The Dividend Strip Strategy

Money, Profit, Finance, Business, Return, Yield

Today, we’re looking at the dividend strip strategy.  We’ll look at the problem of low yielding defensive assets, and an alternative solution.

The Problem 

Many investors, especially men, are always on the lookout for the BBD: the Bigger Better Deal. This can lead to these investors ignoring standard guidelines of proper asset allocation, and/or taking on more risk than they would otherwise be comfortable with. But let’s face it: with interest rates at nearly 0%, who wants to invest in things like CDs or bonds?

The latter varies up to about 2%, while the former comes in at a paltry 0.35%. And money market accounts that offered 12% some 30 years ago aren’t much better than CDs today, with top yields of only 0.6%. And yet, these are all things that the investor is offered as the “fixed income” portion of their portfolio.

So, are conservative investors left with no other choice than to take the soul-crushing rates of 2% or less for upwards of half of their portfolio? Even “aggressive” investors are recommended to have a quarter of their portfolio in bonds.

And to get the top rates, you often have to pick the longest-term investments you can find, locking in those rates for up to 30 years(!).

An Alternative 

Although less popular among investment firms, another form of fixed income can be found with dividend stocks. To be fair, investment firms do not consider dividend stocks part of the “fixed income” portion of your portfolio because, well, you’re investing in stocks. That means that your investment is part of the overall stock market, hence it belongs in the “stock” portion of your portfolio.

But dividends offer a way to generate returns (or income) without having to sell the underlying asset (in this case, the stock paying out the dividend).

There is another problem with dividend stocks being “fixed” income, however: just because the stock has offered a dividend before, does not mean anything about future years. It could stay the same the next year, go down, or even disappear altogether.

It’s possible to try to get around this by investing in mutual funds or ETFs that carry a basket of dividend stocks.

That way, even if some of the companies lower or even stop offering dividends, there are enough other companies who are keeping and maybe even increasing their dividends that you can still derive some income from that investment. Yet even this is hard to classify as “fixed” income.

Wouldn’t it be nice to be able to capture the dividend regardless of whether the stock decided to offer a dividend?

And what if you were able to lock in a rate that you were comfortable with, rather than hope the rate will stay the same?

Another “Option” 

Many traders and some investors are familiar with options.

Options are contracts that you can buy that give you a right to purchase or sell a particular stock (the underlying) for a particular price (the strike price) by a particular date (the expiration).

In addition to buying options, it is possible to sell options – however, selling options means you are taking on the obligation of purchasing or selling the underlying for the strike price by the expiration.

There are call options and put options.

When you buy a call option, you MAY purchase the underlying for the strike price by the expiration if the price of the underlying is above the strike price.

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Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are ...

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