The secret value of dividend yields: reduced risk of capital loss

One thing I try to bring into focus in my various writings is not only the value of various investment tools, but also their risk. There seems to a big movement afloat to find the tool with the least amount of risk. Everyone wants to dodge risk and avoid it all costs.

The problem is, you can’t. The only way to grow adequate retirement wealth is to take on risk and then mitigate it. What does that mean? It means that you recognize risks are out there and you actually have options in place if and when the risks become true. Because eventually, some risk factor will kick in.

When it comes to investing in stocks, I’ve mentioned many times how I have picked some strong dividend payers and am accumulating their dividends to either buy more shares or pay off my debt of funding. Do you know what happens anytime I mention this plan for investing in stocks to other people? I get shocked reactions.

“Your buying stocks? Isn’t that risky?”

“What if there’s another melt down?”

“Wouldn’t it be safer to buy a mutual fund or an index fund?”

These are typical reactions from people that have been coached since Day 1 by their employer’s 401K representative, by money-based magazines, by many financial radio shows, and by gobs of articles. The only place you should be putting such important money is into safe, risk free vehicles like 401K funds.

Risk free 401K funds – they don’t exist

When one of your friends tells you to pick risk free mutual fund, tell them there are none. The stock market corrections of 2000 and 2008 knocked the entire mutual fund industry on its side and caused a huge number of people to jump ship. Not everyone did, but in order to satisfy those that bailed out, a lot of funds had to sell holdings when they were down and lock in a loss for everyone involved. To make matters worse, many funds had to maintain their status, so they actually increased fees on those that stayed in!

Looking at my stock position in VNR, I can see how much the total value has grown since I bought it. It’s actually up, but only a few percentage points. But over the past few months, I have been raking in 8.5% yields on a monthly basis. Essentially, if I added up all those dividends and subtracted them from my cost basis, THAT’s how much the stock would have to dip to REALLY impact me.

Every month that I receive another dividend check from VNR is another month that my position gets more solid. This growing value of my stock position isn’t reflected in either the price of the stock or its cost basis. When looking at historical charts for the stocks performance, there is nothing that tilts the graph based on dividend yield, and hence, many people don’t see the time value of holding stocks directly instead of mutual funds.

Another place I can see this magic of secret value growth is my children’s custodial accounts. I opened an account for each and put a certain amount of money in each. I bought shares in two different stocks and set the accounts to auto-reinvest (DRIP) with each dividend. In this situation, the entire price of the stock plus all dividends will gather together over time. While the value of the stocks may slowly appreciate in value, the compound power of buying more shares will also kick in. I can already see that despite both stocks actually being negative from when I first bought them, the total value of the account is higher than the initial seed money I put in. With that, I can see that the money is truly growing, and nobody is taking out any annual fees on the order of 2-4%. (Of course, I’ll need to run this by my accountant so proper taxes are paid.)

Equity harvesting

There’s a phenomenon that I have seen mentioned in more than one place: equity harvesting.

The fundamental concept is the get your hands on the equity in your home and put it to good use. Certain articles seem to restrict the application to buying cash value life insurance. But for me, I prefer to look at everything in terms of capital and cash flows. When you get a one-time burst of money, that is extra capital. When you purchase a dividend paying stock, a renal property, or another device that pays monthly, quarterly, or annual money, that’s a cash flow.

Basically, fetching the equity from your home (which is paying you nothing in monthly cash flows) and using it buy a cash flowing stock can definitely grow your net worth. There is risk involved. This usually involves some type of mortgage such as a HELOC or a home equity loan (haven’t seen any other way to access home equity). Then the money is invested elsewhere and you must now pay off the debt you incurred.

The risk is whether or not you can pay off the debt. The risk is whether your investment will make money. If you bought stocks for dividends, there is risk in whether or not your stocks will stop paying dividends. I put the balance of my HELOC into Vanguard Natural Resources. Essentially, my stock pays me 9% in dividends and I turn around and use it to pay off my 4% HELOC. I pocket the 5% difference, and over the long term, when the debt is paid off, I will then pocket the entire 9%.

What are some other risks? If prime interest rises, then my carrying costs for the debt will go up. Right now it’s pegged at PRIME-0.25% with a minimum of 4%. Prime would have to go up to 4.5% before I would see a change. NOTE: This has nothing to do with the secondary mortgage market. Lending rates have gone up, but PRIME has not.

What have I done to mitigate the risk? Surprisingly, I bought even more Vanguard stock. I am actually earning dividends above and beyond what the balance of the HELOC would earn, which means I am paying off the debt faster. If PRIME rises enough that I can no longer pay off the debt (which would have to be pretty big), I can always sell part of the position and simply pay off the remaining debt.

The other risk is the chance that Vanguard Natural Resources stops paying a dividend or cuts it. To impact my strategy, they would have to make a significant cut. If that happens, I can still sell the stock and pay off the debt. Of course, such a move would probably have catastrophic impact to the stock price, but since I own a considerably bigger position than the debt, I could still make it out alright. But I don’t really expect this. Vanguard has done a great job at actually growing their holdings, acquiring new oil and natural gas reserves, and increasing their dividend payouts since its inception. You can say “past performance is no guarantee of future returns”, but past performance of this company shows that management is doing a good job.

When I read articles about equity harvesting, they aren’t lukewarm. Many tend to drip with derision, accusing insurance agents of ripping people off. I’m not doing anything like that. I wasn’t sold this idea by some shady agent. Instead, I learned about the value of arbitrage, dividend investing, and viewing everything through a lens of capital and cash flows. It allowed me to break out of the conventional investing molds many people find themselves in, and to apply this tactic to grow a new cash flow that will certainly be useful in the years to come.

And guess what I plan to do when my HELOC expires in ten years? I will most certainly investigate the rates and options, and look into doing it again!

Annual Wealth Building Review

It’s been a year since I started tracking my net worth. This started after I had made the big withdrawal on my 401K but before I purchased any real estate. It has been an exciting and tumultuous year! All I can say is that I wish I had started tracking my progress years ago. I might have realized sooner that things weren’t working. But there’s no value in lamenting the past.

I’ll start with total growth and then break things down to my various assets. In the past year, I’ve seen 85.48% total growth of my net worth.  That is pretty good considering I paid a 37% effective tax rate this year due to the penalties of making an early withdrawal on my 401K. With that tax burden out of the way, I’m hoping next year delivers a strong performance.

Real estate

My real estate holdings have grown by 20% since first purchase. Now take that with a grain of salt; the values are based on Zillow. I won’t really know the value until I sell a unit. But at least it gives me some sense of their value.

My Florida town home has increased from it’s purchase price by about 12%. This isn’t of much value, because I don’t plan to sell it. But instead, it gives me reassurance that I bought it at a good price. All the other short sales that were going on in the same subdivision are gone, and they have even built a new building in this yet uncompleted neighborhood. These are all signs of the real estate recovery in Florida. It definitely shores up future opportunities in case I need to open a HELOC against it to access any cash.

Mortgage debt on my rental properties has dropped by $7200. That’s only a 1.7% reduction in rental debt, but I just started paying off the smallest mortgage by an extra $1000 this month. So, you’ll have to read next year’s annual report to see how well this feeds my wealth building plan.

I could pencil in the value of my new home I purchased back in March and look at its appreciation, but there is no value in that. Nor is there any benefit in looking at the growth of my previous residence either. Instead, what’s more important is how I used this unplanned opportunity to open a new position in wealth building. Which leads us to…


My biggest stock position is Vanguard Natural Resources. But you can’t measure it’s performance by growth in value. That’s because the monthly dividends are being used to pay off my HELOC. The price of the stock doesn’t show a big growth history like Berkshire Hathaway. To best way to illustrate its growth is to take its value and subtract the HELOC balance.  That would show where all the spare dividend cash has been going.

I started with a little over $1000 of VNR a year ago. I have increased that position several times. But back in March, I plunged in by putting the left over cash from the sale of my previous home (made possible by the HELOC used for financing) into more VNR. So far, I have reduce my HELOC balance by -0.82%. It doesn’t sound like much, but I have only been using this cash flow machine for a few months. Next year, the fruits of that should begin to show much better.

My position in Berkshire Hathaway has grown by a modest 6%. My position in Apple has grown by 21%. That is partially because I bought more Apple when it dipped below $400/share. I still believe Apple will continue to grow and innovate, and with the amount of cash they have, it feels like a safe investment to me.


My EIUL has done exactly what is was supposed to do. My contributions were increased back in May by 4% to represent cost of living increases. It is slightly ahead due to some small credits being paid. It’s actual value compared to the amount of contributions represents a 5.1% growth factor. This isn’t bad considering I’m paying big values. But the most important thing it is doing right now is locking in its growth. The value of it will not go negative, and when the next market correction appears, it will keep chugging along even as my stock portfolio takes a hit.

401K and Roth IRA

I still have my 401K with my current employer. It’s value has grown by 31%. My Roth IRA, which are refocused on holding stocks and reinvesting by DRIP, has grown by 22%.

If I assume that the real estate holdings are unrealistic, it might suggest that the rest of investment plan is actually doing worse than these plans. But these plans are currently riding the tide of QE from the Fed and other factors. When the next correction hits, they will probably get a hard knock. My Roth IRA might be okay, because I have refocused it on stocks and not mutual funds. But considering I can’t put any more money in it, it’s fine where it is.

Next year

Next year’s report should be more exciting because I have upped the pay off of one rental mortgage by $1000/month. That combined with 100% occupancy is also helping me to increase my rental cash reserves by $1000/month as well. When things get replenished, I can direct that money towards a rental mortgage and knock it out even faster.
Do I expect the same amount of growth? Hardly. 85% growth in one year is actually way above the mean. You should never depend on it or think you can keep it up. A big piece of this is Zillow telling me my rentals are probably worth more than I could actually get for them. In the next five years, when I finally sell one, I’ll get a proper correction to my net worth.

But there is one thing I’m sure of: everything is doing much better now that I have taken an active role in wealth management.

How to build retirement wealth

If you are a new reader here, perhaps it’s time for an introduction. I like sharing my opinions on how I am building retirement wealth. I also like to document how my own investments are doing. Some of these ideas might sound outrageous or in contradiction to what you’ve heard from your financial planner, financial adviser, or some popular radio hosts.

But the concepts I lay out in my articles are backed up by historical evidence. In fact, I look at history to try and determine the best ways to build wealth. Do you know how you always hear “past returns are no guarantee of future returns”? While true that there is no guarantee, trying to shirk the past and it’s strong evidence is reckless and frankly won’t lead to a good retirement.

So what are the investment vehicles I employ?

  • No mutual funds.
  • No 401K or IRA wrappers.
  • Direct ownership of stocks (not mutual funds).
  • Leveraged real estate
  • Over funded cash value life insurance (also known as permanent life insurance)
  • Build wealth using various forms of arbitrage

These may the types of vehicles I use, but it also includes the concept of actively managed wealth building. Some of these vehicles may be considered passive forms of income, but it takes an active approach to do it right. The concept of simply dumping money into a mutual fund inside your 401K and assuming it will grow to serve you in retirement just doesn’t work.

No mutual funds

The Dalbar report has been monitoring mutual funds and tax deferred savings plans for 20 years. According to the 2013 report, mutual fund investors have significantly underperformed the S&P 500 over the past 3, 5, 10 and 20 years. In 2012, they reported the average performance of investors in equity funds was 4.25%. They further indicate that this is mostly tied to investor behavior rather than fund performance.

The performance numbers are clear: people investing in mutual funds average poorly. Dalbar goes on to make a judgment that it’s the consumer’s fault. This might or might not be a valid judgment. But is that relevant? If people don’t do well, and haven’t been for 20 years, do I really want to plan my retirement under the assumption that I can beat the average? I’m sure it’s what most others think. Dave Ramsey is happy to quote the FDIC in saying that 97.3% of people don’t follow through on their promise to pay off a 30-year mortgage in just 15 years with extra payments.

So why would we expect people to follow through on their attempt to not buy when things rise and sell when a market correction hits? I prefer to build my wealth building plans using the averages.

No 401K or IRA wrappers

401K and other government wrappers come with an incredible entanglement of regulations, restrictions, and other tricks to basically keep your hands off the money. The concept is to get you to put away money and keep your hands off of it until you reach retirement age. But many investment houses take advantage of this situation in the sense that mutual funds and other vehicles available tend to have the highest expense ratios.

People will eagerly point out things like IRAs as giving you more control, but the government has strong limits on how much you can put into an IRA. Suffice it to say, the limits on IRAs aren’t enough to build a retirement plan.

And do you really think the government designed the 401K to help you set aside money and save on taxes? The government wants you to put away money today without paying any taxes, so that you will grow the money into something bigger, and then start paying full blown income taxes when you reach retirement. Yikes!

It’s true that I have a Roth IRA and a 401K, but that is money I put in before I realized it wasn’t working. As you’ll see below, most of that money has been re-applied and is already making way more than what it used to. The only money I have left is trapped in my current company’s 401K and I can’t get to it. The Roth IRA I have is small as well and would serve little benefit if I extracted it.

Direct ownership of stocks

This one really stuns some people that I meet. I don’t like the dismal performance of mutual funds combined with their fees. Instead, I prefer owning stocks directly. If you look at all the studies done over the years, there is one stock market strategy that has proved fruitful: buying and holding dividend-paying stocks.

If you look at people like Warren Buffett, they have created billions by acquiring strong companies when they were on sale. Warren Buffett has also bought cash flowing stocks and companies, and reinvested their proceeds in other strong companies. This has created a compounding affect that has let him beat the S&P500 for years by great margins. The book value of Berkshire Hathaway has averaged it’s growth by 28% during the boom years, and by as much as 18% during bad recessionary times.

It’s not hard to find solid companies. In fact, there are many blog sites dedicated to this, such as Dividend Mantra and Dividend Growth Investor. The companies they invest in are not fly-by-night shady outfits. Instead, they mention thinks like Coca-Cola (KO), Walmart (WMT), and other names you’ll recognize. Companies like Coca-Cola have created millionaires for decades. You can find a list of companies that have paid consistent dividends, increasing them year after year, for over 25 years. It’s not that hard. It turns out, these are some of the best investments regarding inflation. A company that has managed to increase payouts to its shareholders through thick and thin is pretty solid.

Leveraged real estate

After the 2008 housing melt down, many people won’t entertain investing in real estate. The problem is that newspapers were reporting the worst scenarios regarding foreclosures. The truth is, 99% of mortgages are current and paid for. The number of people that suffered rate hikes on risky loans while having insufficient money to keep up were a fraction of a percent.

Real estate has shown a more consistent growth rate than mutual funds. And real estate is one of the easiest investments for middle class people to get into. Using prudent leverage, an average 4-5% growth can turn into 20-25% growth in your investment capital. That certainly beats the 4.25% average growth of mutual funds. Again, this is what happens if you use the averages. You can make more and take on riskier, higher paying options, but why take a risk? You’re already ahead of what mutual funds in 401K wrappers have to offer.

Since real estate was a no brainer, I cashed out my 13-year-old 401K from my old company, paid 37% in taxes and penalties that year, and used it to buy two duplexes with 20% and 25% down. I couldn’t be happier.

The rentals I own are paying me a nice monthly profit as the tenants pay off the mortgages for me. I keep a fair amount of cash in reserve to handle vacancies. And seeing my property yield monthly cash helps me to focus on that instead of pure growth in value.

Over funded cash value life insurance

This is one that stirs a lot of discussion. People have been preached to that cash value life insurance is a rip off and to never, ever, ever buy it! Phrases like “buy term and invest the difference” as well as “don’t mix insurance with investments” flies all over the place.

The thing is, many of the people that preach this opinion have an incomplete knowledge of how it works and how it was designed to function.

To be clear, I’m talking about EIULs, or equity indexed universal life insurance. And the critical component is over funding the policy to the limit set by the IRS. Essentially, buy a policy where you get the minimum amount of death benefit for a given amount of money. That causes your cash value to build faster. If you get the maximum amount of death benefit, then your cash value grows very slowly and it becomes an ineffective tool in storing wealth.

EIULs that are over funded give you the option down the road to borrow from the cash value. Essentially, you borrow money (without paying it back) and when you die, the loan is paid off with the death benefit. Whatever is left over is passed on to your beneficiaries.

EIULs have the benefit on not investing in the stock market, but instead in European options on the market. This is how they institute caps such that your principle is guaranteed to growth somewhere between 0% and 15% of the index it is linked to. If the index goes negative, your cash value stays the same. But if the market goes positive, so does your cash value.

You may not be aware, but that facet is incredibly powerful when it comes to wealth preservation. So many people have seen huge booms in their mutual fund holdings, but the overall performance is knocked back to that Dalbar average of 4.25% due to losses. If your account shrinks by 30% in one year, and then grows by 30% the following year, are back to where you started? Nope. $10,000 would drop to $7,000 and then grow back to $9,100. But if you had an EIUL, that $10,000 would stay put, and then grow to $11,500 (0% loss followed by a 15% gain based on the caps).

EIULs are very expensive for the first ten years; a fact many people like to point out such as Suze Orman and Dave Ramsey. But after ten years, the fees drop to almost nothing. After twenty years, the fees will probably average between 0.5-1.5%/year. Sure beats the 2-4% average cost of mutual funds. And then you get to start taking out tax free loans (compared to mutual fund payments at income tax rates), there is even less to fret about in retirement.

Once I understood the entire picture of what EIULs could and couldn’t do, it was a simple decision to stop investing money in my company 401K and reroute that money into an EIUL.

Build wealth using various forms of arbitrage

Something people are unaware of is how banks make money. Banks borrow money from the Federal Reserve at rates like 3.25% and then turn around and lend it out at 4.25%, pocketing the 1% difference. You can use the same concept.

I took out a HELOC against my home for (PRIME-0.25%) with a floor of 4%, so right now, it costs me 4% to get this money. Then I bought a position in Vanguard Natural Resources, an MLP that has been paying 9% distributions on a monthly basis. As I pay off the HELOC, I am essentially pocketing the 5% difference.

This is also referred to as equity harvesting. All that equity in my house was earning 0%. I am getting the cheapest form of money available, a mortgage, and using it to collect cash flowing assets. After I pay off the HELOC, I can redirect the money towards paying off investment mortgages, buying other dividend aristocrat stocks for even more passive income cash flows, or increase my position in Vanguard Natural Resources. And at that point, I can also renew the HELOC to get more investment capital.

When people ask “would you take out a $50,000 loan on your house and invest it?” my answer is a resounding “yes!”

Stay tuned

I hope you enjoyed this introduction to the concepts of build wealth at the Wealth Building Society. Wealth building isn’t hard, but when you boil things down to sound bites used by radio entertainers, some of the worst advice gets out there. Are the people that are telling you to only take out 15 year mortgages and pay them off as fast possible retiring on mutual funds? Are these people maxing out 401K and IRAs, or are they building wealth through writing books, running TV and radio shows, and piping their business equity pay offs into rental property?

VNR raises dividend 1.2%

Vanguard Natural Resources (VNR) has posted notice that it is raising their monthly dividend from $0.205 to $0.2075 per share per month. This is a 1.2% increase in dividend payouts and comes to $2.49/share every year. It results in a 9.2% dividend yield.

I’m really excited about this. By itself, it isn’t a huge increase. With my position in VNR, it results in an increase of about $7.49/month. Doesn’t sound like much to write home about. But it demonstrates VNR maintaining their historical pace of increasing dividend payments. I am eager for them to continue this over the long term, which will let me pay off my HELOC faster.

After that is taken care of (in an estimate 8 1/2 years), the money will be invaluable to contribute towards paying off real estate loans. Or perhaps I can invest it in other stocks. Or maybe I’ll run into unforeseen circumstances where an extra boost of cash will help deal with something. Every dollar I get through VNR will be thanks to my willingness to take on some low cost debt today in order to build wealth for tomorrow.

Diminishing returns

I’ve previously written about how I took the proceeds from the sale of our old home and used it to buy a big position in VNR, an MLP stock that is yielding almost 9% spread out in monthly payments. I am using the monthly distributions to payoff my interest-only 4% HELOC and pocketing the difference.

So what do you do when the stock goes on sale? I bought my position at a relatively cheap price of $27.85/share. It’s a good deal, considering the stock has fluctuated all the way up to $30 in the past year. But in the past month, due to an SEC investigation of one of their competitors (not VNR itself), the entire MLP sector has shed lots of investors. I have seen it hit bottom $24.23. Buy more? After all, buying companies with solid business but suffering from some emotional panic on Wall Street is a key strategy employed by Warren Buffet.

Well…that depends. While that’s a great price, I have to look at it through the lens of my entire wealth building plan. Let’s see what we can figure out.

Is this too much exposure?

My plan (not necessarily your plan) is to have rental property as my #1 investment with quality, cash flowing stocks as #2, and liquid capital as #3 to hedge my plays. I have already built up a very nice position in VNR, so if I had the cash to buy a similarly sized increase, I have to ask myself if that cash would be better spent knocking out a rental loan.

Knocking out a rental loan doesn’t have the same immediate cash yielding benefit as buying more stock. But the sooner you pay down a loan, the sooner you can sell and releverage that property into more real estate. Using prudent leverage, that same amount of cash can probably produce a higher yield over the years in real estate than buying more VNR. Hence, buying too much VNR could hamper my real estate growth.

What about the other parts of my wealth building plan?

Any good real estate portfolio needs cash to hedge things. At certain times, it’s best to put extra cash into your cash reserves. Instead of investing in other things, it’s best to stuff it in the proverbial mattress. That’s why when new money comes along, we need to see where it fits best.

From time to time, our cash reserves can get depleted and we need to shore things up before taking on new investments.

What will be my net yield?

If it’s not a big chunk of cash, but instead something smaller like $100, $1000, or even $5000, then it’s probably not worth it. The rule of thumb is that I get $7/month for every $1000 of VNR I buy. Even $5000 more of VNR would only yield $35/month more. That’s not even a 10% increase in my current monthly yield, so I doubt this is the right place.


Bottom line, I have a good position in VNR that should provide a nice monthly cash for many years to come. I don’t need anymore. Instead, I’m going to check the other parts of my wealth building plan and decide where to apply the next chunk of change.

Tax deferred mechanics of MLPs

I have seen many articles where people discuss buying and selling MLPs. There are some finer points not covered in most, and its taken me awhile to learn them all, so I thought it would be perfect to capture them here.

First of all, when you buy units of MLPs (master limited partnerships), the cash distributions have many tax advantages. Before we get too deep on that in this article, let me first prep you on some terminology.

  • MLPs have units, not shares
  • They pay distributions, not dividends
  • They have cost per unit, not price per share
  • They have earnings per unit, not earnings per share
  • All things are reported on a K-1, not some 1099 variant

There are other terms, but you get the idea. The terms are relatively interchangeable, but it’s important to realize you aren’t buying shares of a classic corporation. Instead you are buying a stake as a limited partner in a company that doesn’t pay any taxes.

Tax deferred benefits

A huge majority of the cash distributions are tax free (probably 80-90% of it). You won’t know precisely how much until you get your annual K-1 statement.  The small amount that doesn’t fit this will be considered ordinary income, and it’s possible to have losses.

The tax deferred part is considered return of capital. This means that you won’t owe any taxes until you earn back your original purchase amount. After that, anymore return of capital requires paying capital gains tax rates. According to 2013 tax codes:

  • It’s 0% taxes if your income is in the 10-15% bracket
  • 15% if you’re in the 28-35% bracket
  • 20% if you’re in the new 39.6% bracket, plus some supplementary taxes tied to Obamacare
In exchange for not paying taxes on the distributions, your cost basis drops with every distribution. This means that if you plan to sell, the tax ramifications could be big. But if you can keep your position then it becomes a very well structured cash flowing asset.

Let’s dig a little deeper with an example. You buy 1000 units at $20/unit. That means you plunk down $20,000. The distribution is 8% at $1.60/unit. Spread over quarterly payouts, you can expect 40c/unit every three months. In this case, we can expect $400 every three months, adding up $1600 in annual distributions.

Now let’s assume that 90% of the distribution is return of capital. First of all, it means that $1440 of that distribution is tax deferred. We get to keep it all. Only $160 is considered personal income and has to be reported when we file our federal tax statement. If we were in the 28% bracket, this $1600 distribution would result in us owing the IRS $44.80. Not bad!

In exchange for deferring $1440, our cost basis of the stock will drop from $20,000 to $18,560. That means that if the stock price didn’t move at all and we sold our entire position, we would still have to report a capital gain of $1440.

Heck, if the market value of our position fell to $19,000, we would have lost $1000 in stock value, but still be viewed at a $440 gain in appreciation in the eyes of the IRS.

Now do you see why I advocate not selling ever? At this rate of payout, we can expect to get almost 14 years of payouts before our cost basis drops to $0. At that point, if we are in the 28% tax bracket, we would have to start paying taxes of $216 on top of the regular taxes we have been paying all along, still leaving us with a tidy sum of money every year. Of course many MLPs raise their distributions down the road, which totally changes the numbers. We might reach a $0 cost basis much sooner, but if that is the price for getting a higher distribution, I accept!

When you pass away and your heirs or beneficiaries inherit the units, they get a “stepped up cost basis”. This means that the entire cycle begins anew as their cost basis is reset to the current market value at the time they inherited the units. The cash distributions are once again tax deferred until their entire value is paid back. For the record, if your heirs wanted to cash in without a huge tax bill, this would be ideal time to do it before the cost basis drops.

Another piece of the MLP puzzle is the fact that they often do business in multiple states. Because you aren’t shielded by a corporation, you as a limited partner, are viewed as doing business in every state where the MLP operates. You might have to file state income taxes in certain states. Vanguard operates in nine states, so the total distribution is spread across them, and the states that do have income taxes typically have a minimum dollar threshold you have to cross before having to file a return. It means that unless you own huge amounts of the MLP, this might not even be an issue. Talk to your CPA for more details.

It’s quite a good cash flow machine if you can find spare capital or possibly finance it at today’s low rates (like an interest only HELOC). The critical thing is to understand the tax mechanics of MLPs so you aren’t surprised.

Increasing my position in three valuable stocks

I recently increased my position in Apple (AAPL), Berkshire Hathaway (BRK.B), and Vanguard Natural Resources (VNR).


Apple has taken a beating over the past six months, which has caused their price to fall. From a technical perspective, the debate rages on about whether it’s time to buy or sell. But I don’t buy stocks purely from a technical perspective. My wealth building plans don’t involve buying a stock one day and then selling it week later if it increases 5%. That is the behavior of day traders. There are countless studies that have shown that day traders, on average, lose money. In this one, it is reported that 8 out of 10 day traders, over a six month period, lost money.

Instead, my stock investments are driven by more fundamental concepts. Is Apple going to continue to making money with the iPhone? What about the iPod and iPad? Will Apple continue to innovate and make new, ground breaking devices? They have a long history of developing new concepts in consumer electronics and generating a healthy profit. The fact that I’m writing this post on my MacBook Pro (which I’ll never give up due to it’s quality) is another data point.

In April of this year, Apple reported $43.6 billion in quarterly revenue, up from last year’s Q1 $39.2 billion quarterly revenue. Increased earnings is important. Their profits sank slightly from last year’s $11.6 billion to this year’s $9.5 billion, so I’ll be keeping an eye on that. They sold 37.4 million iPhones this quarter compared to 35.1 million in last year’s quarter, a 6.6% increase. They also pulled in $12.5 billion of cash flow from operations leaving them with a cash balance of $145 billion. They are sitting on a huge mountain of cash, and part of the suspense is that they haven’t decided where to plow their huge cash proceeds. Should they decide to develop some new product, they have the cash in the bank to move forward. So I took advantage of the drop in price and increased my position.

Berkshire Hathaway

It seems awkward when people keep betting against Warren Buffett. I see article after article pointing out how now it seems time to bail on Berkshire Hathaway. Others frame it like “Five Reasons Why It’s Time To Sell”. Frankly, Buffett’s got a much longer historical record than any of these people writing the negative articles. Go back in time, and see how people reacted when Buffett dodged the tech industry.  People thought he was daft, had lost his touch, and yet, Berkshire Hathaway didn’t get crushed when the Dot Com bubble collapsed. If you read the annual shareholder’s report, you will get a lot of insight in Berkshire Hathaway operates. It’s probably more akin to the concept of a mutual fund without the nasty issues mutual funds contain. The company owns or has significant investment in over sixty companies. It has had a good 18-28% annualized growth in book value of the past 40+ years. And when others bail out, it doesn’t cause bad results to lock in, the way mutual funds do. You can think of it like a mutual fund, except the person running it has a long, public record compared to the unknown person running your mutual fund, who has no obligation to actually meet your needs, just their own brokerage.

Vanguard Natural Resources

The last company I have poured more money into is Vanguard (not to be confused with Vanguard Brokerage). Vanguard is a master limited partnership. This means they pay 90%+ of their earnings as distributions to unit holders. These payments are essentially tax free. An added benefit is that this company distributes earnings on a monthly basis rather than a quarterly one. I’m using my position in it to pay off a HELOC and hence keep my position. In the long run, if I can pay off the HELOC, I will have a cash flow machine that won’t stop. I can then point it at my rental portfolio and let it help me continue to build wealth. Combine that with their history of increasing payouts, and it sounds like a good deal to me. What are the taxable implications? Instead of paying taxes on the monthly distributions, you pay taxes on the depreciated cost basis. This means that while you hold the stock, it’s original cost basis keeps falling. So if you sold it one day, at a loss to the price you originally paid, you might still face a hefty capital gains tax. But considering my plan is to never sell the stock, it makes for a sweet deal.

While I have a nice pile of cash sitting around to cover my real estate play, it doesn’t hurt to plow some spare cash into companies that I have done extensive research on. I’m only managing five stocks, so it makes it possible for me to track what they’re doing. If I was trying to handle 200, that would be impossible. I’m also not stuck with the decisions of others when they decide to bail on their mutual fund. Warren Buffett doesn’t have to liquidate anything if there is some downturn in the price of the stock, compared to a mutual fund manager who doesn’t have enough cash on hand. Instead, he can focus on what he needs to do: find better deals, invest when the price is down but the quality of businesses are up, and continue to grow the value of the shares of which he owns more than me.

Always be prepared if you receive chunks of money

It’s good to always be thinking, “what would I do if I had a bunch of money?” I was reflecting on a previous article I had written, and really observed how the people that get a lump of cash often call a radio show because they DON’T know what to do. It’s important that we aren’t caught off guard and panic, but instead are prepared with a plan in mind.

The reason is, opportunities occur. We need to be prepped and ready to go with putting that money in action. For a long time, many years in fact, I had developed an approach that any big chunks of money I received would be sent into a spare bank account. I would “park” the money there, and let it collect. That way is was a little out-of-sight/out-of-mind. Every few months, I would examine the bank statements, and think about what to do with it.

Back in 1999-2000, before banking went online, I worked a particular assignment that paid me double my usual salary. I also had huge reimbursements for food and lodging. So I called up my local bank and asked if I could set up an automated deposit to another bank. My checkbook was filling up too fast! They said sure, not a problem. Apparently, they’ve been doing this type of stuff for decades!

Suffice it to say, working this way for over a year allowed me to sock away plenty of cash. At the time, I bought mutual funds and also kept enough cash to put a down payment on a house a couple years later. I didn’t just spend the money on things, I saved for the future.

What about today?

My wealth building plans of today are very different than back then. At one time, a few years ago, my plans had shifted to the point that if I came in contact with a big sum of cash, I would focus on paying off our primary mortgage. Much to my benefit, the money didn’t materialize before I learned to NOT DO THAT.

Here is my current mental process for dealing with big sums of cash:

  • Can this money be used to buy cash flowing assets (real estate or VNR)?
  • Would the cash flow be enough to pay any carrying costs and still profit?
  • If not enough for real estate or VNR, what about a solid growth stock like BRK-B?
  • Have all costs, risks, and rewards been considered?
That is how I was able to take the sale of my previous home and quickly figure out that it would be better to buy a big position in VNR instead of paying off the HELOC. When the HELOC costs me 4% and VNR pays 8.6%, then the profit margin is clear.

I am also looking at cashing in my next stock option to buy even more VNR in order to pay off the HELOC faster.

Finally, when I withdraw the remains of my 401k, I’ll probably buy another chunk of BRK-B. There are no carrying costs involved with that chunk of money, so I think it would be good to “park it” in BRK-B. Should pay much better than a money market fund let alone some index fund.

What do these options provide?
I’m now at the point where if one part of my wealth building plan needs help, another part can assist. For example, if BRK-B grows really fast, it’s always an option to sell a piece of it and pay off a real estate loan. Or if I build up enough VNR and pay off the HELOC, I can target the monthly dividend towards the rental loans or buying more BRK-B. Or I can sell one of my rentals and buy another EIUL in four years and a day to lock in the wealth.
Options beget options. The more active I make my role in my investment plan, the better I seem to do. It also pays to get out of investment vehicles that offer little if any choices and have a bad history of performance (401k and mutual funds anyone?) By being ready with plans in place, we are more likely to spot these opportunities and not get steered into destroying our wealth building vehicles like mortgages out of panic from some radio host.

Are you ready to seize the opportunity?

A couple months ago, I was presented with an opportunity I had not planned on when I initially formed my wealth building plan. I bought a new house using a little bit of creative financing. While we got a classic 25% down, 30-year mortgage, we opened a HELOC and borrowed an additional 15%, allowing us to reduce the amount of capital outlay.

This was all designed to let us sell the old house after we moved and minimize the amount of cash we needed to transition. But it opened the door to another wealth building opportunity. On one hand, I had an interest-only loan at 4%. On the other hand, I had a big check from the sale of our old house.

In classic money management, the natural approach would be to simply pay off the HELOC. But there are other options out there. I had already done the leg work of researching stocks, real estate, and some other things. One of the stocks I have a position in has been paying consistent, increasing dividends for over five years. It’s an MLP which meant that it has to pay over 90% of its revenues to stock holders resulting in a high yield around 8.5%.

The opportunity was to make money the old fashioned way: arbitrage. Banks borrow money at one rate and then loan it out to consumers at a higher rate, making money off the difference. We can do the same. In this case, I had a lump sum loaned out to me at 4%, interest-only and could increase my position in VNR that would pay me 8.5% on a monthly basis. Each month, I can take every dollar of dividend and put it towards the HELOC, slowly paying off the balance of the loan. Eventually, I would pay off the HELOC and be left with a nice investment in a well paying stock!


To make wealth building decisions, we need to identify and weigh the risks. We also need an exit strategy. Essentially, we need to be ready to handle things if the risk actually kicks in. So let’s list them out and see if we can spot a way to mitigate each one.

  • HELOC interest rates rise
Right now, the gap between the HELOC and the stock is over 4.5%. If the HELOC rises 2-3%, there is still a profitable margin. Even if the HELOC rises 5% and somehow the stock does NOT increase payouts (like they have for the past five years), I don’t have to panic. That probably wouldn’t happen overnight, and it would still be possible to sell the stock position and immediately pay off the HELOC. I would have still made money.
  • Stock value plummets
This is definitely a risk when buying any stock. Stocks are driven by logical circumstances, but they are also driven by irrational behaviors as well. The key is to not get swept up into day trading and instead look at the big, long-term picture. In our situation, it’s important to realize that dividend yield is the critical value of buying more VNR, not appreciation. We aren’t monitoring the stock for appreciation, but instead seeing that it keeps up its dividend payoffs. If the stock price plummets, we need to watch it and see if dividend payouts are being threatened, or if instead, it presents us with an opportunity to buy a bigger position. After all, one man’s panic is another man’s opportunity. If we keep getting the same dividend, then we can stay put and continue building wealth.
  • Dividend payouts fundamentally change
The key part of this wealth building activity is to get regular dividend payouts that far exceed the cost of the HELOC. If the board of VNR stops making dividend payments or severely cuts their payouts, a serious reevaluation must be made. Some of our options on the table include selling the stock position and moving the money into a competitor. It’s a valuable reason to research VNR’s competitors, and there are many. That means that this wealth building activity doesn’t have to wrap up with paying off the HELOC.
If all of these risks materialize at once, what then? No doubt we’d be in the middle of a a catastrophe! What then? First of all, we must recognize it’s a highly unlikely situation. Even so, what would we do? Simply put, if the stock position drops and dividend payouts cease, then we can no longer continue our original plan of using the stock pay off the HELOC. Time to get out.
I have liquid cash as well as multiple investment properties. I could refi or sell a property and pay off the remaining balance of the HELOC. Or by that time, I might have another investment vehicle in motion that could take over paying off the HELOC. Any way this goes down, if this tragic change were to happen five years from now, we would have definitely accumulated more wealth. What’s critical is having the research, options, and ability to seize this opportunity that fell out of the sky, and then actively tracking our progress.
So we’ve viewed the risks and weighed them accordingly. What rewards does this present us with?
  • By seizing the HELOC money and investing it into an MLP stock, we might eventually pay off the HELOC and continue receiving the dividend payouts.
By building up a position in a tax advantaged stock like VNR, we can continue to pipe that dividend payout into other opportunities, like paying off real estate investment loans. We could buy more VNR and increase our position. We can also use it to buy up an alternative like BRK-B.
  • VNR continues to increase their dividend payouts.
Right now, the payout is about 8.5%, which is already pretty good. Maybe that sounds like peanuts because you’re financial advisor promised 12%. But let’s assume VNR continues its trend of increasing payouts. It’s possible I could be receiving 15% sometime in the future, perhaps after paying off the HELOC. Or maybe the increases come sooner and help me pay off this fixed debt faster. That would be great! It’s one of the reasons for investing in stocks that have a history of increasing dividends.
  • MLPs weather inflation pretty well.
MLPs by definition are involved in storage, transportation, and delivery of natural resources like oil and gas. Those commodities tend to increase in value with inflation. Their stocks do as well. That means as inflation rises, the chances that our stock value and dividend payments would rise is pretty good. It might not happen at the exact same moment, but in general these markets travel together. That makes this a good long term investment.
  • Every dollars invested in paying off the HELOC is another dollar in our pocket
The HELOC gave us the opportunity to build some cash. Every dollar of dividend that goes towards the HELOC reduces our total liability. It also slowly reduces the monthly amount of interest we owe.
Would you really borrow money to buy some stock?
I hear this question often on radio shows and in blog articles. People have a life altering event that suddenly drops a big wad of cash in their lap. For example, a loved one passes away and they get an insurance payout. Or sometimes they got some big severance check and find another job. They call into these radio shows and want to know what to do with all this money.

The fact that they are calling into the shows is a strong indicator that they don’t have a well developed wealth building plan. The tone of the callers often indicates they haven’t really learned about stocks vs. real estate vs. EIULs vs. other options to build wealth. Instead, it seems like they either have some mutual funds or nothing. I don’t hear much else, except the rare instance of a perhaps living in one side of a duplex and renting out the other side.

The host often tells them to go nuke the mortgage on their house. Sometimes you hear doubt in the caller’s voice. Some even ask, “But I could invest it, right?” To me, it sounds like a glimmer of hope that they could make some money. Why? Because silently, they know their current plan isn’t working. The followup from the host is usually what’s meant to be a softball question, “Would you walk down to your nearest bank and borrow that money to invest it?” The caller always answers “heck no!”
If someone asked me the same question, I would answer a resounding “yes!” If given the opportunity to borrow at 4% interest-only and invest in something with a steady payback of 8.5%, then I would definitely make a profit! But most people haven’t spent any time actively putting together a wealth building plan, so when these life changing events happen, they aren’t prepared to seize the opportunity. Are you? If you’re not sure, contact me and we can talk about it.