This is an interesting one from Doug Fabian that I got a few days ago, teasing an income boosting strategy that uses dividends in a special way. He’d like you to sign up for a subscription to High Monthly Income to find out how to get this great dividend cash flow.
In his words, “I couldn’t believe my eyes when I recently discovered a totally legal loophole in the new U.S. tax law that you can exploit to collect 50% more dividends than you already are!”
The Gumshoe doesn’t much care whether you subscribe to High Monthly Income or not, but I do think it’s better to remove the immediate temptation of this hidden teaser and make the decision with a clear head. So let’s figure out what investments he’s talking about, and then if you want to go subscribe to his newsletter, you go right ahead.
And we’ll let slide for the moment the fact that he calls this “Dividend Doubling Dynamos” while only claiming that they allow you to gather 50% more dividends.
Still, 50% ain’t bad. So how does this work?
He says you can get 10-14% annual dividend yields, along with “double digit” capital gains, which certainly adds up nicely. Feel those palms getting itchy yet?
He talks about the fact that the magic of this system began with the tax cuts of 2003, which is when everyone really started to love dividends again — remember, analysts used to make fun of dividend payers during the internet boom, as if sending the money back to shareholders meant that companies didn’t have anything cool and exciting to do with their cash (those that actually had any cash, at least). So the bursting of the internet bubble made everyone (myself included) much more interested in dividends, sort of rediscovering what Jeremy Siegel also emphasized with his recent book, The Future for Investors, that dividends are what matters more than anything else over the long run. Mark Skousen has been a convert to this way of thinking, too, with his new high income newsletter, and there are dozens of other high income services that try to trade on our new(ish) thirst for dividends.
So the 2003 tax cut set rules for holding periods but, if you follow those rules, taxes qualified dividends at a much lower 15% rate (“qualified” dividends are most common stock dividends, save REIT-like structures, partnerships, and some foreign issues that don’t trade on a US exchange).
So, as you can probably imagine, the 61 day part refers to the required holding period — if you don’t hold a stock for at least 61 days including the ex dividend date, the dividend doesn’t qualify for the lower tax rate. Please don’t take my word as your tax advice, but that’s the basic rule.
But the teaser here is not for a dividend stock in particular, but for a group of money managers, who Fabian calls the “3D” Managers (that’s for Dividend Doubling Dynamos”) — this management team apparently decided that they had to take advantage of the new tax law and come up with a way to profit from dividends and enhance their returns with a new trading strategy.
That new trading strategy is a variation on “dividend capture,” which has been a well known trading strategy for decades, but one that was changed significantly by widespread recognition of the techniques and, of course, by the new rules in the 2003 law that were in part designed (depending on who you talk to) to reduce the widespread short term trading of the dividend capture strategy.
The various strategies that fall under the classic “dividend capture” name have been hallmarks of the finance literature for a long time, and have made some academic careers, but there’s not necessarily just one strategy. The basic strategy relied on trading immediately around the dividend (ie, buy on the day before ex dividend, sell on the ex dividend day) — that way, you get the dividend and, because stocks — at least, in theory — generally went down by a little bit less than the dividend amount due to the impact of the tax law at the time, you got a corresponding capital loss that was a little bit smaller than your dividend gain — and you could use the capital loss to offset your dividend for tax reasons. This is all the time I’ll spend on this, because that original “classic” dividend capture strategy doesn’t really work anymore — and I think I probably haven’t explained it very well, anyway, let alone covered all the myriad variations that have been tested over the years.
So anyway, this teaser is for a fund company, and for three specific funds, that have come up with a new dividend capture strategy that apparently is working very well.
So what clues do we get about these specific investments?
He calls them a “non stop dividend machine,” and he describes their basic strategy thusly:
“After pocketing the dividend and nailing down the 15% tax rate — they quickly sell the stock and plow the fund money back into other securities poised to announce their own dividend payouts and ex-dividend dates … And on and on it goes. Over and over again, they pile up dividends … Over the past seven years the “3D” funds have been averaging 12% in dividend returns.”
So, essentially a constant dividend chain and a search for the next great dividend — and the 61 day period is the reason you get 50% more dividends (in number of dividends, not necessarily in cash amount). Most dividend stocks pay quarterly, but if you are switching every 61 days to a different stock that’s about to go ex dividend, you theoretically have time in a year to harvest six dividends with the same capital.
And yes, 6 is 50% more than 4.
The managers also apparently look for special dividends, which are the one-time payouts that companies often make if they have unusually high cash flow for some reason. (There’s also quite a bit of academic research around these, by the way, and most folks seem to agree that — ON AVERAGE — stocks that pay special dividends also give above average capital gains in the 6-12 months following the dividend. I don’t know how reliable this “average” is, or whether it will hold true in the future — it certainly doesn’t always work. FYI, This is the strategy that Stansberry and Associates is following, or some like variation, with their Dividend Grabber service — it doesn’t look like it’s working with their heavily teased recommendation of Palm so far, and that particular service is also the one that I’ve gotten the largest number of complaints about from irritated subscribers. Don’t know if that means anything, but thought I’d pass it along.)
But back to business — what are these funds?
The specific details are not enough to make me 100% certain, but I’m 99% sure that these have to be …
The various dividend capture funds from Alpine.
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