Do you gravitate to sky-high payouts? If you must reach for yield, at least be reasonably intelligent about it.
Result of reaching for the sky.
Forbes“Reaching for yield is really stupid,” opined Warren Buffett in a 2020 CNBC interview. “If you need to get 3% and you’re only getting 1%, the answer is to [give up on] the 3%, not to try to get the 1 up to 3.”
Three percent? That’s for pikers. How about reaching for 6% or 7% or 9% or—hold your horses—16%? Below, a look at four investments with very high yields. For each, I will suggest a substitute investment, something comparably risky but with better terms or better disclosures. If you simply can’t resist reaching, buy the substitutes, and buy in small quantities.
1. Get 6% From Bitcoin!
The effervescent world of virtual currency creates many an opportunity for sharp operators to lure in the yield-hungry. The problem is not things like Ponzi schemes, although there have been some notable scams taking in a few billion dollars. The problem is what’s legal.
You put up capital that gets lent to a bitcoin speculator. If the coins go up in value, you get some interest. If they crash, your principal is at risk.
Not a good deal, says Bill Singer, a securities lawyer and former stockbroker. This is how he describes crypto lending: “Panhandlers outside the casino” taking your money inside.
Consider BitcoinIRA, a firm that wants to help you invest your retirement savings in virtual coins and/or in a loan to a bitcoin player called Genesis. With the latter choice you deposit dollars and collect 6% interest.
Legit? Evidently, yes. Singer tips his hat to BitcoinIRA’s lawyers, who have carefully structured the arrangement so that the entity that takes your money is only a middleman, not an investment advisor, broker-dealer, bank or investment company. So, BitcoinIRA doesn’t have to register with the Securities & Exchange Commission or publish a prospectus.
BitcoinIRA sends your cash to Genesis Global Trading, which describes itself as “the world’s largest digital assets lender.” Genesis talks about its multi-billion-dollar loan program, its attention to collateral and its risk management. It is part of a digital conglomerate that includes the very successful Grayscale Bitcoin Trust.
But wait. Surely it would be easier for Genesis to borrow money at 6% in the institutional market, a few hundred million dollars at a clip, than to tangle with BitcoinIRA and its $10,000 retail clients. What’s going on?
One could perhaps infer that institutions are hesitant to lend money to Genesis at 6%. Whatever hesitancy might derive from a glance at the Genesis balance sheet one can only guess. If Genesis publishes a balance sheet for the benefit of prospective BitcoinIRA customers, it’s very hard to find.
Do you want to reach for a 6% yield while taking some risk on bitcoin? Here’s a better way to take that risk.
Deposit $100,000 in a brokerage account and write a June 2022 put option, with a strike price of $240, against Coinbase. Coinbase is an exchange whose fortunes are closely tied to the prices of digital currencies. Coinbase shares recently closed at $286, so it’s unlikely the put buyer will be forcing you to buy 100 shares for $24,000, but that could happen sometime between now and June.
For writing this option you will be paid something like $3,000. Repeat in six months, writing a second option with a suitably adjusted strike price. You’ll collect another $3,000. You will also pocket a small amount of interest on the portion of your $100,000 that is not tied up as collateral for your puts. All told, you will earn 6% on your $100,000.
With these out-of-the-money puts you are making a modestly bullish bet on the future of digital currency, just as you would be doing if you let Genesis borrow $100,000 from you. If bitcoin thrives, you’ll pocket 6%. If it doesn’t, you may wind up owning 100 or maybe 200 shares of Coinbase that you don’t particularly want. But the most you can lose from your $100,000 stake is $48,000, and then only if Coinbase shares go to $0.
With Coinbase you are getting an SEC-registered company with elaborate public financial statements; when selling options on it you are trading in a brightly illuminated market with well-informed investors on both the bid and asked sides. With BitcoinIRA you are sending money into a darkened pool.
2. Get 7% From Plain Old Stocks And Bonds!
Hot item on Wall Street: the Strategy Shares Nasdaq 7 Handl ETF. In the past six months its assets have tripled to $1.4 billion.
What’s the allure? A huge payout. The distribution yield of 7% looks terrific in a world of meager dividends and bond coupons. It looks terrific, that is, to people who would fall in the lower half of the investor intelligence spectrum drawn by Buffett.
Where does that 7% come from? Not from dividends and bond coupons. The portfolio, a collection of other exchange-traded funds, yields only 2%. The remaining 5% of the payout represents a liquidation of assets.
It costs a pretty penny to have this fund of funds liquidate assets for you. The underlying ETFs have a composite expense ratio of 0.2%, but buyers of the Strategy Shares fund pay five times as much because Strategy adds its own 0.8% fee on top.
Here’s the substitute investment: Buy the underlying funds, which are mostly excellent choices from Schwab, Vanguard and BlackRock. Pocket the dividends. Also, every year, sell 5% of what you just bought. Now you’ve got your 7% payout, and you’re saving a bundle on fees.
3. Get 9% From A Mortgage Portfolio!
The Vanguard Ginnie Mae fund yields 1%. So a mortgage investment with a 9% yield catches your eye.
That handsome return is promised on Aspen Income Fund, run by the Aspen Properties Group in Overland Park, Kansas. The payout comes off a portfolio of troubled home mortgages (mostly, second mortgages) bought at a discount to the mortgage balance.
Two factors boost the portfolio’s yield above what you see on Vanguard’s very safe Ginnie Maes. One is that second mortgages have stiff interest rates. The other is that when things work out, a discounted mortgage generates a capital gain. The Aspen fund gets a windfall when a homeowner either refinances or sells the property at a decent price.
Minimum investment: $50,000. You can’t buy in unless you clear a hurdle for net worth ($1 million) or income ($200,000). Aspen is candid about the risks. The right to redeem depends on available cash and is on a best-efforts basis only. The 9% payout is “preferred” but not guaranteed. A 2019 audit, the latest available, says that the fund has mortgages worth $14.5 million funded in part with a $2.3 million line of credit.
The Aspen website includes flattering podcasts, testimonials to the mortgage-buying skills of the two men who started the fund eight years ago, a graph projecting what 9% can do for you if you let it compound for 15 years and a declaration that the fund has never missed a preferred payment. What it doesn’t publish for prospective investors is a coverage ratio.
Coverage is the first thing that any bond analyst or any mortgage loan officer asks about. It compares the income available for debt service to the payment due. It would be nice to know that Aspen’s payout is coming from interest and capital gains, not from mortgage runoffs, sales of fund shares or that line of credit.
Aspen cofounder Robert Fraser assures me that the preferred payout has always been covered out of earnings, not other sources of cash. If Aspen Income were SEC-registered, you could, before sending off your $50,000, have documentation to that effect. You could look at the profit-and-loss statement and calculate the coverage ratio. Alas, it is exempt from registration.
I’m inclined to assume that the Aspen guys are good at what they do. But there are a lot of fish in the sea. Why buy something unregistered when there are so many things to buy that are registered?
Here’s my substitute product for the investor yearning to shoot for the moon with mortgages: the common shares of Chimera Investment Corp. Chimera is a $16 billion (assets) buyer and seller of mortgages whose dividend yield of 8% is amply covered by net income. Its financials, in elaborate detail, are on file with the SEC.
4. Get 16%!
A Forbes reader wrote in to ask for my opinion on his investment idea. He was going to take out a home equity loan at 4.5% and invest the proceeds in Icahn Enterprises, a limited partnership whose $8-per-year dividend comes to 16% of the share price. This reader, the presumably astute chief executive of an industrial corporation, seems to think that he has come up with a way to coin money. All he has to do is borrow at 4.5% and invest at 16%.
Apart from being organized as a partnership rather than a taxable corporation, Icahn Enterprises is rather like Berkshire Hathaway. They are both a blend of operating businesses (in Icahn’s case, some oddball activities like fertilizer manufacture and auto repair) with a passive investment portfolio.
There are big differences. Warren Buffett’s portfolio is doing fairly well; Carl Icahn’s has been, in recent years, a disaster. Berkshire Hathaway trades at not too much of a premium above its liquidating value; Icahn Enterprises trades at 2.5 times its value. Berkshire is profitable; the Icahn company is losing money. So don’t even ask where that $8 dividend is coming from.
My substitute idea, if you are remotely tempted to buy Icahn Enterprises for its dividend, is to acquire a position in Berkshire Hathaway and then sell off 16% of the shares every year.
My opinion on the would-be arbitrager who wrote in is the same as the one Buffett applies to people who reach for yield.
