VNR files for chapter 11 bankruptcy

For those that have followed along, you know me to be an investor in Vanguard Natural Resources.

Today they have requested chapter 11 bankruptcy. This is also known as reorganization. It’s a way to restructure existing debts and keep going, not dissolve the company. So I’m not panicking.

Price per unit is around $0.35 or about 10¢ on the dollar the price I invested. Frankly I wish I could get in at this price.

Nevertheless I’m long on VNR as in Warren Buffett long. I predict that ten years from now they will have recovered, dealt with much of their debt and be profitable again. Alas welcome to risk.

Stay tuned!

VNR suspends cash distributions

newlogo7.9.10For those of you tracking my reentry into VNR may be interested to know that VNR has suspended cash distributions for both common and preferred units. If you’re not used to deal in MLPs, it means they have suspended the dividend.

panicSo, time to panic? Time to worry? Nope. I knew this was a risk when I bought my position at $3.17/unit. At time of writing, price is at $2.44/unit. That is 23% drop in value with no cash coming.

I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. –Warren Buffett

panicInvesting in the stock market has to be long term. People that day trade have been proven over time to actually lose money. Instead, I am investing in the odds that natural gas and oil will eventually recover, VNR will resume paying distributions, and the price will rise again.

VNR has shown a strong history of making profitable decisions. Halting outgoing cash flow while waiting for commodities is a good decision.

dont-panicThe problem lies with emotional investors. People that either depended on VNR’s monthly cash flow (perhaps retirement income) or expected to make a quick buck, are more likely to panic and sell out now, locking in a solid loss.

I don’t need the money today. Instead, I prefer to wait for the recovery.

Good luck and don’t panic!

 

What you should and should NOT do when investing in stocks

newlogo7.9.10For those of you tracking my reinvestment in VNR, you may have seen it drop to a historic low of $1.47/unit. Given I reentered the market at $3.17/unit, this is a 54% drop from what is an astounding low!

Time to panic? No. It’s time to play the market long term. Remember this:

I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years. –Warren Buffett

I have invested in VNR under the assumption that I can make cash on a monthly basis. Driven by the lower prices, VNR has already reduced the distribution to match. In my humble opinion, the further drop in prices is more emotion and less facts.

This morning I saw an article citing how VNR is in a great position for people to score some arbitrage. That is when you make money by leveraging a change in value. This article has in depth analysis on how this is the time to buy since the author is predicting a quick recovery to a more stable price.

I don’t go for that. That is betting on appreciation, something I wouldn’t do short time. But I do use that analysis to back up my assertion that the current price isn’t based on fundamental risk in the company, but instead that the market is getting loaded up on emotion relevant to VNR.

panicDon’t invest in the market if you are riding on emotion, because it will get the best of you. Emotion is the reason mutual funds are a terrible failure. We are constantly pitched how they let us sidestep the risk of the market, but when things drop, people panic because it MUST mean something is wrong.

For those that don’t sell their mutual funds during losses, fund manager are forced to sell anyway to make pay outs. It doesn’t matter if we panic or not. Other people freaking out will drag us along. If you buy individual stocks and can keep your cool and stay objective, then you can make money in the long run.

DO: Invest in stocks if you have done extensive research, you understand how they make money, and understand dividend payouts, risk of making dividend payments, and have an exit plan.

DO NOT: Invest in stocks if you are looking for a quick buck, hoping to make your money on appreciation, or need a certain cash value at a certain time in the future.

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!

VNR cuts dividend in half

newlogo7.9.10Vanguard Natural Resources, a stock I have written about many times, has cut their dividend from $0.21/unit to $0.1175/unit. That is an almost 50% cut. Good for me that I moved that money to discounted notes a few months ago.

Perhaps you’re wondering if I would continue recommending it? I would if it fits the need. For any critical analysis, you must understand the business. VNR is 85% natural gas. This has nothing to do with the oil market, which caused its price to tumble in the first place. In essence, a lot of people panicked and took a lot of the energy market down. In my opinion, VNR has been acquiring solid assets. They have a strong history of paying dividends.

To be honest, this appears like a great opportunity to collect some VNR stock at a discount. Again, if it suits your purpose. My purpose in owning VNR stock was to pay off an interest only HELOC. If my monthly payment on that debt was cut in half, it would no longer be the right tool for me.

My prediction (take it or leave it) is that VNR will eventually recover and slowly but surely be able to raise its dividend again. How quickly? I don’t know. But MLP stocks have a high payout ratio due to their corporate structure.

Thankfully I moved my money into a warrantied, discounted, first position note. It is paying off my HELOC at a higher rate than before and isn’t linked to tremors in the stock market.

I’m not a financial advisor. Don’t buy or sell anything simply based on my opinions. Do your own analysis and make your own decisions.

Goodbye VNR, hello discounted notes

Mortgage_Loan_Approved1This may be a bit of shock to the readers of my blog, I have sold my entire stock position and used the cash to buy some discounted notes.

Say what?!?!

Anybody that has read my blog for awhile is aware that some of my most passionate articles have been about my big position in Vanguard Natural Resources (VNR). And it’s true. VNR has averaged a yield to 7.5%. In fact, in light of the recent sell off the market, their dividend yield is now looking like 14%+. Suffice it to say, VNR has been pretty good. To top things off, the HELOC I used to buy a majority of my position has been knocked down by 20% thanks to monthly distributions from my past position.

So why drop something so good? Because I have something better. First, a little background.

Discounted notes

What are discounted notes? A “note” is another word for a loan. And we’re talking about real estate loans, i.e. mortgages. When you secure a mortgage with the bank, they hold what is referred to as a note. When you buy a note from someone, you hand them a chunk of cash in exchange for receiving the monthly payments from whomever secured the loan. You also take over the lien on the property meaning that you have the power to foreclose and sell the property to get your money back in case something goes wrong.

To top things off, there are different positions regarding notes. When a foreclosure happens, the notes get collected in order. 1st position notes get first dibs on collecting on the sale until their obligation is satisfied, then 2nd position, etc. The name of the game is to get a first position, discounted note, secured by a piece of real estate, ideally where the value of the property exceeds what you paid for the note.

Time for a real world example in the realm of discounted notes. Imagine someone decided to buy a house for $125,000. They go to the bank and put down $25,000 cash and borrow $100,000 at 5% for 30 years. The monthly payment would be about $536/month to the borrower.

Now, for whatever reason, the bank that loaned out that cash needs some money fast. So, they decide to sell the note. Perhaps at the time, the balance is now down to $90,000 based on past payments. But to move the note quickly, they are willing to part with it in exchange for $65,000 of cash. That’s where you step in. If you have $65,000 burning a whole in your pocket, you can buy the note and start receiving $536/month backed by a total obligation of $90,000.

What are the numbers? Over twelve months, you would receive a little over $6400. And since it only cost you $65,000, the yield on that would be 9.9%. This is not only higher than the original loan’s rate of 5%, but is in fact higher than the 7.5% yield of VNR. Tiny hint: the note I bought is actually yielding 12%. Sweet!

In addition to collecting monthly payments, people are paying off loans all the time. Let’s fast forward and imagine that we managed to collect five years of payments. That would add up to $32,160. The principal balance would be down to about $79,000 (remember, you are the one collecting the interest). At that stage, the person, perhaps through inheritance, perhaps through devote saving, decides to pay off their note by sending you a check for that remaining balance. You have now collected a total of $111,160, virtually doubling your initial investment. Given the timeline of 5 years, that would be a 14.4% ROI. With your bigger pile of money, you can now go and buy some more notes. Rinse and repeat.

Tradeoffs

So what are the trade offs? There are always tradeoffs. When you buy a stock, you can get in and out in a second. You can buy a big position, and sixty seconds later, sell it all. I built up my stock position over a couple years and then cleared it out in no time flat. I sold VNR at a peak price of $30.85/unit. Today, VNR was dragging along at $17/unit thanks to the panic of the energy market. I nicely pocketed a nice 10% total gain on the money I had stuffed into my brokerage account. That wasn’t pure skill on my end. It was fortuitous. The time frame it has taken me to cash in and wait for a note has been seven months. I have been paying off my HELOC out of the 10% gain, and still come out ahead.

All in all, it’s pretty nice compared to this recent massive sell off that has fleeced many people’s mutual fund accounts.

Notes don’t work like stocks. Each note has to be investigated. Is it a first position note? Is it a performing note (meaning the borrower is currently paying and up-to-date)? What is the value of the property that is collateralizing the note?

This is an area where DIY can kill you. You need professional people that know this industry. It’s why I have been working with Jeff Brown for about a year and his efforts to find the best note investment company to work with. Jeff has decades of note buying experience, which means he knows the questions to ask when researching companies that deal with notes. In fact, he has fine-tuned what is known as the “Bawld Guy Fund” and how it operates to make it worth my time. For example, every note this company gets appears to have a life of about 20 minutes before someone snatches it up. Sound stressful? The Bawld Guy Fund lets top tier members get first dibs for two weeks. Then second tier members (me) get second dibs for two weeks. After that, any member can go for a note. That’s fair in my book.

The note I bought also includes a warranty, so if it stops performing, I can still collect and not lose my money. Did you even know about warranties? Didn’t think so.

At the end of the day, what we seek is yield. We want to grow our net worth with a solid yield. And as Dr. Dave has shown, we need double digit growth if we expect to enter retirement with someone of value. By slowly but surely moving my investment portfolio into real estate, EIULs, and discounted notes, my net worth is not based on flimsy mutual funds, but instead on tools that minimize losses during down years, and instead, are poised to do well in positive years.

Happy investing!

How to evaluate a cash value life insurance policy

Every day that I turn on the radio, I hear cash value life insurance get denigrated. The problem is, the comments are highly generalized and rife with big assumptions that aren’t always true.

First of all, let’s back up and look at what cash value life insurance is compared to term life insurance. Cash value life insurance is also known as permanent life insurance. Some people also call it “whole life”, because that version has been around for decades. But there are other types that are NOT whole life.

Boiling things down, cash value life insurance is designed such that the face value of the policy can be paid when the policy holder dies. So how DOES it work? Basically, you buy a policy with a given face value. Imagine we picked a policy that offered $100,000, payable upon death to the beneficiary. So how can an insurance company come up with a way to guarantee paying this amount of money at some random time in the future? They collect premium payments form you, and use part of it to buy some immediate term life insurance and the rest is set aside to build up “cash value”. As more and more premiums are collected over the years, the cash value builds up.

The cornerstone of cash value

What is cash value? Essentially, it provides a cornerstone of the face value. Imagine you had built up a $30,000 cash value to back the $100,000 face value. At that point, 30% of the insurance is covered by the cash value, meaning the insurance company only needs to buy an additional $70,000 of term life insurance. At a certain point, they no longer have to collect premiums from you. Instead, interest from the cash value can be used to fund term life insurance making up the difference.

This is what leads to haughty TV and radio show hosts balking at how insurance companies “only pay you the face value” and “keep the cash value for themselves”. Ahem. If you have a $100,000 policy backed by $30,000 of cash value, where do you get the idea that they owe you $130,000?

This is just the scenario I heard the other day on the radio. Most of the time, the dollars aren’t mentioned. Instead, the radio personality seems to imply that you could have racked up $50,000 of cash value, and yet only get paid something smaller, like $25,000. That WOULD be horrendous. What they don’t mention is that the face value is typically HIGHER than the cash value.

Some real numbers

The only real numbers i often hear on various shows is how cheap term life insurance is compared to cash value. Like how dollar for dollar, term life costs 5% of cash value life insurance.

In a rare moment, I heard someone call in with numbers precisely matching what I’ve said so far. This caller had paid $20,000 in premiums over 25 years, and built up a $30,000 cash value, backing a $100,000 face value policy. His primary concern was that if he cashed in this policy in order to ditch it, he would get the first $20,000 tax free. It would be consider return of capital and not cost a cent in taxes. The host tried to say people almost never have tax consequences. But in this case, he would be facing a $10,000 profit. This is where he would need to talk to an accountant. I don’t know if that would be long term capital gains, or something completely different.

The talk show host couldn’t believe his ears. He repeated his usual complaints about how you never GET the cash value. And then I heard the caller reveal the face value of $100,000. When he dies, his wife will ONLY get $100,000 and not the additional $30,000. Instead, the insurance company is keeping that money for itself! Sorry, but that is grossly wrong. At this stage, the insurance policy has $30,000 in cash along with an additional $70,000 of actual insurance. Liquidating everything would result in a combined total of, surprise, $100,000 to pay out. There is not pile of gold left behind that the insurance company dumps into a giant vault and begins to swim in like Scrooge McDuck.

HINT: Insurance companies gear things such that they rack up their maximum profits at the beginning not the end. Term life insurance policies tend to get cancelled within a couple years. Same for many policies. Things change and people stop paying premiums. Insurance companies aren’t dumb. They want to rack up their profits early and move on.

What really stunned me was how the talk show host failed to look at the actual growth of the caller’s insurance investment. The caller has the opportunity to borrow against the cash value, perhaps to fund retirement. In that event, imagine they could borrow the entire $30,000. It’s usually something less to avoid collapsing the whole policy, but let’s assume they can take it all. We should be asking, what was the rate of return on that?

Actual yield of a whole life policy

If the caller invested $20,000 and accumulated $30,000 over 25 years, we can easily calculate the annualized growth rate. Simply take $30,000/$20,000 and take the 25th root. Result? 1.6% annualized growth. THAT is the indicator that this policy was horribly set up. THIS is the reason I would dump the policy and instead take the cash elsewhere, like buying up a big chunk of VNR stock.

With $30,000, the caller could buy roughly 1350 units of VNR. That would yield $283.50 every month, resulting in a hair over $3400 annually. In ten short years, the caller could easily double his money due to VNR’s 7.5% yield. This is much better than the dismal 1.6% yield which isn’t even keeping up with inflation. And this analysis assumes no growth in distributions from VNR.

Or take this $30,000 and buy KO, WMT, GIS, or a dozen other solid companies you have known about your whole life. Or perhaps buy a real estate note. Anything is better than 1.6% in my book.

Thankfully, the EIUL I have setup is designed properly. The face value has been dialed back to the minimum amount allowed by the IRS. This means that the cash value will grow much faster than 1.6%. My agent plugged in a estimate of about 8% based on a 20 year look minus 10%. This paints a very conservative estimate. 8% of growth is certainly possible even though mutual funds are averaging 4% thanks to an EIUL’s ability to guard against market drops.

Happy investing!

VNR increases monthly distribution by 1.2%

newlogo7.9.10VNR has announced April’s distribution will increase by 1.2% to 21¢/unit. That doesn’t sound like a lot but consider that the previous rate only ran for seven months. The previous rate went for only three months, and the one before for six months.

If you tabulate growing from 20¢ to 21¢ in 16 months annualizes to 3.7% growth of distribution. That’s not bad, but it’s not the best. According to the Rule of 72, it will take 19 years to double the distribution. But I’m willing to put up with this because the annual yield is around 8.5%, which is pretty good.

The only thing I need to fine tune is the timing of my payments on my HELOC. The due date is the 15th of the month, but I usually don’t get my distribution until the 15th or sometimes a few days later. Given the time it takes to cut a check and mail it to my bank, I am planning to pay the HELOC on time, and then transfer the distribution into my checkbook, backfilling the earlier payment.

VNR announces $581 million acquisition

VNR announced yesterday that it was set to complete a $581 million acquisition in Wyoming in January.

The land is estimated to produce 113 million cubic feet everyday of which 80% is natural gas. This is estimated to increase VNR’s reserves by 80% and it’s daily production by 55%. It’s also noted that this involves working with Ultra Petroleum to develop new drilling options. This means that Ultra Petroleum will be fronting most of the cash for new drilling activities, allowing VNR to hedge the risk.

People have noted that in the past, VNR has been very conservative. Given that their distribution is paid out on a monthly basis instead of a quarterly one, it appears they have a strong focus on providing cash flow to unit holders. Given this big of an increase in production, I easily see another distribution increase coming soon. But I also predict that VNR will hedge things in order to produce a stable increase. They don’t want to increase things too fast and have to cut later on.

People are predicting that this will catapult VNR into the ranks of LINN Energy and BreitBurn Energy Partners. Those two are strong industry leaders in the MLP market space.

VNR pays $0.2075 distribution

Like clockwork, VNR has paid out it’s $0.2075/share distribution late on Friday. Considering this is my biggest stock holding, I get a nice warm fuzzy every month this arrives. I’ve already scheduled the entire distribution to be sent as payment on my HELOC.

I also enjoy that my children’s custodial accounts have picked up some more shares of VNR thanks to reinvested dividends. I’m building wealth for myself, and for my children as well.

As a side note, I may have to revisit my spreadsheet used to track cost basis. For my other stocks, it’s no big deal. You only need to track the purchase price of each lot you own. But with VNR and it’s MLP nature, every dividend payment causes a reduction in cost basis for each lot. This means I have to track about five bits of information each month. It can get complex, but this is something I can’t depend on my broker maintaining