Friday, November 4, 2011

Fixed income, dividends, and distributions

As you might have guessed from my the title of this post, I'm going to attempt to talk about these things in terms of how a hand-to-mouth artist like you (myself included) should know.

The joy of our society is that Capitolism works.  Regardless of your political stripe if you're reading this then in some way or another you've given money to big corporate.  (Unless you live under the freeway, panhandle for change and are reading this at the public library).

What does that mean?  It means that companies make money and some (but not all) choose to split the winnings with the shareholders.

Why does that matter to me?  

It's very easy to become a shareholder and get some of those profits!  Does this make me a "Wall Street" (or Bay street) fat cat?  Hardly.  My monthly income from my investments barely covers 25% of my monthly budget.  (And since most of it is in registered accounts, I don't use it to pay for my groceries.)

Why do you want to become a shareholder?  You like money right?  Ok ok, you might hate it...  But look at it this way, if you buy a small piece of a company that you expect to be around for a very long time then they will send you your share of the profits based on how many shares you own.

For example, in Canada, any of our big banks will no doubt stand the test of time (at least during my lifetime) so if you buy 100 shares of say Scotiabank (full discolsure: I own some!) then based on today's yield will pay you $0.52 per every share you own every quarter.  (4 times a year).  It works out to approximately 4%.  

Did you have to do anything to earn this money?  No...  aside from opening a brokerage account and scraping up enough money to cover the purchase price of the shares and the trading commission.  So once you buy you can sit on it the rest of your life and every 3 months you get $0.52*(number of shares you bought).  

Will they change the dividend?  Most likely yes, it will go up.  Even during the "disaster" of 2008/2009 they kept paying the dividends.  They didn't increase the payout, but they didn't decrease them or stop them completely like many other companies.

Does this make you evil for getting profit for doing nothing?  I can't answer that one for you.

There are other types of companies that pay a "distribution" but it's essentially the same thing, but it generally arrives monthly AND there may (or may not) be some taxation differences.  Mind you if you have your holdings in a registered account than it doesn't matter.

The story is the same:  they do something, they make money, they send you your slice.

Now the last part of this posting has to do with fixed income.  What does this mean?  In the investing world it essentially means BONDS or GICs.  Now I'm not talking the "Canada Savings Bonds" of yesteryear that offered decent returns.  I'm talking about "real" bonds both corporate and government.

How do bonds work?  Well, companies don't just appear magically out of thin air...  They essentially all start with one person, or a small collective of people working together to realize their dream of being able to manufacture and sell the best widget ever. 

Companies need to borrow money too!  (Just like you and me!)  So if they are a public company (more on the difference between public and private in a later post) they have a couple ways to do it.  If they decide they want to use bonds to do it, they make an offering to the market.  Company ABC is offering x number of bonds at a 5% coupon.  This means they are offering 5% interest.  There are terms to how long the bond takes to mature etc etc. but that's about it.  You would BUY the bond from them to get the interest payout.  You can also sell the bond back to the market before maturity if you need the money back without any penalties.  (There ARE trading commissions on bond trades though)  

Bonds do go up and down in price a bit (or a lot if the company or country sucks) representing the RISK that you (the investor) might be exposed to when you want to get your money back.

So if you bought Greek Bonds because they were offering 9% interest last year at this time, then sorry my friends you've lost at least half of your money!  But if you had bought government of canada bonds, or bonds from Telus, or Bell, or BMO or Scotia or hundreds of other well run boring Canadian companies then you would be sitting pretty.  The yields (how much they pay you) is of course somewhat lower but that's just the way the cookie crumbles.  You have to carefully consider what company you're lending your money too.  Just like people, not all companies or countries are responsible debtors.  They ran up their debts on booze or hookers and now are pleading poor.

So, the more risk the higher the yield.

That's about it for bonds...  Mind you most of you folks I'm writing this blog for shouldn't be thinking about bonds.  You just don't have enough money to do it!  There are easier ways to do it such as the Bond ETFs from Claymore.  (Some of them you can trade without commission with Scotia iTrade!)  They do the busy work, take a TINY percentage (0.25% for the corporate bond funds and 0.15% for the government ones) of your distribution and you don't have to do ANYTHING.  They are excellent products for the risk-adverse investor.

But if you're still young, beautiful, (and a little stupid) you don't need to worry about bonds yet...  Think about them when you hit your mid 30s.  They should be accumulated slowly as time goes on and the commission free ones from iTrade/Claymore are the PERFECT way to do it.  You can buy a handful of units at a time every month.

Disclaimer: I'm writing this article to HELP you.  If you do something stupid based on my advice without thinking it through yourself, then you have only yourself to blame.  Plus if you try to sue me for bad advice I don't have any money either, so good luck with that.  Seriously people, stop making your lawyers rich... they don't need the cash!  WE DO!  If you get burned a couple times, it's a learning experience.  Just try to remember to NOT fall in love with your holdings.

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