America is the land of small business. When small businesses thrive, so does the American economy. We need to leverage these small businesses to build income for our retirement.
Picking small-cap stocks can be tricky. You must do a lot of research to stay on top of small companies as the media covers them less than mega-caps like Apple (APPL) and Microsoft (MFST).
You can invest in a small-cap ETF like iShares Core S&P Small-Cap ETF (IJR), which yields only 1.5%. We need a massive yielding product to get the income we need for retirement—enter Business Development Companies (BDCs).
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Welcome back to the Income for Retirement Series (Preferred Shares, Closed-End Funds, Mortgage REITs, Dividend ETFs), where we leverage the American economy to live the American dream.
What are Business Development Companies? Business Development Companies lend money and invest in small businesses across America.
You can view them like banks, but they have the ability to be much more hands-on with the businesses under their charge.
BDCs can take an equity stake in their portfolio of business, which lets them participate in the upside. They can also assist struggling companies with resources and mentorship.
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It’s in the BDC’s best interest (and ours) for all their companies to perform well. BDCs make the most of their money from the interest payments from their portfolio of companies.
What makes BDCs special? BDCs are Regulated Investment Companies (RICs), which means they must distribute 90% of their net interest income.
RICs are unique because they avoid the double taxation that most corporations like McDonald’s (MCD) face.
McDonald’s pays tax at the corporate level; then, the shareholders pay tax when they receive dividends. However, this usually makes the dividends “qualified.”
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BDCs and other RICs (like Real Estate Investment Trusts) usually don’t pay qualified dividends because the government doesn’t tax them at the corporate level.
BDCs are special because they pay massive dividends to their shareholders. Also, they can benefit from some capital appreciation along the way.
Investing in BDCs. Each BDC can focus on different specialties inside the small business arena. Some invest in larger businesses, and others focus on smaller ones.
You should do some due diligence on each BDC you invest in to give yourself a little diversification.
It’s common to receive yields between 8% and 12% for BDCs. When interest rates rise, BDCs can suffer because they make their money from the spread between their borrowing and lending.
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However, most of their loans have inflation markers that adjust to the current Federal Funds rates or inflation. This gives them more interest income during a high-interest rate environment.
My favorite BDCs. I invest in several BDCs. The biggest blue-chip BDC of them all is Ares Capital (ARCC). The second and third largest are FS KKR (FSK) and Blue Owl Capital (OBDC).
I also invest in Capital Southwest (CWSC), Saratoga Investment (SAR), Oaktree Speciality Lending (OCSL), and Sixth Street Speciality Lending (TSLX).
Many more BDCs are out there, so perform your due diligence and build an excellent portfolio for income and some growth.
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BDCs in ETFs. You can also find BDCs inside of ETFs and closed-end funds. One of the most well-known BDC ETFs is Van Ecks BCD Income ETF (BIZD). I wrote two articles about individual securities versus funds that have relevance here.
You will probably get better returns by investing in individual BDCs; however, you must balance the time commitment.
BDCs can also have some periods where they don’t perform well. Remember, they only do as well as the companies in their portfolio. Many of these small businesses can suffer simultaneously, like in 2020.
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Using BDCs during retirement. Unlike Dividend Growth Investing, you can invest in BDCs for income today—they pay high income as soon as you invest.
Your goal during retirement is to receive a high amount of revenue, protect capital, and get a little growth. BDCs can help you in all three areas.
You can reinvest 25% of your dividend income into your BDCs to ensure you keep growing your pot of revenue.
BDCs do increase their dividends from time to time, but less consistently than blue-chip dividend-paying companies.
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Feeling special with special dividends. Business Development Companies pay a lot of special dividends along the way.
Remember, RICs must pay shareholders 90% of their net interest income. However, this number can vary tremendously across months and years.
Therefore, BDCs pay regular, steady dividends. They can then pay supplementary and special dividends when they have too much net interest income in their hands.
With BDCs, you can be flush with cash—precisely what you need during retirement. If you want to live a Happy Cash Flow Retirement, BDCs are a must-have.
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Once you understand how BDCs operate, you’ll never want to be without them. They give you a slice of the American dream of owning a small business.
Conclusion. Most people will never follow or understand BDCs. They fly under the radar for stocks like Tesla (TSLA) and Nvidia (NVDA).
However, these high-flying stocks don’t pay dividends and can be very volatile. Your retirement is not a time to pray for stocks that perform well—you need cold, hard cash in the form of dividends.
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You want to become a bank, not open a business. BDCs lend money but can also participate in the upside of these small businesses due to owning an equity stake.
Knowing the difference between debt and equity is critical to income investing. Do you own the loan or the business?
BDCs can own debt and equity, which makes them unique, and can increase their payouts as they sell equity shares at a profit.
If you want to serve as a high-yield bank operator, look no further than business development companies. I should be getting my dividend from Ares Capital (ARCC) tomorrow. How exciting!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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