Learn about Mortgage Backed Securities, Real Estate Investment Trusts, and Master Limited Partnerships
These three are also considered “dividend” paying securities.
So, what are they?
Mortgage Backed Securities (“MBS”) – Exactly what they sound like. You buy some MBS shares and the mortgages paid by homeowners pay the interest. That is, until they don’t.
At that point Investment Banks like Goldman Sachs that own tons of these things start selling them to their customers as fast as they can. When the music stops it’s the individual investor that eats mud pie instead of them. And yes, this happened in 2008. Goldman was indicted and fined for doing exactly this. So were many of the other major Wall Street Banks.
When the next recession hits, you can expect overly stressed homeowners to stop paying on their mortgages, just like last time. You probably already guessed the problem – no principal protection.
Real Estate Investment Trusts (“REITS”) – Basically, these are companies that invest in real estate of different types or in mortgages of different types.
Without getting too complex, they can pay a really nice dividend (5% – 12%) but they come with risks that are sort of a cross between corporate bonds and mortgage backed securities. They can work well over time if you buy the right company, or even a basket of REITS in the form of a REIT ETF, but is your principal protected? Nope.
And that can be a problem come recession time.
Master Limited Partnerships (“MLPs”) – Most MLP’s are in the energy industry and own the infrastructure that oil, natural gas and other energy industry products move through meaning pipelines, etc. In this respect, a lot of planners look at MLPs as tollbooths on the energy industry and in many respects they are right.
So where are the problems?
Building and maintaining that infrastructure can be pretty expensive. As a result, MLPs borrow a LOT of money to maintain and increase their capacity. This works great until commodity prices crash. If your money is in a poorly managed MLP and oil stays low for more than a year or two, your principal could face some serious risks as the MLP struggles to pay it’s debt load. If their debt is too high, that MLP may start drifting towards insolvency.
There are positives in MLPs which aren’t present in other types of dividend securities. Namely, the dividends paid by MLPs aren’t legally viewed as dividends by the IRS until your original investment has been completely repaid. Up to that point, it’s considered a tax free “return of capital.”
Sounds pretty good, right? And it can be. But the income isn’t guaranteed, and your investment is still at risk. Dividend Payers like MBS, REITs, & MLPs can fit well into a retirement plan, but the question is does it fit YOUR retirement?
It’s a pretty important question to answer.
Talking with one of our experts can help.
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