Ep. 92: The Honest Math of Income — From 1% to 100% Yields, and What Actually Survives

So if you put your money into the Vanguard total stock market ETF right now,
with TI, yeah, exactly.
VTI, which represents basically the entire US economy.
Your 30-day yield is this just microscopic 1.01%.
It's basically nothing.
You're practically lending your money to the market for free at that point.
You really are.
And that is why we're doing this deep dive today.
Custom tailored for you listening.
We are exploring the choices you actually have to do better than that 1% and more importantly,
the hidden trade-offs lurking in every single one of those choices, because they're always there.
Always.
We're going to run the entire spectrum today.
We're starting from rock solid dividend growers and we are going all the way up to these ultra high yield traps.
Oh, the traps are fascinating.
They really are because we want to uncover one ultimate truth here.
A distribution rate is not a total return.
Net asset value or NAV erosion is the silent killer.
It really is.
People just look at the yield and completely ignore the NAV.
I kind of think of yield like a car's speedometer, right?
It looks great if it says 80 miles an hour.
But total return is the GPS.
It tells you whether you're actually driving forward to your destination or, you know,
sliding backward off a cliff.
That's a great way to put it because if you're driving 80 miles an hour in the wrong direction,
speed doesn't help you at all.
It just gets you into financial trouble significantly faster.
Exactly.
So before we start chasing those complex high yield exotic funds,
the 80 miles an hour stuff, we really need to establish the baseline of durable income,
the foundation of the house, so to speak.
Right.
You got to have the foundation first.
And our sources point to this core and satellite framework for that.
Yeah, where the core of your portfolio is built on low fee dividend growth ETFs,
things like a SHD and DGRO.
Though if you're looking closely at the data,
SHD's Q2 payout was actually down 3% year-to-year, which freaks some people out.
Wait, down 3% is that something to worry about for a core holding?
Not really, no.
That normal variance is exactly why you don't abandon a core strategy over a single quarter.
I mean, it's an aggregate of many companies adjusting their balance sheets.
It fluctuates.
Okay, that makes sense.
The real fascination, though, is how you build the satellites around that core.
You use individual dividend aristocrats,
you know, companies that have grown their payouts for half a century.
But you can't just buy them blindly, right?
No, definitely not.
You must screen them for value against their historical price to earnings or PE norms.
So you're looking at reliable stalwarts like Lowe's, Abbott, PepsiCo, PPG.
But I was looking at the data on McCormick ticker MKC, the spice company,
and it's showing a really strange anomaly right now.
Oh, yeah, McCormick is a perfect example to dissect here.
Right, because it's been beaten down to a 16 PE,
and its historical norm is around 23.
So it's offering a roughly 4% yield right now,
which is crazy compared to its historical 1% yield.
It's a massive jump.
But at the same time, its payout ratio is creeping up into the 60% range
amid this fresh unilever spice unit merger.
So I got to push back on this a bit.
Go for it.
A spice company heavily discounted to a 16 PE
with a suddenly high yield.
Is this a brilliant value play?
Or are we just walking straight into a yield trap?
It's the classic dilemma.
I mean, it's like buying a designer code on 80% clearance.
Is it a steel, or is there a giant hole in the lining
that you just haven't noticed yet?
Well, that right there highlights why valuation discipline
is literally the only way to play aristocrats.
You don't just buy the ticker because it's a famous brand name on a discount rack.
Right, you have to look at the math.
You must track the underlying mechanics,
specifically, like you mentioned, that payout ratio.
For those listening, the payout ratio is just the percentage of the company's earnings
paid out as dividends.
Simple enough.
But if that ratio creeps from the 60s into the 80s or 90s,
the company has no cash left to reinvest in its own growth.
The dividend growth just stops.
And suddenly that 4% yield becomes a ceiling, not a floor.
Exactly.
So you have to be highly careful.
You can't just blindly buy the dip hoping the brand reputation saves you.
In fact, the creator of this specific strategy in our sources
doesn't even buy these stocks outright at market price.
Really?
How do they do it then?
They write cash-secured puts on them.
Oh, wow.
OK, let's explain how that works mechanically for the listener
because options can sound intimidating.
Sure.
So instead of buying shares in McCormick today, you sign a contract.
You promise to buy 100 shares at a lower specific price, say, a 14 PE equivalent,
by a certain date in the future.
And for making that promise, the market piss you an upfront cash premium.
Exactly.
Money in your pocket today.
And if the stock price never drops to that level,
you just keep the cash premium.
You walk away happy.
Yep.
And if it does drop, well, you're forced to buy it.
But you're buying it at the exact steep discount you wanted in the first place.
That's actually brilliant.
It dictates the price you're willing to pay
and enforces this really strict margin of safety.
Exactly.
It transforms just kind of hoping for a good entry price
into a disciplined income generating system.
But the limitation with a 4% yield on spices
is that for a lot of income hunters, it just isn't enough.
They want more.
Always yield chasing is a powerful drug.
So if you need more yield, you typically move away from retail brands
and step into physical real estate, real estate investment trusts, or REITs.
But right now, the macro environment is just absolutely squeezing REITs.
It's creating a massive divergence in the whole sector.
Let's get into the mechanics of why that is happening.
Because REITs are leveraged businesses by design.
Highly leveraged.
They finance physical properties and make their money on the spread
between their borrowing costs and the rent they collect from tenants.
And when the two-year treasury yield pops to 4.2%,
which our sources show just happened recently,
that fundamental math completely changes.
It shatters the math.
Because it means that financing spread gets crushed.
Borrowing and refinancing debt gets significantly more expensive for the REIT.
Right, because their loans are tied to those broader rates.
Exactly.
And if they can't raise rent fast enough to cover those new loan costs,
their profit margins just shrink.
Plus, as risk-free government treasury yields rise to that 4.2% mark,
investors take their capital out of dividend stocks like REITs.
Because why take the risk on a building when the government pays you over 4% guaranteed?
Exactly. They rotate it into safe government bonds.
So, the entire real estate sector gets dragged down by this macro current.
But as always, macro pressure creates microdeals.
Oh, it does.
Look at the ZI properties, ticker VICI.
They own casino and experiential properties.
We're talking huge chunks of the Vegas strip,
clubbed, stuff like that.
Premium real estate.
Yeah, but their stock hit a 52-week low recently.
And because yield moves inversely to price,
that mechanical drop pushed their yield up to a massive 6.8%.
Which looks scary on a chart, but you have to look under the hood.
Right.
Here's the key detail.
VICI boasts 100% occupancy, 100%.
And they've had eight years of consecutive dividend growth.
That's incredible.
The underlying business is humming along perfectly,
even if the stock price is taking a macro level beating.
And it's a prime example of separating the operational business
from the stock price volatility.
The business is fine.
Now, that's the physical, traditional real estate side.
But there's another angle to real estate right now
that is honestly fascinating.
Artificial intelligence.
Oh, this is the best part.
Because people usually think AI income doesn't exist.
The big players, like Nvidia, just don't pay a meaningful dividend.
Right. But AI's actual constraint
isn't just the silicon microchips.
I mean, it's electricity.
It's massive data centers.
It's cooling.
How you invest in the physical footprint of the AI boom
is one of the most critical questions in the market today.
Which brings us to digital realty.
Ticker, DLR.
They are literally the landlord of AI compute.
I love that phrase.
They yield 2.54%, which breaks down to about $1.22
since the share quarterly.
And their honest math is just incredible.
Since 2004, their price return is up over 1,412.5%.
And their total return is up in astonishing 3,460.6%.
That is insane compounding.
Owning DLR is like selling the picks and shovels
during the gold rush,
except the shovels are, you know, Gauot compute campuses.
And the beauty of that 3,460% total return
is that the yield is paid on top of a rising share price.
There is zero NAV erosion there.
That's the holy grail right there.
It is just contrast that briefly with its peers
to see the different ways to play the exact same bottleneck.
You have Equinix, Ticker EQIX, yielding 1.77%.
Or you have the utility next to your energy ticker NEE,
yielding 2.65%,
which represents the power generation side of things.
So you're getting paid a growing yield
while the underlying asset is just rapidly appreciating?
Exactly.
But let me push back on the accounting here for a second.
If you look up a REIT standard earnings
on any basic stock screener,
they usually look terrible.
Because of a heavy non-cash depreciation
on those massive buildings.
Oh yeah, the gap accounting makes them look awful.
So how do we actually know the dividend is safe?
How do we know VCI or DLR can actually
afford to pass that yield?
That is a vital distinction for any investor
looking at real estate.
For REITs, you cannot use standard net income
or standard earnings per share.
OK, why not?
Well, the tax code requires companies
to depreciate the value of their buildings over time.
They have to claim them as a loss on paper.
Even though in the real world, real estate usually appreciates.
Right.
The building goes up in value.
But on taxes, they say it's losing value.
Exactly.
So this artificial paper loss
grabs down the official net income metric.
So the earnings look artificially deflated on paper
which makes the dividend look completely unaffordable?
That's exactly why you have to look at FFO funds
from operations or AFO, adjusted funds from operations.
And what does that do differently?
That metric takes the net income and adds
that artificial depreciation right back in.
It strips out the accounting fiction.
So it shows you the actual tangible cash flow
the business is generating from rent.
Got it.
And VCI's AFO comfortably covers its 6.8% dividend.
The cash is genuinely there in the bank.
OK, that makes me feel a lot better.
Just one quick caveat for you listening.
Read distributions are generally taxed as ordinary income.
They don't usually get that favorable qualified dividend
tax rate.
Yeah, that's a really important note.
So from a tax perspective, they often
sit much better inside a tax-advantaged account
like an IRA.
Definitely.
So the challenge with REITs is they are entirely bound
by physical properties and interest rates.
Right, brick mortar.
But what if you want an asset that isn't dependent
on physical buildings, something engineered purely
as a cash flow factory?
Then you have to step into the world of closed-end funds
or CEFs and business development companies known as BDCs.
And our sources call this space the income fund Hall of Fame.
It's a great name for it.
Because the defining characteristic here
is that they prize durability and capital preservation
over maximum current yield.
They are designed to survive multiple economic cycles.
They're built for the long haul.
Let's highlight some of these legends.
You've got Adams Natural Resources, ticker, PEO.
They call it the energy survivor.
It yields 8.5%.
And it literally survived the Great Depression and World War 2.
Talk about battle tested.
Right.
Then there's Adams diversified equity, 80X,
which they call the wealth compounder.
It yields 7.7% without using any complex option strategies.
And it's been around since 1929.
You also have infrastructure stalwarts in this Hall of Fame.
Like Reeves, utility income, UTG, yielding 5.8%
and Conan Steer's infrastructure, UTF, yielding 7.3%.
Wait, let me stop you right there.
Because there is a glaring flaw in the stats
for the BDCs on this list.
So it's here.
So we have Eris Capital, ticker, ARCC.
Yielding 10.8% and Main Street Capital, ticker, main.
Yielding 8.8%.
Both legends.
Sure, but both RSCC and Main had negative one-year returns
in the data.
Eris was down 8.6%.
Main Street was down 7.4%.
Are they really Hall of Famers
if they're actively losing you money over the last year?
I get it.
It looks undeniably bad on a one-year chart.
You see negative 8% in you panic.
But true income durability doesn't mean absolute immunity
to down years.
OK.
We need to look at how BDCs actually make their money.
Business Development Companies act like banks
for middle market private businesses.
Businesses that are too small for Wall Street,
but too big for your local credit union.
Oh, like a regional manufacturing plan or something.
Exactly.
And Eris Capital, ARCC, is considered
the benchmark of the space because of two decades
of rigorously disciplined underwriting.
They are notoriously strict about who they lend capital to.
So a bad year is just the cost of doing business
in credit markets when interest rates fluctuate.
Precisely.
The core lesson of the Hall of Fame
is that compounding and distribution coverage
matter exponentially more than any single year's return.
Because they'll bounce back.
Right.
They suffer to 7% or 8% drawdown recently.
But over a 20-year horizon, they protect the principal.
Quality survives the dip.
OK.
So BDCs can give you around a 10% yield,
but you have to stomach that underlying credit
risk in periodic down years.
Yep.
You have to write it out.
And naturally, investors look for a shortcut to that 10%
without the credit risk, which leads them
straight to covered call ETFs.
The allure of the covered call.
It promises high yield from the broad stock market
with supposedly lower volatility.
And funds like SPYI, GPIX, and JPI
are immensely popular right now.
They're everywhere.
Yeah.
But the honest math on those is deeply flawed.
Let's slow down and look at the actual mechanism here.
Selling a covered call is basically
like selling someone a winning lottery ticket
before the numbers are drawn.
That's a great analogy.
You get guaranteed cash today, the premium.
But if the market skyrockets, you are legally
obligated to hand over all that massive upside growth
to the person who bought the call.
Right.
You are trading away your future growth for cash today, which
inherently caps your upside during bull market.
It completely caps it.
You capture all the downside risk of the market falling,
but you cap your ability to recover when it inevitably rises.
It's a tough trade-off, but there
is a smarter mechanism out there.
Let's talk about OVL.
That's the overlay shares large cap equity ETF.
OVL is fascinating.
They approach this entirely differently.
It holds VOO, so it just holds the basic S&P 500 index.
But it overlays put credit spreads instead
of selling covered calls.
And that completely changes the game.
It leaves the upside completely uncapped
while defining the downside risk.
But break that down for us.
What is a put credit spread?
The mechanics of a put credit spread
change the entire geometry of the trade.
You were essentially acting as an insurance company.
OK, how so?
So OVL sells a put option, agreeing to buy the market,
if it drops, and collects a fat premium for taking on that risk.
Just like an insurance premium.
Exactly.
But to protect against a catastrophic market crash,
OVL immediately takes a portion of that premium
and buys a lower priced put option further down.
So they buy their own insurance policy just in case?
Right.
They cap their maximum potential loss
while keeping the net credit from the two transactions.
And they pay that net credit out to you as yield.
And because they aren't selling the rights to their actual S&P 500
shares, like a covered call does,
if the S&P 500 goes up 20%, OVL goes up too.
Exactly.
The upside is uncapped.
So what does the resulting math actually
look like for the investor compared
to the covered call funds?
The math is wild.
OVL pays roughly a 10% distribution rate.
It has a 0.79% expense ratio.
But because it doesn't cap your upside,
it actually beats the S&P 500 on total return.
It beats the index while paying 10%.
Yeah.
Year-to-date in the data, OVL is up about 12%
compared to the S&P's 10%.
And over the last two and a half trading years,
OVL is up nearly 100%.
Wow.
It is absolutely crushing SPYI, which is at 61%.
It's crushing GPIX at 76%.
And it's destroying JEPI, which is at just 33%.
The difference is staggering.
I kind of think of it this way.
Selling covered calls is like selling
the roof of your house to pay the mortgage.
If housing prices skyrocket, you don't get the upside
on that new value.
And honestly, you're stuck in the rain.
You're getting soaked.
Right.
OVL is more like renting out the basement.
You get the income, but you still own the whole house.
That perfectly illustrates the structural difference.
OVL is the rare income product
that didn't sacrifice total return,
purely because it stopped capping the upside.
It's a great setup.
It is.
But we need to be intellectually honest
and note the caveats.
There's no free lunch.
OVL still carry share price risk
in a severe rapid market crash
before that lower put insurance kicks in.
Right.
It's not totally immune to drops.
And it's also relatively small,
with only about $250 million in assets under management.
So liquidity could be a minor issue.
Eventually.
And that 0.79% expense ratio is fairly high.
You are paying a hefty premium
for that complex options management.
True, but OVL proves a sustainable 10% is actually possible
with the right architecture.
It does.
But human nature dictates that when 10% is available,
someone will inevitably ask, well, why not 100%.
And that's where people get destroyed.
What happens when greed takes over
and investors reach for 45% or even 100% yields?
We have this terrifying cautionary tale from our sources.
It's the $1,000 margin experiment run by this guy,
the infinite dividend hunter.
Oh, this is where the honest math gets exceptionally brutal.
It really does.
So he borrowed $1,000 on interest-free margin.
He buffered it with $2,000 of his own cash
and a stable T bill fund, PAAA.
OK, somewhat safe base.
Right, but then he took that borrowed $1,000
and bought ultra high yield ETFs targeting 75% to 100%
annualized yields.
100%?
Yeah.
Tickers like COIW, MSTY, NVYY, SNY, and Harchow.
I mean, the result was inevitable, the silent killer.
NAV erosion struck almost instant.
Let's do the honest math on how this actually looks in real life.
Imagine you buy $100 stock that yields 50%.
You expect $50 in income over the year.
Sounds great on paper.
But if the stock price bleeds out to $50,
that same 50% yield on the screen is now only paying you $25.
Exactly.
The percentage looks amazing, but your actual physical cash
in hand is just vanishing along with your principal.
And that's exactly what happened here.
As the share prices of his funds bled out,
the physical dollar amounts of the dividends dropped rapidly,
even though the percentage yield stayed sky high.
It's a mirage.
Totally.
He panicked, and he sold out of all of them.
He surrendered to the erosion.
And it gets worse.
He swapped them for other ultra high yielders.
BLOX, CHPY, and NBI, which targets a 45% yield.
You doubled down.
He did.
And in just one week, BLOX fell 11.3%, CHPY fell 5.6%,
and NBI fell 8.75%.
Overall, his ultra high yielders are down about 43.5% combined.
Wow.
He's dragging his total portfolio down roughly 20%.
It's a catastrophic destruction of principal disguises income.
I want to ask about his psychology here,
because the source notes his safe haven forever fund,
where he parks his long-term hopes, is SPYI.
OK.
Wait, didn't we just establish in the last segment
that SPYI lags the market because it caps upside?
Why is he running to it now like it's a life raft?
Because trauma changes your perspective.
Oh, that's interesting.
When you get burned by a 100% yield that just aggressively
melts your principal down to zero,
you suddenly realize that NAV stability is the holy grail.
Ah.
So he doesn't even care about the capped upside anymore.
Exactly.
He ran to SPYI, despite its capped upside,
simply because it doesn't violently erode.
It's a revelation born of pure financial pain.
It really is.
The margin experiment conclusively proves
that chasing the absolute highest headline yield
gets your principal eaten faster
than the distributions can pay you back.
The math just doesn't work.
If your investment is shrinking by 40% to pay you a 40% dividend,
you haven't made a single dime.
You've just complicated your life
and lost your initial capital.
So what does this all mean for you listening?
Let's wrap up this deep dive.
The honest math of income is crystal clear.
It really is.
A distribution rate is an absolute mirage
if it's eating your net asset value.
Durable income.
The kind that actually builds lasting wealth
comes from coverage, like BCI's cash flows.
It comes from quality, like the aristocrats
and the Hall of Fame CEFs.
Right, and uncapped strategies like OVL.
Exactly.
It does not come from the biggest headline
yield on a stock screener.
It comes from understanding what is actually
under the hood of your portfolio mechanics.
Total return is your ultimate compass.
Which brings us back to our GPS analogy.
If you aren't tracking your total return,
you might be going 80 miles an hour
straight backwards off a cliff.
It's a scary thought.
Before we go, I want to leave you with one final,
slightly maddening thought to mull over.
Oh, I love these.
We've talked extensively today about how
NAVI erosion destroys your portfolio.
But think about the tax implications of that erosion.
Oh, man.
Right, if you buy a fund paying 100% yield,
but its share price is simultaneously
bleeding out to zero, you aren't actually making any new money.
Your net worth isn't growing.
Not at all.
But you're still receiving those cash distributions,
which triggers a taxable event every single time.
Aren't you essentially just being taxed
by the government on the slow, painful return
of your own stolen money?