Retire Early With Passive Income: 3 Safe High-Yielding Bargains

Reliable passive income is the surest ticket to financial freedom and buying your time back. However, building a dependable passive income portfolio is not easy; there is no such thing as a free early retirement. In this article, we will share 3 high yielding top picks that offer dependable income and trade at a compelling value to help get you started on the path to financial freedom.

Dividend Stocks: Your Golden Ticket To Passive Income

While there are many methods to approaching financing an early retirement, we believe that living off of a steady stream of passive income from a diversified dividend stock portfolio is the best path.

Rental property investing is a popular method that has worked well for many over the past decade’s housing boom. However, it is not really a passive investment since you either need to hire an expensive property manager (which can potentially skew the risk-reward against you) or you need to put in a lot of time on your end to effectively manage the investment. As a result, you are essentially buying yourself a part-time (or even full-time depending on your tenants and the location, type, and quantity of your property portfolio) job and are not truly retiring in this case.

Furthermore, housing in the U.S. is at its lowest level of affordability in modern history right now and cap rates in many places are equal to or even less than mortgage interest rates, so it is very difficult to cash flow these properties unless you can buy them with all cash. However, even then their yields are often lower than what you can get from dividend stocks and purchasing properties with all or even mostly cash can make it very difficult to properly diversify a portfolio.

Investing in low-cost index funds like the SPDR S&P 500 Trust ETF (SPY), the Vanguard S&P 500 ETF (VOO), and the Invesco QQQ ETF (QQQ) is another very popular approach and it is truly passive investing. However, the downside to this approach is that the dividend yields are typically far too low – or even volatile – to reliably and reasonably fund a retirement lifestyle with passive income. Instead, retirees are forced to sell shares on a regular basis to fund retirement. While this may work fine in a bull market, when we experience steep and prolonged downturns, this can cause rapid and permanent principal erosion that can ruin one’s sleep at the very least and potentially even ruin an early retirement.

Instead, we advocate for building a diversified portfolio of 20-30 high quality, high yield dividend stocks that can fully fund your desired retirement lifestyle. It is also important that this portfolio combine a slight surplus in current income to your current expenses to provide a margin of safety against black swan events with at least some of the positions regularly growing their dividends in order to offset the harmful effects of inflation on your purchasing power. This approach enables you to enjoy the passivity and easy diversification benefits of publicly traded securities in combination with the ability to completely ignore the short-term volatility of public markets. Instead, you can focus on what you want to focus on during your retirement and just live off of the passive income without touching the principal.

While this all sounds wonderful, unfortunately selecting the right stocks is far from easy. Many high yield stocks are nothing more than yield traps: stocks that lure unsuspecting investors with their attractive dividend payouts, but in reality are headed for financial distress and/or a declining underlying business and eventually have to slash their dividend payments. Given that a plunging stock price almost always accompanies these declining dividend stocks, these are an early retiree’s worst nightmare and must be avoided as much as possible.

However, there are also plenty of high yield stocks with perfectly sound businesses and balance sheets underpinning them and are able to pay out very reliable dividends to the point of even growing them consistently over time. Here are three of these stocks that we currently hold at High Yield Investor:

#1. Ares Capital Corp. (ARCC)

ARCC is a best-of-breed business development company (“BDC”) that boasts an investment-grade balance sheet with plenty of liquidity, strong growth numbers in the wake of rising interest rates, and low non-accruals. It also boasts a double-digit dividend yield that is fully covered by earnings.

Furthermore, it has a phenomenal track record of generating market-crushing returns through a wide variety of market cycles and has done a great job of increasing its dividend over time while not eroding shareholder principal.

This is precisely what an early retiree wants from his dividend stocks.

We remain happily long after it reported Q3 results. Core earnings per share increased 6.4% year-over-year while net investment income increased by a whopping 42.5% year-over-year from $0.40 to $0.57. That said, rising interest rates and a softening economic outlook hurt the mark-to-market value of ARCC’s investments, dropping the NAV from $18.81 to $18.56.

Thanks to the rapid growth in the income, management decided to declare the largest hike of its quarterly dividend in the company’s history, growing it by 11.6% sequentially and 17% year-over-year to $0.48. On top of that, ARCC will also be paying out a $0.03 special dividend as per its announcement back in February. You can read our full investment thesis here.

#2. Enterprise Products Partners L.P. (EPD)

EPD is probably the single best early retirement investment available today. In its latest quarter, its distributable cash flow rose by a whopping 16% year-over-year on the strength of transporting record volumes (11.3M bbl/day) through its pipelines. Furthermore, its natural gas pipelines transported 17.5T Btus/day (also a record) in Q3 while also setting quarterly records for NGL fractionation, ethane export, butane isomerization and fee-based natural gas processing volumes.

EPD has arguably the strongest balance sheet in the entire midstream sector with an industry-leading BBB+ (stable outlook) credit rating, a meager 3.1x leverage ratio (which is below the low end of its target leverage ratio range of 3.25x-3.75x), a whopping $3.3 billion in consolidated liquidity, and weighted average term to maturity on its debt of 20 years.

EPD is also poised to generate sufficient free cash flow after distributions and growth capital expenditures moving forward to fully retire near-term maturities when combined with its current liquidity. As a result, there is little to no concern about EPD’s financial strength and ability to respond opportunistically to market dislocations. As the CEO said on the Q3 earnings call:

Thinking back on my career, first with Dow and here at Enterprise, I can’t count the number of downturns I’ve been through. At Dow, the downturns were always painful, but here at Enterprise they always bring opportunity. In the current environment, while the uncertainties are real, the certainty that Enterprise will always deliver is real too.

EPD is about to hit a quarter century of consecutive distribution growth and also boasts a phenomenal distribution coverage ratio of 1.8x. Perhaps best of all is the fact that it currently yields 8.1%, making it a very lucrative and safe source of passive income. EPD’s management hinted at continued mid-single-digit distribution growth moving forward, stating on the earnings call:

2022 marks our 24th year in a row for distribution growth, and we think next year, it’ll be 25 years in distribution growth… in talking to a lot of investors given the inflationary environment they’re in, they really appreciate the 5.6% distribution growth year-over-year. That’s helpful to a lot of our individual unitholders.

You can read our exclusive interview with EPD here and our full investment thesis here.

#3. Brookfield Asset Management Ltd. (BAM)

BAM recently split its business in two by spinning off part of its asset management business (trading under the same ticker symbol “BAM”) while retaining some of the asset management business along with its invested capital in Brookfield Corporation (BN). Its new BAM security is largely an attempt to give investors access to a rapidly growing asset-light alternative asset management business similar to peers like Blackstone (BX) and KKR (KKR). Furthermore, BAM is expected to pay out 90% of its distributable earnings, resulting in a current yield that is just a tad under 5% and the dividend payout is expected to grow at a 15-20% CAGR over the next half decade. As a result, it is likely one of the very best dividend growth stocks on the market today, especially when requiring at least a mid-single digit current yield.

It is even more attractive when you take into account that it has no debt and billions of dollars in cash and investment securities on its balance sheet and its earnings stream is largely underpinned by long-dated or even permanent capital under its management. Furthermore, its managed assets are very well-diversified across industries including renewable power generation, all manner of mission-critical global infrastructure assets, world class real estate assets in the world’s greatest cities, and competitively advantaged businesses in its private equity portfolio. It also has a large and growing private credit portfolio and insurance business that will likely drive its assets under management growth in the coming years.

Overall, we view BAM as one of our highest conviction bets in the coming years. You can read our full investment thesis here.

Investor Takeaway

Early retirement is a wonderful prospect and can open up a life full of adventure, meaning, and fulfillment for those who can achieve it. However, life anything worthwhile in life, it is far from easy to reach and perhaps even harder to sustain. While high yield dividend stocks are a great vehicle for achieving and sustaining this lifestyle, investors need to be careful about which ones they pick. Otherwise, their early retirement dream can vanish very quickly in the wake of dividend cuts and rapidly diminishing equity.

In this article we shared some ideas that we believe can give investors a great start on building their early retirement passive income machine. At High Yield Investor, we are filling our portfolios with ideas like these as we continue to compound our passive income stream while achieving substantial market outperformance in the face of substantial market volatility and economic uncertainty.