The goal of many is to reach a stage of Financial Security, where you create alternate streams of cash flow so that you depend less on your main source of employment or business.
The problem faced by many is a certain unwillingness to build up competency in wealth management, or that they lacked the time for it. Due to that, the only way to go about creating an alternate source of cash flow is property.
Stocks is for punting and Bonds are unknown to them.
This gets people dejected because a private property in Singapore cost $800,000 upwards. To start by putting down a 20% downpayment, you will need $160,000. Your wealth is also concentrated in 1 property. If you are rich that $800,000 is a portion of your net worth, that is good but not if your entire wealth is tied to one asset.
[Related: How much do you need to reach Financial Independence?]
The Power of Keeping $50,000 or $100,000 lying around
My friend Chris at Growing your tree of prosperity likes to talk about the power of building up $300,000 in wealth.
With $300,000 and put into 8% yielding stocks, a wealth builder gets $24,000/yr or $2,000/mth in dividend income.
If you are frugal, $2,000 covers your subsistence living, or your Financial Security cost. You can chose to take a short break from work, you can choose to make a riskier shift in career. You have the backing of your Wealth Fund and Wealth Machine.
My take? Stock markets go up and down. Recently, the Singapore stock market is down 21%, which puts it in an official bear market.
Having $100,000 of cash, bonds or Singapore Savings Bonds allows you to take advantage of these market fall to pick up high yielding income stocks at a large dividend yield.
If you manage to pick up 5 stocks yielding 12%, your dividend income is $12,000/yr or $1,000/mth.
That amount can cover a large part of your subsistence expense. As a gauge, what the CPF team used for their justification that is good enough for retirees with CPF Life is about $1,200/mth. I can think of how much a single person can offset a lot of his or her expenses with $1,000.
8% and 12% is not out of touch with reality considering the market fall and the list of stocks on my Dividend Stock Tracker here showing very attractive yields.
Even if you do not want to keep so much in low volatile and low yielding cash, bonds, having $50,000 around and taking advantage of 15% yield will give you $7,500/yr or $625/mth, it is very helpful to offset some household subsistence expenses.
[Related: How to rationally build up wealth versus dreaming about it]
Why did the dividend yield shoot up
Here is the historical yield of retail REITs, which shows you that 12% and 15% is not out of the norms. My Dividend Stock Tracker will show that the retail REITs yield around 6% currently.
One of the reason is that stocks in general go down due to the negative sentiments. It doesn’t mean that the business or the underlying assets have an issue. Good business, good assets go down with the bad ones because the mass of people trades and punts more, view things with short term thinking and they cannot bear with the pain.
Capitamall was seen as a stable blue chip REIT now, and one of the largest in Singapore.It IPO near 2002 and the dividend yield was more than 10% because it was a bear market. Again, we revisit close to that level in 2009.
[Related: When you overpay for dividend stocks]
The caveat here is that much of these high yielding stocks were a problem as well.
They are either:
Overpriced during IPO
During the hey days of 2006 and 2007 we have many banks engineering a packaged asset of things that traditionally income generating assets like trains, airplanes, aged healthcare.
Most of the time there is nothing wrong with these assets. The problem is that the banks buy these assets at not cheap prices and inject it into the stock during IPO at even more expensive price.
So an asset priced at $10 was producing an income of $0.60 for 6% yield.
The $0.60 is produced during good times, and in normal times it produces only $0.40 or even $0.30.
To have an attractive yield to attract you and me, the stock price will have to go down.
Suffice to say, the stock investors got the short end of the stick. The share price of $10 fell to $3 or $2 which is what the stream of recurring income is actually worth.
This is why IPO also means Its probably overpriced.
[Related: Look at Total Return instead of only Dividend Yield]
Some asset managers like Allco and the Shipping Trusts such as FSL are more of finance managers who do not understand the real business of the underlying asset.
After being put with better managers (Allco is being managed by Aims Amp as Aims Amp Industrial REIT, and FSL have management that are more tuned to the shipping scene), they manage to stabilize and even improve the prospects.
Organic Industry Problems
The first 2 reasons are things to be careful about. Organic industry problems happens to good stocks but were beaten down because their outlook going forward is changing for the worst.
Think of the property situation in Singapore looking forward versus in the past 10 years.
Think of shipping before 2007 and versus after 2007.
Some of these shipping trusts are not bad, however the industry outlook is so challenging that the worse likely will not survive and the good ones are struggling like mad. Pacific Shipping and the new look FSL Trust learnt their lesson and are doing very prudent management. However, the industry is so challenged.
Most of the risks have shown up during bear market
Purchasing a high yield stock during a normal market versus during a market drawdown is that, the former have risk situations that you have not thought of, and risk situations that almost everyone have not thought of. The dividend yield compensation is high but probably not enough given these situations.
During a normal market, rising tides lift all boats, including the wobbly ones.
If you do not think hard enough, and sometimes even if you do, you would think these high yield stocks are attractive.
Conversely, during a bear market, it is likely all the risk situations that we did not see it coming, are laid out. Hence the share price fall.
So as an income investor, you can prospect these income stocks after viewing most of these risks:
- credit risk of not able to roll over their debts
- liquidity risk of not being able to sell off assets they want to sell off
- poor managers are separate from good managers
Buying in this environment leans you closer to an acceptable compensation for the risk taken. So if you have a REIT at 20% yield, even if the income is cut to 15% yield, it is still a very high return versus the traditional equity cost of capital of 10%. It definitely look better than buying at 6%!
Low Start Up Cost and Diversified
Many would have corrected me that property prices would have come down as well. However, if you are like me, who have an aversion towards concentration risk, properties in Singapore is a struggle.
It is not like in the USA where you can buy properties at $50,000, $100,000 or $150,000.
Buying listed assets such as REITs, business trust allows you to do that with $3000, $20,000, $100,000.
Have all the risks shown up? I am unsure. I do not see the tightening of liquidity and more stringent lending affecting the business trust and REITs.
To be fair many would have learnt form the challenging Great Financial Crisis. That made a lot of the risks visible and now prudent managers plan for it.
However you still need competency to evaluate well so do pick up a book such as Building Wealth through REITs by Bobby Jayaratham which is quite a good primer or look through my resources section.
I leave you with the thought of my friend who manage to snag Cambridge Industrial REIT when it reached 20% yield. $50,000 in it generates $10,000/yr.
How are you going to find that in Singapore properties? Think of what $10,000/yr can do for you to supplement your daily life. It doesn’t buy you freedom, but it moves you closer to there.
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Sunday 4th of October 2015
Nice article. I agree with having enough passive income from dividends to offset my daily expenses. In fact, I am close to achieving it.
Sunday 4th of October 2015
oh you are a strong one.