A common concern these days, to judge by reader correspondence, is how to invest for higher income without taking on much more risk.
It is impossible to obtain high returns without any risk. However, if you depend on investment income, and need more income than you are receiving from conservative investments, you might do well to consider other alternatives such as master limited partnerships, real estate investment trusts, and utility common stocks and stock funds.
By U.S. Code, MLPs are limited to specific businesses. Most are related to the use of natural resources, such as petroleum and natural gas extraction and transportation. Some real estate projects qualify.
MLPs differ from ordinary corporations in that they have two classes of investors: limited partners and general partners. When you purchase publicly traded shares, you are a limited partner. Although general partners own only a small percentage of the outstanding shares, they have almost complete control of the business. However, their compensation is largely based on how well the limited partners do. So it is in the best interests of the general partner to reward the limited partners.
MLPs combine the tax advantages of a limited partnership with the liquidity of publicly traded securities. MLPs generally pay dividends quarterly. In order to qualify for MLP status, at least 90 percent of the income must be distributed to limited partners. I have invested in many MLPs, and I have been very satisfied.
MLPs are partnerships, so there is no federal or state corporate income tax. Limited partners are entitled to a prorated share of the MLP's depreciation. This is advantageous to you as long as your investment is not in a tax-deferred account.
I highly recommend "The Ultimate Dividend Playbook" by Josh Peters (Wiley). Peters is an equity strategist and editor of the monthly newsletter "Morningstar DividendInvestor." This book contains an extensive discussion of MLPs, including recommendations regarding selection. He points out that three of the significant advantages of energy partnerships are predictable cash flows, high returns on equity and high dividend yields. Mr. Peters currently recommends Kinder Morgan Energy Partners (KMP), which currently yields approximately 6.2 percent, and Amerigas Partners (APU) which currently yields close to 8 percent and which he has owned for several years.
Another good source is "The 7 Percent Solution" by John Graves (Safe Harbor Publishing), a retirement planning specialist. His book has a comprehensive discussion of selection criteria. He points out that a significant advantage of MLP investments is that they tend to hold their value even when other assets fall in price.
There are tax complications in investing in MLPs. You will receive a K-1 form rather than a 1099. Your tax return will be more complex, so you should use a knowledgable tax preparer, and you will have to retain your records for multiple years. Although there may be other tax advantages, distributions are taxed at ordinary rates, in contrast to the more favorable treatment of qualified corporate dividends. In addition, MLPs are difficult to own in tax-deferred accounts without tax complications.
One way to avoid the K-1 issue is to invest in exchange-traded MLP funds. The disadvantage is that these investments are subject to corporate taxes, which reduces the return. The advantage is that you would receive a 1099 rather than a K-1.
If you are interested in MLPs but are unfamiliar with them, I recommend you do some background reading before investing. The two books mentioned above are a good place to start. "The Ultimate Dividend Playbook," in particular, contains an in-depth analysis of the advantages and disadvantages of these and other investment alternatives than can provide you with more income without high risks.
(Elliot Raphaelson welcomes your questions and comments at email@example.com.)