Summary
- February has arrived and one month of the year is locked in.
- Your income needs are relentless as expenses never stop coming.
- We look at two outstanding income stocks to add to your portfolio this month.
Co-produced with Treading Softly.
When January arrives, everyone is usually filled with hope. We've exited the holiday season and celebrated the arrival of a new year.
Often that 31-day jaunt from January to February is marked by strong returns in the market as investors start reinvesting the money they took out during tax loss selling.
Historically, January is a bullish month for market performance, and this year has shown no interest in bucking that trend.
So we look to Act 2 of 2023 with the arrival of February. The month we celebrate a holiday focused on "love" and relationships.
Two aspects seem to always be in a contentious relationship - your income and your expenses. Most of us want our income to exceed our expenses, but sometimes we have unexpected expenses that tip the scale.
A balanced relationship is healthy in your personal life, but an income-heavy one is better for your financial future.
Lots of pundits and authors have opinions on how to generate income from the stock market.
They may involve trading options or selling shares to get cash. Both require extra effort and input but also more risk. I like to take a hands-off approach. I want to do nothing and get paid while doing it. A "less is more" approach to my income generation.
So I have two picks to help you do just that along with me. These stocks pay monthly dividends in my account and can do the same to yours.
Let's dive in.
Pick #1: PFFA - Yield 9.4%
I've said it before, and I'll say it again, if HDO were to operate a preferred exchange-traded fund ("ETF"), it would look a lot like Virtus InfraCap U.S. Preferred Stock ETF ( PFFA ). PFFA is a unique ETF that takes some of the best attributes traditional in the closed-end fund, or "CEF," structure. PFFA uses leverage, and it is actively managed, these two things are very common in a CEF but rare in ETFs.
Some investors hear the word "leverage" and panic, they won't buy any fund that is leveraged. What does leverage do? It increases volatility. This is a simple exercise in mathematics. Leverage increases return when an investment has a positive total return, but it also increases losses when it has a negative total return.
We can see the impact of leverage on PFFA over the past year. It had higher peaks and lower lows than its index PFF.
They ended in more or less the same place, but PFFA was a steeper rollercoaster. What do investors get in return for being on a more active roller coaster? Higher total returns. You can see that in the long run, PFFA has returned 85% more since inception than PFF.
The big risk with leverage is that a fund is forced to liquidate assets at low prices and, therefore, cannot recover from a severe downswing. It is a legitimate concern – more than one fund has been permanently impaired by a market collapse and forced deleveraging.
When we look at PFFA, we can see that it handled this risk well through March 2020, an extraordinarily volatile period for all stocks, including preferred. Prices of preferred equity saw downward pressure last year as the Fed aggressively hiked rates. As an ETF, PFFA always trades near its net asset value, so as the price of preferred shares decline, its price comes down, this is set to reverse in 2023, as an end to rate hikes is in sight. PFFA will see its price recover as the preferred shares it holds trade back closer to par value.
More importantly, the price swings last year did not put the dividend at risk. In fact, the dividend was raised by 1.5% to $0.165 – announced in January.
PFFA has proven itself to be responsibly managed and capable of outperforming its index over the long run. Preferred shares are likely to enjoy a recovery in 2023, and we can collect a 9.4% yield while we wait!
Pick #2: RQI - Yield 7.3%
At HDO, we have been focused on ensuring that our portfolio is "agnostic" toward interest rates. We've invested in BDCs and commercial mREITs with earnings that benefit directly from rising interest rates, and we've invested in holdings that traditionally do better when interest rates are stable or declining. Cohen & Steers Quality Income Realty Fund ( RQI ) is a CEF that provides us exposure to high-quality real estate investment trusts, or REITs.
REITs are often perceived by Wall Street as being "interest rate sensitive." The initial reaction in a rising interest rate environment is to sell them off. REITs tend to carry a higher-than-average amount of leverage, so naturally, rising interest rates mean higher interest expenses.
Yet the other side of the coin is rising rents caused by inflation. The inflation increases are happening right now. RQI's largest position is in Prologis ( PLD ), an industrial REIT that just reported Q4 earnings.
Core FFO was $5.16/share, up 24% in 2022 compared to 2021. Earnings were driven by rental contracts renewing at a staggering 32% higher on a cash basis.
Meanwhile, PLD has minimal debt maturing through 2025, with a weighted average maturity of 9.4 years on its debt. Source .
Rising interest rates don't impact earnings until PLD has to refinance a material amount of its debt. The interest rates in 2026-2030 matter a lot more to PLD than interest rates today. In the meantime, earnings are substantially higher right now, thanks to inflation.
This is a story we will see throughout RQI's portfolio. The impacts of higher interest rates today will be minimal as most debt is fixed, and debt maturing in 2023/2024 has already been refinanced. Meanwhile, earnings today are already much higher, reflecting the inflation from last year, and will continue growing - albeit at a more modest pace - in 2023.
RQI's holdings represent a Who's Who list of blue chip REITs. Source .
We would be willing to invest in any of these REITs individually, except for one small problem - their yields are too low for our goals. If you are constructing a dividend growth-style portfolio, and you are happy with lower yields and strong dividend growth, consider anything on this list.
For those looking to achieve a high yield and get the benefits of exposure to these blue-chip REITs, RQI is a great option. RQI will convert their returns into a solid income stream.
Conclusion
With PFFA and RQI, I can glean monthly income from excellent sources in portfolios curated by highly skilled portfolio managers. PFFA, with its recent dividend increase, shows that skilled management can produce superior income from a market that is providing headwinds to passive ETF holders. RQI and PFFA both utilize leverage to generate large returns for their holders, but this can also increase volatility.
When I buy a holding, I look to hold for years. PFFA and RQI are structured so that I can be comfortable holding them for years, all while collecting excellent income along the way.
This February, perhaps it's time to strike up a new relationship with PFFA and RQI. You'll find they help you shift your income/expense relationship towards income. It pays to own income investments instead of paying dollars to the school of hard knocks trying to time the market.
My retirement portfolio is fine-tuned to overcome any economic obstacle or headwind. How is yours going to survive a recession? A depression? A bull market?
I plan to kick back, collect income, and enjoy the show regardless of what show arrives to be seen. I'd love to have you kick back and relax beside me, my team, and the over 6000 members of our High Dividend Opportunities community. We always have room for more income investors to kick back along with us.
For further details see:
2 Great Income Buys For February