Back in the game with VNR…with a twist!

newlogo7.9.10For those of you that have followed me for some time, you might remember that I held a big position in Vanguard Natural Resources (VNR)…and sold it a year ago. To recap, it went up about 10% from my purchase price. I pocketed that small profit and used all the cash to buy a discounted note, locking in a great yield.

So what’s happened since? That note has continued to yield solid cash. But I had another handful of cash that was going nowhere fast: my Roth IRA.

What to do when you can’t invest anymore

I opened a Roth IRA a few years ago. Since then, I can’t contribute anymore, because I am making too much money! That fund was initially loaded up on mutual funds. As you can guess, I sold those positions.

Wanting to put the cash into more discounted notes, I called John Park at PGI Self Directed. His expertise is setting up self directed IRAs and also wrapping them inside LLCs. There is a lot involved with doing this correctly. He even helped me educate a bank associate when I opened a checking account. (First time she had ever dealt with an LLC that was NOT some local business.)

With all this completed, my Roth IRA changed homes, and I essentially have its cash in hand to do with as I please (within IRA limits).

What if you can’t afford a note?

For six months, I kept looking for a note I could afford. Notes tend to start at around $30,000. Anything below that is hard to find. There was one that was within $800 of my cash position, and the note sellers refused my offer. My cash was going nowhere.

John called me up and mentioned he had access to a better account for my money. We discussed it in detail, and I transferred from a pure checking account to TD Ameritrade, where I could buy anything: stocks, bonds, and discounted notes. I figured I could pick some dividend paying stocks, grow the cash value, and when it reached critical mass, sell it to buy some notes.

Know your target investment

If you have been the slightest bit curious, you might have peeked at VNR’s performance over the past year. It’s been TERRIBLE! The distribution rate was cut in half back in February, and again just a few weeks ago, all the way from $0.21/unit to the current $0.03/unit. That’s an 85% drop.

It’s price tumbled from the low $30s (when I last sold) down to $2.75/unit at the time of this writing. That is almost 90% drop in price. Why?

The whole energy sector is down. Oil, natural gas, the works. So why invest AGAIN?

Because the time is ripe for a recovery. The general market has been panicking and getting out of VNR. As Warren Buffett has said, “You pay a very high price in the stock market for a cheery consensus.” VNR has strong acquisitions that will yield more natural gas and oil, and I feel I’m getting it at a discount.

But you should never invest in pure appreciation. Too many have lost too much on that premise. I’m not. If you look closely at the numbers above, you may notice that the price drop is greater than the yield drop. That means dollar for dollar, I’m buying more yield than I had before.

1% distribution per month is pretty good, and if the commodities tick up at all, I see great upside potential (which is the reason I called my broker to DRIP my VNR distributions).

Also, when I previously owned VNR, it was aimed at paying down a HELOC. That has made me very happy to have sold the prior position before such a loss hit (a very fortuitous situation!) My Roth IRA has no obligations except to grow itself. So the risk to the rest of my portfolio is minimal and the opportunity is grand.

Another word of wisdom: I have been reading detailed reports on VNR for more than two years. You should understand risk, cash flow, debt obligations, and other factors when you invest in anything. VNR has reduced its distribution with intentions to pay down debt. Many MLPs use debt to finance new deals and new positions. VNR is making a smart move by cutting back the cash spigot and strengthening their balance sheet. Hopefully, things will start to grow again as their new acquisitions begin to yield cash.

Stay tuned and let’s see if VNR takes off!

Checking ALL the facts

rodin_thinkeSkimming some financial forums, I once again spot people making gross assumptions with inadequate facts.

One popular discussion is whether or not you should pull out your 401K money, pay all those taxes including the extra penalty, and buy rental property.

People LOVE to point out the superior option of rolling your 401K money into a self directed IRA and using that to buy property without any tax repercussions.

And once again, such advice is rarely challenged as not a good bet. People seem ignorant that no bank will write you a note for only 25-30% down if it’s from an IRA. For a non-recourse loan, they will probably want more like 40-50% down.

It kind of kills the whole effect. If they are cutting the number of rentals you can buy in half, what’s the point of dodging the taxes?

Factor this too. IRA funded rentals require all proceeds to go back to the account. You can’t “touch”‘any of the money. It’s not an option to write a check at Home Depot for things and fix it yourself. You have to hire a contractor.

With the net effect canceling out your tax savings, you might as well just pull out your money and leave all those pesky regulations in the rear view mirror. After a few years, the penalties will probably become a distant memory.

What to do with the change in your sofa

My Roth IRA had some spare change sitting around. Essentially, the stocks I had invested left me with about $56, well below the price of any of my stock holdings. This is what happens when you pipe money into your brokerage account and can only buy whole shares.

For my regular brokerage account, this hasn’t been a problem. Since I’m using the monthly dividends to pay off my low interest HELOC, I simply tacked on it’s spare $10 into the next month’s payment. But my Roth IRA is different.

I setup a Roth IRA years ago. It was invested in some mutual funds. I transferred all the funds to another brokerage house, but then repurposed all that money into General Dynamics, Berkshire Hathaway, Apple, and Chevron. Amidst all that, I was left with $56 in change. Since then, I have checked the “DRIP” option on each of those to route all dividend payments into new units of stock. So what was I to do with that loose change in my Roth sofa?

I decided to buy one share of British Petroleum (BP). You may remember them as the company responsible for the oil leak in the Gulf back in 2010. Their stock price had peaked at $61.64 until that catastrophic leak. Their stock price plummeted. Despite paying out almost $42.2 billion in claims and resolving federal charges laid against them by the Department of Justice and the SEC, BP still generated $400 billion in revenue last year. This has resulted in a P/E ratio of 5.09 while sporting a dividend yield of 5.0%. I don’t think I’ve ever seen a stock selling so cheap while having such a high dividend yield, such that those two numbers are the same! My hope is that BP will successfully weather this storm and continue to generate dividends which I can use to grow my position.

Some of the risk involved with investing in BP is that there may be more claims coming. There are chances they may have to pay some other fines as high at $17.6 billion. They also made a dividend cut, which explains why Dividend Growth Investor sold his position after holding it for a long time. Hence the reason I only entertained using this as a place to invest the change in my sofa. I’m not ready to buy a bigger position in BP, and I don’t have the spare capital right now to do so. This move certainly puts BP on my shortlist of stocks to watch. There are others I’m monitoring as well. We’ll see how it does.

P.S. After writing this article, I observed that Dividend Growth Investor has purchased a new position in BP. Go figure!

How much does maxing out your IRA go towards your retirement?

I just received an email from my discount brokerage firm. Most of the emails I receive from these financial houses are oriented towards mutual funds and IRAs, because, of course, that is what they sell. It’s only natural. The only other emails I get is when I perform some transaction.

Today I got one that read “Even if you are only 10-15 years from retirement, you can still save a substantial amount in an IRA.” Is that true? What would the evidence suggest?

Looking at the table they included (as well as checking the IRS web site), contribution limits for 2013 are $6500. It’s possible to save up to your total earned income, but it’s capped at $6500, so let’s assume we manage to do that. Let’s also assume we get that maximum window they are telling us of 15 years. What is $6500 x 15 years? $97,500

But don’t forget, the increase the contribution limit each year to compensate for increased cost of living. They increased it by $500 from 2012, so let’s assume they will do that every year. Using a spreadsheet, you will find that saving $6500, then $7000, etc. for 15 years creates $150,000.

First of all, how useful would $150,000 be if we were just entering retirement? At first blink, that sounds nice. But when talking about retirement planning, which hopefully would last at least 20 years if not more, it just’s not that much. If you factor in a 4% inflation, in 15 years, that chunk of money would be equivalent to $83,000 plus a latte in today’s dollars. Yikes! That kind of sinks the party.

Next, let’s think about the magic of compound interest. Everyone likes to mention that in financial articles, because it’s the most powerful tool every invented! Whether or not Einstein actually referred to compound interest as the most powerful force every created, financial advisors like to make you comfortable in your progress to retirement by making it sound as if it will always be there to catch you up at the right time.

In the article I saw they said that “you’ll benefit from time and the power of compounding to significantly grow your retirement savings.” That is a killer soundbite. Except your performance according the financial laws of compound interest can swing wildly either in your favor or against your favor.

If you restrict yourself to only investing in mutual funds and index funds, then you’ll have to be happy with averaging around 4% in annualized growth according to the Dalbar report, which won’t cut it. I took the liberty of punching the numbers up above into my spreadsheet, multiplying the total cash saved each year by a fluctuating growth rate of mostly positive growth with only one loss in that entire 15 year stretch. Considering we have historically suffered a market correction about every ten years, this should prove somewhat conservative.

You know what I got? A total cash value of $210,000. That may sound better, but it’s not a huge return after investing $150,000. In fact, that it’s only a measly 2.2% annualized growth rate!

Click on the image to zoom

You could potentially do better than the mutual funds if you invested that money into some dividend kings and reached retirement with a nice 4% yield in stocks. But don’t fool yourself into thinking this is all you need to do to retire. That kind of yield would only produce $8400 annually, averaging $700/month.

I don’t think $700/month, or $388/month in today’s dollars, counts for “significant” in retirement savings as that article implies. When these articles wave the magic wand of “compound interest” and “dollar cost averaging,” watch out. They are attempting to cast a spell on you to make you think this can grow HUGE.

Dividend kings may help you grow the net worth of your equities better than mutual funds, but make no mistake. Limiting yourself to setting aside $6500 in an IRA just won’t cut it. For example, if life interrupts and causes you to miss any of these contributions, your end results will only diminish. This is the best, and it doesn’t and consider what happens during the worse, such as a market correction the year before you retire or two corrections in the same span of time.

If you already have something else that will provide your main source of income in retirement, then I wouldn’t object to having this IRA to use as fun money. But consider this: is your other source of retirement an order of magnitude bigger in the amount of money being saved, or is it similar to this? If it’s relatively the same in total dollars saved every year, the best you can is double the outcome. Is that really going to be enough?

By all means, I encourage you to create your own version of the spreadsheet up above. Don’t like the rates I picked? Punch in your own percent growths. Try the last 15 years in average S&P 500 performance and see what you get. You may find that things don’t quite work out as well as you heard about in articles and on the radio. And feel free to contact me if you have any questions.