by Travis Johnson, Stock Gumshoe | May 16, 2011 12:28 pm
A couple variations on this teaser about “black market income” have been rolling around the marketplace for months now — the actual investments are still relatively normal, mainstream-ish companies and strategies, just as they were when the 12% Letter called parts of this “black market income” strategy by other names, which is why I haven’t gone through and written about them recently.
But the questions from readers are piling in, so I thought I should share some of the truth behind the “black market income” website from Dan Ferris and the 12% Letter, and explain a little bit about what those income “loopholes” are that the ad talks about.
It’s a long ad, and they tease a bunch of “loopholes” in their “black market income” strategy, so I’ll be brief with each one. But just to make sure you’re revved up and in the mood, let’s get a little taste of the teaser’s lead-in first:
“A Secret Website Wall Street Doesn’t Want Anyone Over Age 55 Logging Onto
“Because it could help you collect as much as $653 in extra income every single week, for the rest of your life…
“Without touching regular investments… and Without going through brokers and money managers ever again!”
So … the “secret website” is their own Black Market Income site, of course, and I haven’t seen it … but they do go on to hint about what a bunch of these “loopholes” are that allow you to collect this special super top-secret income …
“Well, quite simply, the website exposes several ways to completely avoid stock brokers and money managers… And potentially collect thousands of dollars a month in extra retirement income.
“In other words, you could cut Wall Street out of the picture almost completely!
“According to Dow Jones, angry brokers have lobbied Congress to restrict the advertising of some of these income ‘loopholes.’ They’ve made sure you don’t hear of these unique opportunities… so they can protect their own interests.
“As MarketWatch recently reported: ‘Brokers and money managers won’t tell you the ‘best-kept secret’ and they’ve made sure Congress and the SEC keep it a secret too.’
“The American University School of Business put out an academic paper about how the SEC restricts advertising of one of these ‘loopholes.’
“And The Wall Street Journal reports: ‘Because brokers, fund managers, and other middleman can’t make any fees or commissions… you won’t hear about the secret from these middlemen.'”
So let’s run down these “loopholes” that they say will let you collect black market income — the first one is called the “Dividend Boost” …
“Why Brokers Won’t Tell You About the #1 Way to Build Wealth
“Most people don’t know this… But there’s a corporate ‘loophole’ that lets you collect $5,000… $10,000… even $30,000 or more in extra income… Starting with just $25.
“You don’t have to go through a Wall Street stock exchange. And you’ll never have to pay huge fees and commissions to brokers ever again.
“As the secret website reveals, there’s a group of profitable U.S. companies that could pay you 5 to 10 TIMES bigger dividends than normal – over a period of time – if you avoid your broker… and use a route outside the regular stock exchange.”
Well, this is just our old friend the dividend reinvestment plan, or DRIP — many of you have probably heard of this, and this is the one that those quotes from Marketwatch and the Wall Street Journal refer to above. This same newsletter has used the DRIP plan as the core of their marketing pitch for years now, calling it things like the “801k Plan” and the “424 Dividend Boost,” among other things, and I’ve written about it dozens of times … I’d argue that in a world of discount brokers who will reinvest your dividends for free and keep fees low, there’s little inducement to use a traditional DRIP, but they do still exist and they have their place.
DRIP investing basically means that you buy your stock straight from the company, or from the company’s transfer agent (firms like Computershare or AmStock or BNY Mellon). Some of these plans require you to own a single share in your name already, some will facilitate buying that first share — the SEC loosened the rules about this 15 years ago, so companies can sell you your first share now, but before that you had to jump through more hoops. Then you usually set up a plan to invest a certain amount in the stock every quarter or year or whatever, and the company will automatically reinvest your dividends for free. Sometimes they’ll even give you a small discount on dividend reinvestments, though that seems to be very rare now. And unfortunately, there are also more and more companies who charge small fees for buying shares or similar services, so the advantage over a discount broker gets even smaller. Companies like it, I suppose, because DRIP investors tend to be very long-term investors who don’t sell, so they get a fairly stable investor base of small investors.
Pros? You have your money tied up to some degree (not really tied up in most cases, but you can’t sell a stock and do something else with the money in five minutes) and it’s a little tougher to trade the shares you hold in a DRIP, so it’s hard to change your mind and swing it around to a different hot investment every week … and you’re perhaps more likely to let it sit and compound (this becomes a con, of course, if you select the wrong stock). This is a “Pro” mostly for folks who know they should be buying dividend stocks and letting the investment compound, but who can’t stop themselves from trading in and out of more exciting ideas.
And yes, you do get to avoid broker’s fees, and commissions (though there are often some commission-like fees in a DRIP, depends on the company and transfer agent). This can be a huge advantage if you’re someone using a traditional, high-cost “investment manager” type of broker who charges you a fee of 1-2% of your portfolio every years or who charges very high commissions (if you’ve never enjoyed the rarefied air of a full-service broker, commissions of $50-100 are not unusual, compared to more typically $5-10 for a discount broker). But you could basically make the same argument for discount brokers vs. full service brokers — yes, if you’re just buying a bunch of dividend-growth blue chips and reinvesting the dividends and choosing the companies on your own, you’d be silly to pay a full service broker for that … but whether you use a discount broker or a DRIP plan is far less of an easy call to make. Full service brokers should be providing you with a lot more advice and service than a DRIP or a discount broker would, of course.
Cons? For active investors who want to monitor pricing carefully and act accordingly, you can’t choose the price at which you buy shares — you’re locked into a schedule of dollar cost averaging (that is, of course, a “Pro” for probably more of us — even if we don’t want to admit it).
More importantly, as a DRIP investor you have to keep track of the plan yourself, not all DRIP plans will track your reinvestments and cost basis the way even most discount brokers will, so tax reporting can be confusing. And you would have separate plans for separate companies, creating additional paperwork and consuming additional time — that irritation has improved somewhat with online DRIP enrollment and management through the big transfer agencies like those I noted above, but it’s still more complex than just placing a buy order at Scottrade or Fidelity or TD Ameritrade and telling them to automatically reinvest your dividends (those brokers are just examples, there are dozens more).
And yes, these plans are somewhat “secret” — but that’s only really because companies aren’t allowed to solicit DRIP investors, which would mean they’d have to be acting as brokers for themselves, which would get a bit sticky and probably scare their lawyers, anyway (and I suppose it’s true that the traditional brokers don’t want the competition, so they might push back on further liberalization). Even if they weren’t “secret,” though, it’s hard to imagine McDonald’s advertising their shares when they could be advertising cheeseburgers or frozen lemonade — established companies are trying to market themselves primarily to customers, not to shareholders, so that’s probably where their promotional money would go in any case.
If you’re interested in those quotes that were in the teaser, they are a bit stale — the one from Marketwatch is from a Paul Farrell column and, like Ferris, he sets up the full service brokers and annual fees as a straw man instead of more fairly comparing DRIPs to discount brokerage accounts. And the Wall Street Journal quote was from … a different version of that Paul Farrell column that appeared in the WSJ instead of on the Marketwatch site, at about the same time. There have been several academic studies on DRIP investing and on why companies do or don’t offer these plans, but I’m not aware of any particularly recent or groundbreaking ones as it pertains to performance of these plans for individual investors — most scholars have studied why companies offer these plans, or how they work as a funding mechanism compared to alternatives. The most recent one from an AU scholar that I saw was here, it’s interesting but probably not of particular use to you.
So that DRIP portion of the “black market income” is the core of the marketing letter, but there are a few other pitches for different “loopholes” as well … I’ll look at a couple more now, and finish up tomorrow with the rest.
The next one, loophole number two, they call “Private Equity Dividends” …
“Backdoor Way to Collect Extraordinary Income From Private Companies
“As you know, it’s very hard for regular folks like you and me to invest in private companies.
“But the truth is, private firms are some of the most profitable and cash-gushing businesses in America.
“For example, you might have heard recently about the worth of social networking site Facebook. According to the New York Times, it’s valued at $50 BILLION.
“Or take E&J Gallo Winery. It’s one of America’s most profitable wine companies — raking in around $3.15 billion in revenues every year.
“But what few Americans know is that there’s a backdoor way to invest in private firms not traded on any stock exchange — and collect 10%-12% in annual income payouts.”
There are some private equity firms that you’ve probably heard of who actually are publicly traded and do pay dividends, like giant Blackstone Group (BX), but that’s not who Ferris is pitching here — and truth be told, they don’t actually disguise who the companies are very stringently, as you can see from these quotes:
“** One ‘Private Equity’ Dividend company called BlackRock is currently paying you a 11.2% dividend…. And it has shot up 318% since March 2009.
“** Another ‘Private Equity’ Dividend company called Ares is yielding 8.4%… And it’s shares have nearly quadrupled over the past 2 years.
“** Kohlberg, a third ‘Private Equity’ Dividend firm, could pay you a 9.3% dividend payout right now…. And it has paid investors a whopping 431% in gains since 2009.”
So yes, these are Business Development Companies, or BDCs … they exist largely to fund middle-market small businesses, companies who are too big for local banks and too small for Wall Street equity or debt financing. They get a spur from small business development financing from the government, and they basically lend money to businesses and also sometimes get equity in those businesses and some input into management (like a seat on the board, for example).
They amplify their stockholder returns a bit by also using borrowed money, though they’re usually limited to half debt/half equity for their balance sheets, which is why those numbers since March 2009 look so awesome — the little companies they lend to had hard times in the recession, and their cost of borrowing also went up, so they got squeezed on both ends and some BDCs fell dramatically more than the overall market did. So, not surprising that they also recovered more dramatically when the world financial system returned from the brink and the economy started to at least gradually recover. BDCs, like REITs, can be tax exempt as long as they pass through the lion’s share of their earnings to shareholders, so they generally pay very high dividends as part of that pass-through, and those dividends, like REIT dividends or bond coupons, will be taxed as income.
If you’re curious about those specific ones noted above, they’re BlackRock Kelso (BKCC), Ares Capital (ARCC), and Kohlberg Capital (KCAP). Ares Capital might sound familiar, it’s the biggest in the bunch by most measures and the one that was teased recently as the “Secret Bank” with an “8.2% Savings Account” by Ian Wyatt. The Dividend Detective site offers a directory, not necessarily complete, of more BDCs than I had heard of, so might also be a place to dig in and look for these kinds of stocks. Most of them offer reasonably diversified debt exposure to large numbers of mid-size companies, some push more for equity or board influence, some focus on specific sectors, and some seem to be more aggressive than others in the extent to which they use their allowed leverage, but the norm is a distribution yield in the range of 8-10%.
And one more loophole before I have to leave you today …
“How to Collect $350 in ‘Overnight’ Income
“Did you know there’s a way for you to collect $350 or more — in CASH — from the stock market within the next 24 hours?
“We call it the ‘Overnight Income’ secret.”
I won’t even sample more from the teaser for you here, because this is quite clearly the other main “income” strategy that several newsletters have used over the years to pitch their services: Selling covered calls. The 12% Letter has teased this concept before, though most of the “covered call selling” pitches from Stansberry’s folks have been in the service of Advanced Income, which is more stringently an options trading newsletter.
So you may have heard of this idea before — whether the copywriter was calling them “California Overnight Dividends” or “Transfer Dividends” or “Unclaimed Dividends,” and the pitch is still pretty much the same — you buy a stock, preferably a “blue chip” that you intend to hold, and sell a call option against that stock. You collect the option premium, and if the stock stays below the option exercise price you also get to keep your stock — if the stock goes up past the exercise price, you’re forced to sell at perhaps less than the market price. I’ve explained this dozens of times, probably most clearly (you can certainly argue that point!) when I covered the “California Overnight Dividends” a few years ago if you want more info.
So that’s three of the “loopholes” that give you “black market income,” according to Dan Ferris — there are a few more that might be of interest to folks, including “the Fed trade” and a “Toronto income secret” … I’ll try to write up my thoughts on those for you tomorrow. Most of these can certainly be interesting or useful strategies for small investors who are trying to boost the income from their portfolio, though the “loophole” and “black market income” terms make them seem, as you no doubt noticed, far more secretive or exciting than they are, there’s no reason why most investors can’t learn all about these ideas on your own if you’re so inclined.
If you’ve a favorite idea for generating your “black market income” from DRIPs, or BDCs, or selling covered calls, well, I’m sure we’d all be delighted to hear it — and don’t worry, we’ll never, ever tell your secrets. Unless you write them in the comment box below, of course, for the benefit of the great Gumshoe multitudes … in that case, I’m afraid the cat’s out of the bag.
Update: followups on the other “Black Market Income” teasers are here:
Toronto’s 13% Income Secret 
“Secret of the Fed Trade“
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