Oran Hall | Earning monthly income from stock market investments
QUESTION: I was recently made redundant and am in a position to invest $2 million. My hope is to have a return of at least $30,000 to offset my living expenses. My risk potential is medium to high. I am thinking of trading in stocks. What advice would you give? Is this approach realistic?
FINANCIAL ADVISER: I am sorry to hear of the change in your employment status and hope it will change soon. I must disappoint you though. Equities will not give you the income you need to offset, as you put it, your living expenses.
There are two ways that equities can provide cash for you - dividends and realised capital gains. I am assuming that you are expecting to receive $30,000 each month - $360,000 per annum. That is a dividend return of 18% per annum.
This is not a reasonable expectation because few companies pay dividends to give that level of return before or after tax at today's prices. Further, there is no guarantee that a company will pay dividends as this depends on the level of profits that it makes and whether the directors decide to recommend the payment of a dividend.
Beyond that, dividends are not paid on a monthly basis. Many companies pay dividends annually, but some do pay more often than that. Companies rarely pay dividends as often as four times per year.
To generate cash from trading, you would have to sell each month at a profit. You could not afford to use any of your principal lest you risk depleting it. Is it possible to earn profits of that magnitude every month? I hardly think so. In fact, there are some months you would more likely make a loss than a profit.
Let us say you could, indeed, realise that level of profit each month, do you believe you would be able to select the stocks that would increase in value each month, and at the rate to give you your required return? Would you have the time to do the required research and track the market, not to mention timing it?
That level of trading, even with a relatively small sum, would make your broker quite happy, considering that you would incur commission charges for each transaction in addition to the other fees you would be required to pay.
It is misleading to see the stock market as a medium from which to make quick and certain money. It is not meant for that and should be seen as a means of making long-term investments with the potential to make real returns but with the possibility of making losses as well.
This is why it is important to diversify an investment portfolio by investing in various types of securities and in several securities of the same type. Thus, if you are buying equities, for example, it is prudent to invest in companies in more than one sector of the economy.
I believe I understand why you need to generate the level of income you have stated that you want to earn because you, like anybody else, would want to be able to generate a level of income to meet your living expenses.
In a case such as yours, the preferred course to follow is one that protects your principal and generates a known and certain level of income. Ordinary stocks are not the investment instruments that offer what you need most now.
Fixed rate bonds offer safety of principal if you hold them to maturity and generate a known level of income which is paid on a set schedule. There are two problems though. They tend to pay interest only twice per year and the current low interest rates would hardly generate the level of income you have stated that is desirable for you.
Preference shares also pay income - in the form of dividends - on a set schedule, but they do not pay at a rate that would generate the income that you are seeking, they do not pay monthly dividends and it is possible that the directors could recommend that a dividend not be paid. If the preference shares are cumulative shares, though, you could reasonably expect payment at a future date.
To get income each month, you would have to put your funds into interest-bearing instruments that mature every 30 days or so. Should you identify such instruments, at current rates, you would fall short of your monthly target.
I hope you have savings to help you through this challenging period if you do not succeed in gaining employment soon, and suggest you make every effort to protect the resources you have.
- Oran A. Hall, the principal author of 'The Handbook of Personal Financial Planning', offers personal financial planning advice and counsel. firstname.lastname@example.org