How Can I Buy an Annuity Without Giving Away my Principal?

Annuities can provide a steady reliable source of income for someone who is not working perhaps due to retirement. Basically, you buy an annuity and it pays you a set amount on an agreed schedule for an agreed length of time. When that time is up, the original principal invested stays with the annuity’s issuer. Often the length of time is until the buyer dies. But what if you want the steady reliable payments but you don’t want to permanently hand over your principal? Is there some way to buy that?

A Reasonable Facsimile for an Annuity

So far I haven’t found any product that is the same as an annuity but that doesn’t use up your principal. I have found what advertisers used to call a “reasonable facsimile” though. It looks a bit like an annuity and works a bit like an annuity but it isn’t one.

For this to Work You Should Act as if You’re Buying a Vacation

If you’d asked me ten years ago if I had any stocks I would have said no. Then, after thinking for two or three minutes I might have corrected myself and said “well actually yes I do. But not real stocks.”

My confusion would have stemmed from the way I acquired those two stocks. Many, many, many years ago, I bought stock in my employer when it was privatized. As a then resident of Alberta, I also bought a small amount of Alberta Government Telephones when it privatized. (You may know it better by its current incarnation “Telus.”) In both cases when I bought the stocks I never expected to sell them again. They were impulse buys and I thought of them the same as if I had spent money on a vacation. It seemed like a good way to spend the money at the time and I’ve never thought much about it ever since.

If you are seriously interested in this “facsimile” of an annuity, you’d have to do the same thing. You’d have to consider the money you spent as being “almost” as gone as if you’d bought a true annuity. You’d have to go in with the possibility that you might never see or touch that money again.

You’d Also Have to Be Prepared for a Possible Drop or End to your Payments

If you buy an annuity from a well-respected source, part of the payment is insured. If the company issuing the annuity goes bankrupt you’re guaranteed to get at least a portion of your regular payments.

If you buy an annuity from a fly-by-night source, however, you might lose the whole thing if the issuer goes bankrupt.

Some people still choose this second option, especially if the proposed annuity payment is much higher than a well-insured one.

If you’re going to buy into this “facsimile” annuity you’d also have to be prepared that the payments could drop or could stop. How likely it is for the payments to be at risk depends on from which issuer you choose to buy your payments.

Have You Guessed the Nature of the Facsimile Annuity Yet?

Yes, the reasonable facsimile is a collection of dividend paying stocks.

Your principal might be recoverable unlike with a true annuity because you might be able to sell your stocks to get back all or part of your principal.

Your payments would not be guaranteed to stay the same or to continue because some companies do cut their dividend payments and some do stop paying dividends.

The risk of a dividend being cut or stopped can be estimated for a stock if you look at its dividend history and its current and announced company plans. Some companies are well aware that their investor-base is people who need steady, reliable income. If their business plan tends to produce steady reliable profits they usually plan on maintaining their historical approach to paying dividends.

Why I Forgot I Own Two Stocks

This brings me back to the two stocks I owned and actually forgot about. One of the stocks plummeted to half its value within a couple of years of when I bought it. From that point forward, I never included it in any estimates of my net worth. The other was such a small amount of stock it would be like counting the contents of my childhood piggy bank.

While I forgot about these stocks as “investments” or “capital gains plays” I never forgot they pay dividends. In fact, out of curiousity I recently worked out the yield for these stocks based on what I paid to acquire them all those years ago. (I didn’t factor in inflation or the lost time-value of that money. I kept it simple and just divided how much I get per year now by how much I paid in cash back then. This is not good math. It was just fun.)

The shares are now yielding 8% and 18% per year on their initial investment. That’s substantially better than the current yield for someone buying the same stocks today. Which is good because the increase is supposed to help cover some of the rate of inflation. (In fact when I compared it against the CPI increases for those years, the increase has been higher than inflation.)

Both stocks have also enjoyed large capital gains over the years. But since I have never sold the stocks and since I act like the money I paid for them is long gone, that’s not actually relevant. If I’m still holding them when I die, though, my survivors may be pleased. They could donate some of the shares to charity and use the tax credit to help offset some income taxes on the rest of my estate.

How Can I Pick the Stocks to Buy for my Facsimile Annuity?

Ah, now there’s a difficult question. I’ll have to get back to you on that with another post. In general, though, you’d be looking for a stock that has

  • paid a dividend for many years without interruption
  • is a business that tends to have a steady profit, such as a utility, financial or telecomm business
  • preferably has increased the dividend steadily to keep up somewhat with inflation
  • does not jeopardize its own survival just to pay a large dividend

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Can I Buy the Day Before the Dividend and Sell the Day after and Make Money?

Dividends fascinate some investors. Many are looking for a steady long-term source of income. Others, though, are looking for a quick buck. So a common question from the Easy Money crowd is whether you can buy a stock just before the dividend is paid and sell it just after to make a quick profit without investing for the long term. The answer is: Maybe. Here’s how dividends work.

The Three Key Dates for a Dividend

It’s important to understand how dividend payments are made. The company paying the dividend wants to know who to issue the cheques to and for how much before the actual day the cheques are payable. Otherwise they would always be late making the payments.

The Record Date or Date of Record

So the company sets a date to take a snapshot of who owns their stock. This is called the Record Date. A shareholder must officially own their shares on the Record Date to receive the next dividend payment. What makes them “official” owners is whether they have been entered into the books as the owner of those shares.

The Record Date is NOT the date you enter your order to buy a stock and your order is filled.

Settlement Date

When you place an order to buy stock and someone agrees to sell it to you the clock starts ticking towards the Settlement Date. At the start of business on the third day after your request to buy stock was accepted, you become the official owner of the shares.

You’ll see it reported on your Transaction History as the Settlement Date.

The timing of the Settlement Date is standard. It dates back to the days when the paper share certificate had to be physically delivered to the new owner or the new owner’s broker. Getting it out of a safe or safe deposit box and couriering it to the new owner took time. Even now when most share certificates are electronic and can be transmitted instantly, the Settlement Date is still Trading Day plus 3 Business Days, making you the official owner on the third business day. This is sometimes reported as T+3.

For a clearer example,
I put in an order for CGX (Cineplex) on Tuesday, May 28.
The order filled May 28.
The money was taken from my account May 28.
The trade settled on Friday, May 31.
I became the Owner of Record on May 31.

When Is It Too Late to Buy a Stock to Get the Dividend?

As described in an article discussing things to consider before buying a stock, you must purchase a stock BEFORE the Ex-Dividend Date if you want to get the next dividend.

The Ex-Dividend Date is the second business day before the Date of Record. That’s because you have to buy the shares 3 business days before the date you need to be the owner. So the last business day you can buy and get the next dividend is the business day before the Ex-Dividend Date.

Dividend Payment Date

This is the date on the dividend payment cheques.

Where Can I Find These Dates?

The best place to find the Date of Record and Payment Date is on the company’s Investor Relations’ Page. Some websites also show the Ex-Dividend Date but not all of them.
Although most trading screens show the Ex-Dividend Date, most do not show the Payment Date.

So If I Buy Before the Ex-Dividend Date and sell on the Ex-Dividend Date Then I Can Make a Quick Buck, Right?

Companies don’t actually want you to flip their stock. They want investors not speculators. Stock Markets themselves don’t want you to flip either. While they can’t stop the practice, they can try to take the profit out of it.

Say you buy a stock at $50 a share on the business day before the Ex-Dividend date. You sell it on the Ex-Dividend date. The dividend will be $0.50 a share. It’s a pretty stable stock that doesn’t bounce around much, so you assume you can sell it for $50 at the opening of trade.

Very unlikely.

Even though the stock closed at the closing bell at $50, it was immediately adjusted down by the dividend to an Adjusted Close of $49.50.

The stock price will be manually adjusted downwards for the value of the dividend before the next open of the market.

To see an example, look at the price history for Cineplex on ca.finance.yahoo.com

You’ll see on May 28, the stock closed at $34.26. Then further to the right, you’ll see a column of the Adjusted Close which says $34.14. The line above it says: “0.12 Dividend.”
In fact, on May 29, the stock opened at $34.10.

Of course trading will continue to affect the price. Many investors don’t want to buy a stock immediately after it goes Ex-Dividend because they will have to wait over a year (for an annual dividend), or over three months (for a quarterly dividend), or two months (for a monthly dividend) to get paid anything.

Often on the Ex-Dividend date and for several days following the stock will remain flat or fall.

That’s ok, you may think, I’ll wait a few days and when the stock goes up, I’ll sell it and make a profit both on the dividend and on the capital gain.

OK. Or you might sell it and make a capital LOSS that is only partially offset by the dividend. Stocks do not always go up.

Remember you will also have to pay two trading commissions for the buy and sell. That cost can range from about $10 to $60 depending on your brokerage.

If you bought 100 shares of Cineplex at $34.26 with a $10 trading commission on May 28, you’ll need to sell it for at least $34.46 just to break even. Cineplex closed at $34.34, 34.25, 34.06, 34.36, 34.34, and 34.43 for 6 of the next 7 trading days. You could have broken even a few times if you sold on the High, but it would not have been easy or routine.

Why is the Dividend So Small? I Thought They Paid 4% !

Another common mistake made by new investors is mentally calculating the size of the dividend. When they buy the stock, they see a nice 4% yield listed. On a $10 000 purchase, they expect to get $400. But the cheque is only for $100.

For some reason, they don’t check how often the dividend is paid. The 4% is the annual yield.

Many dividends are paid quarterly. That means each dividend payment is 1%, or $100 on $10 000.

If the dividend is paid monthly, the dividend payment is a mere $33.33.

That can be quite a shock to someone paying $29.95 a trade! If they are receiving a monthly dividend, they can’t sell the stock for at least 2 months and even expect to pay back the two trading commissions.

It’s Been 3 Business Days Since I Bought: Where is My Dividend?

Although you must buy shares before the Ex-Dividend date in order to be the shareholder on record on the Record Date, that doesn’t have anything to do with when the dividend will actually be paid.

Some companies, such as Canadian banks, have a Record Date that is a month or so before the payment date.

For example,
BMO goes Ex-Dividend on Tuesday, July 30, 2013.
BMO has a record date of Thursday, August 1, 2013.
The corresponding dividend will be paid August 27, 2013.

In another example, Cineplex pays a monthly dividend.
CGX goes Ex-Dividend on July 29, 2013.
It has a record date of July 31, 2013.
It will pay the corresponding dividend on August 30, 2013.

This last Cineplex example points out another item to watch out for: when I checked the Quote for Cineplex on BMO InvestorLine, it reports the Ex-Dividend date as May 29 today on June 9. This is true because that is the last time it went Ex-Dividend. It will be going Ex again, though near the end of June. For monthly dividend payers, you have to keep an eye on the Record Date on the company’s Investor Relations page if you want to make plans based on when it will next go Ex-Dividend.

So Can You Flip Stocks To Make a Quick Profit Off the Dividend?

Maybe. Your success will have more to do with market volatility, however, than with strategy or common sense.

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