environments. However, O is positioned defensively with most of its holdings in non-discretionary businesses that may even outperform during a recession. This is a buy-and-hold asset that can easily make you a wealthy retiree.

My position: Long 438 shares with active DRIP, will continue to buy more on a regular basis.

2) Prospect Capital
Price: $5.07
Dividend: $0.06/month
Yield: 14.2%

PSEC is a Business Development Company (BDC) which loans its capital to small and medium-sized business that either need money to get started or to get their finances in order. This is as risky as it sounds, and BDCs tend to perform well during strong economies and poorly doing recessions. Although we are now in the weirdest recession ever, BDCs stand to make a comeback as the economy reemerges. PSEC is one of the largest BDCs and so is in a position to profit from economic recovery. Coupled with a huge dividend, this monthly payer may be worth a look.

My position: Owned shares from 2012-2013 but have not taken a position since and have no plans to do so.

3) Armor Residential (ARR)
Price: $9.63
Dividend: $0.10/month
Yield: 12.46%

Another run-of-the-mill REIT, ARR offers monthly dividends like O. ARR invests mostly in properties backed by Ginnie Mae or other agencies, and as the name suggests, focuses on residential properties. ARR took a beating during the March crash and is only beginning its recovery. If residential properties take a real hit later on in this recession, ARR will certainly perform poorly. However, those who expect continued government intervention to keep the economy floating until actual recovery begins may be interested in picking up ARR while the yield is high and riding it back up.

My position: Not holding shares but may sell cash-secured puts when the economy shows marked improvement and we get passed the looming foreclosures and evictions issues.

Basket 4: Premium Hunters

A lot of companies posting high yields above 10% are usually indications that the market does not expect the dividend to be sustainable. However, investors who grab shares at depressed prices to hunt yield will be well-served if the dividend proves reliable and the stock remains strong. I am actively building positions in two such plays, banking on a sustainable dividend and hopefully a stock price increase as well.

1) Annaly Capital Management (NLY)
Price: $7.38
Dividend: $0.22/quarter
Yield: 11.92% 

NLY is far from a safe bet after a number of dividend cuts. But as a mREIT, we know it will be legally obligated to pay a dividend as long as it is receiving income. This is hardly reassuring when viewing its recent dividend cuts. But to strengthen the dividend argument, CEO Finkelstein stated in the Q2 2020 earnings call, "So, we set the dividend at $0.22 because we believe that to be the sustainable level for the foreseeable future as long as we had a lens into the horizon." If the CEO believes the dividend has finally reached a stable level, I'm happy. Further, the company has been buying back shares, so that will be a tailwind for price appreciation.

My position: Long 1,065 shares and will continue to wheel 5x lots and reinvest the dividend into more shares.

2) Energy Transfer (ET)
Price: $6.43
Distribution: $0.305/quarter
Yield: 18.97%

ET owns infrastructure designed to transport hydrocarbons, aka fossil fuels. ET managed to weather the April crude prices well, posting a $0.13 gain for the quarter despite massive headwinds. Although it can be hard to root for the dirty oil and gas industry, fossil fuels still power our cities and someone needs to move the fuel around. ET is in a good position to grow with the recovering economy and sustain its distribution. Since ET is a limited partnership and not a corporation, it has cash distributions instead of dividends, which are not taxed until you sell the shares. Meaning, if you buy shares for $10 and collect $1 in dividend, you will pay no tax. However, if you then sell the shares for $12 later, you will get taxed the $2 gain plus the $1 distribution for a total of $3 capital gains. They are not appropriate for a retirement account, but they're suitable for non-retirement accounts.

My position: Long 660 shares with plans to continue selling cash-secured puts until I reach 1,000 shares.

Tips

1) Wheeling: Just because you are holding a dividend stock, that does not mean you can't sell covered calls on it. Since you know when dividends are coming, be sure to sell calls that expire before the ex-dividend date. That way, you have no risk of exercise and can hold shares through the ex-dividend date.

2) Tax: Hold shares for 60 days during the time surrounding the ex-dividend date (either 60 days before, 60 days after, or a mixture of the two) so that the dividends are qualified for reduced tax burden. If you don't hold the shares for 60 days in the time surrounding ex-dividend date, you will have to pay the higher non-qualified rate. REITs are not eligible for qualified dividend, so you will always pay the non-qualified rate. 

3) Hunting: Do not hunt dividend without doing research first. Most of the time, super-high dividends will get reduced, the company will get rid of dividends, or it will go bankrupt altogether. Make sure any dividend play you make considers the overall health of the company and ensure the company has actually announced a dividend. Do not take whatever Yahoo Finance says regarding dividend yield because it uses the previous quarter's dividend information. 

4) DRIPs: If your broker offers it, take a look at Dividend Reinvestment Plans. Your broker will automatically take your dividends and buy shares straight from the company usually at a modest discount, but sometimes as much as 10%. DRIPs also allow you to buy fractional shares so you can reinvest faster.

Disclaimer

The above is an assessment of dividend stocks based on Mikey's risk tolerance. Perform your own assessments before making any investment. When in doubt, consult a financial advisor.