Turbocharge Your Stock Dividends

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How? Indirectly, by buying mutual funds that specialize in capturing multiple payouts

 

Alpine Dynamic Dividend, a stock fund, is yielding 9%, not counting capital gains. This is more than four times the paltry 1.8% dividend payment of the average large U.S. company. And Alpine is not alone. Eaton Vance Dividend Income pays 8%, and a dozen other stock funds yield 6% or more.

 

The funds achieve these outsized yields with a variety of techniques, mainly “dividend capture” and “call writing.” Most companies pay dividends every quarter. To increase dividend income, an investor using dividend capture doesn't hold the shares for long. Instead, he buys the stock just before the dividend payments—and then sells soon thereafter, moving into another stock just in time to collect its dividend.

 

Mutual funds didn't begin using dividend capture until 2003, when Congress cut the tax rate on stock dividends to a maximum of 15%. To qualify for the low rate, you must hold the dividend-paying stock for at least 61 days. Investors who had been collecting four dividends a year could manipulate their holdings to reap an average of five or more payments a year.

 

Funds also use covered-call writing. In this approach an investor who owns stock will sell the right to buy the shares at a fixed price. Say IBM sells for $100 a share. You might be able to pay $2 for the right to buy the share for $105—the strike price—three months in the future. Who would want to do this? Sellers like the strategy because they get extra income.

 

If the shares don't rise to the strike price, the seller pockets the income from the sale of the call and keeps the shares. If the shares do rise, the seller loses some of the appreciation, but he still keeps the money paid for the call. Buyers participate because they anticipate acquiring stocks at bargain prices. Lately, covered-call writing funds have been successful, including Nuveen Premium Income, which yields more than 9% in unprecedented recent growth.

 

Eaton Vance Tax-Managed Global, which also yields 9%, uses both covered-call writing and dividend capture. By combining the approaches, the fund diversifies. This is important because each technique has different strengths. Dividend capture thrives in flat or rising markets, but the approach falters during down markets. Say a stock sells for $20 and is about to declare a $2 dividend.

 

After the dividend is paid, the stock price could drop to $18. In a bear market, the price could stay at that level or go lower, and the investors would suffer a capital loss. During good times, the shares would likely rise back to $20 or more.

 

On the other hand, covered-call writing does well in bear markets. The extra income from selling calls helps to prop up declining portfolios. But during a bull market, covered calls are less appealing because investors will be forced to part with shares after they hit strike prices. By holding several of the dual-strategy funds, you can be prepared for any market twist and enjoy solid income yields.

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