The Perfect Plays for Passive Income

What’s old is what’s new again… or will be soon enough.

I’m sure you’ve heard that the Federal Reserve, at its December pow-wow, noted that interest rates will very likely head lower this year. I’ve been saying for a while now that this move was coming. And here we are…

The point of this dispatch, however, isn’t to tell you I was right or why it’s happening. It’s to tell you that now’s the time to start locking in some decent yields that are available by owning various high-quality stocks.

See, as the Fed lowers rates, yields are going to fall across the board.

1-year certificates of deposit—which were up in the 5% range—have already started to slide and will dive farther with each rate hike.

Bond yields will start shrinking as well.

And the yields across the stock markets will largely retreat, too. That’s because Fed rate cuts are likely to drive a rally in stocks, and as stock prices go higher, yields go lower. It’s a math thing.

So now’s the time to put money to work in high-quality, high-yield assets while you can.

I did so recently in one of my retirement accounts.

I’ve suspected for many a month now that the Fed was going to tap out soon (as I’ve written to you about too many times to note).

Now, I never know when exactly. That’s a crystal ball game for traveling medicine men pitching snake oil as a cure-all. Then again, I really don’t care about the when. I focus on the what. It’s easier to see and it tends to be more important. Whether it’s next Tuesday or next quarter—meh.

I just want to be positioned properly for what I expect is in the offing.

And rate cuts are clearly in the offing.

As a soon-to-be 58-year-old (January 27; cash and gift-cards are perfectly fine), I think more than I ever have about what I want my investment portfolio to accomplish for me in retirement one day. I want it to generate a bunch of monthly income without me having to dip too deeply into principal.

So, instead of focusing on growth stocks, I tend to focus largely on quality companies that kick off quality dividends. Over the last six months or so, that has meant buying shares of real-estate investment trusts, master limited partnerships, and underappreciated consumer-vice plays with big ol’ dividend payments and a very sticky customer base. (The only non-income plays I’ve made was grabbing Coinbase, the giant crypto exchange, at a very steep discount hours after the SEC sued it; and options on a regional bank that I expect will have a great 2024.)

Too many investors I talk to are all too eager to chase the trendy stock-of-the-moment. They want to turn $1,000 into a million dollars overnight. I understand that mindset, but chasing the fire is the best way to get burned.

Like I said, I’m not so worried about growth as I am income. And I do understand that with a lot of growth, a portfolio will be large enough that drawing on principal won’t be a problem.

Very true.

However, since 2000, the U.S. stock market has suffered two major collapses and two major pullbacks—the dot-com implosion, the subprime mortgage crisis that nearly blew apart the entire banking sector, the COVID-19 crisis, and the Federal Reserve’s extremely aggressive interest-rate-hike cycle that sent the markets down nearly 30% in about nine months.

When I was 30-something and the dot-com crash hit, I didn’t really worry much about it. I had plenty of time for the recovery. Now that I’m nearing 60, I don’t have that time and, thus, I don’t really want to expose my nest egg to that kind of risk.

Yes, even quality dividend stocks go down in a crisis.

But those quality companies keep paying dividends. And because they do, their share prices tend not to fall as far, and they tend to stabilize and rebound sooner. Plus, if I’m still collecting my quarterly income payments, I am not so worried about the share price.

If my strategy was to buy the hot growth stocks and sell off parts here and there to fund retirement, then a crash would be devastating to my lifestyle. I would need to sell off much larger parts of my holdings—maybe even the entire position—just to maintain my standard of living… or scale back my standard of living.

Whatever the case, a crash is far more painful to those who own a portfolio of growth-and-momentum stocks than it is to those of us who own a portfolio of quality income stocks.

My most recent income addition is Pembina Pipeline Corp., a Canadian company traded on the New York Stock Exchange (symbol: PBA) that owns and operates a spiderweb of energy pipelines across Canada and into the U.S. Those pipes transport everything from oil to natural gas to natural-gas liquids.

It’s an incredibly dull stock. No one goes to a cocktail party eager to hear about a company that moves natural gas through a pipeline. Tesla it is not.

But in my world view, it’s a perfect company for what I want to accomplish: Income.

Pipelines are the toll roads of the energy industry. Oil and gas producers have to move their oil and gas from the production platform to storage tanks, refineries, and shipping facilities to load onto tankers headed overseas.

That’s a company like Pembina.

Their business is an absolute necessity. Their contracts are years long and often “take or pay,” meaning a buyer pays for pipeline volume whether they use all that volume or not. That creates a highly stable income stream from which the dividends flow. And all that stable income flows to shareholders like me who are quite happy collecting a 6% annual dividend that grows steadily larger.

Going into retirement soon enough, I’d rather pack an army of Pembina-type companies than the Teslas of the world.

And my bet is that as the Fed cuts interest rates, the old strategy of income investing is about to become what’s new again. The hunt for income stocks will heat up again, and Wall Street will gravitate toward companies like Pembina.