Regulated Investment Companies
Among some really cool things and subjects we often discuss, we wanted to write a little about the companies that are in the portfolio, Regulated investment companies (RICs), and why they are so important for this portfolio.
When we started looking for companies with high earnings and high dividend yields, these companies just naturally floated up to the top. There was something special about them apart from their having extremely high earnings and dividend payments relative to all the other stocks in the stock market. Looking a little bit closer as to why they are outperforming everybody else, what we found was these companies by law must pay out at least 90% of their earnings to shareholders in the form of dividends.
This is a special class of stock!
Part of them being special is the IRS exempts them from paying corporate income taxes, and that’s very important to an investor, as you’re already ahead in the investing race because you’re avoiding double taxation. Any other stock that’s not a RIC, the company’s first going to pay its corporate income taxes, and then you’re going to get taxed on any dividend.
Now that’s interesting! Are we saying that they’re exempt from paying corporate income taxes so really, we’re paying the taxes?
Not exactly. RICs pay no taxes on their profit, but the dividends are taxed as pass through income to you, and only if you are holding them in an after-tax account. In contrast, companies that aren’t RICs must pay corporate taxes on their earnings, and the investor must pay taxes on the dividends they receive from these non-RIC companies. Usually, the tax rate is 15%, which may be higher than the investor’s effective tax rate. (Dividends generated by RICs are known as non-qualified dividends because they are not subject to the 15% tax rule.) If you own RICs in a pre-tax account such as a 401K or traditional IRA, the dividends are tax deferred. If you own them in a Roth IRA, the dividends are tax free, like any other type of investment. That’s a HUGE advantage especially when you start compounding dividends at these high yields and not paying taxes for years.
Additionally, there’s a little bit of an altruistic motive in putting money into these companies. The reason they were started years ago was that the federal government looked at the stock market and said, all this money is just chasing after this handful of Blue-Chip stocks, and there’s very little money going to young startup companies that we want to help get those businesses going because the small companies are the ones that create most of the jobs in this country! So, Congress said, ‘hey let’s incentivize investors to buy stocks in companies that will then turn around and lend it out to other small companies and startups and plant seeds all over the economy’. And that’s exactly what happened. There are billions if not trillions of dollars in RICs now because of their superior returns and because they’re helping the economy grow. RICs come in several different forms, but the ones Fly High Investing invests in are either Real Estate Investment Trusts (REITs) or Business Development Companies (BDCs).
Real Estate Investment Trusts (REITs) are a very popular investment option, especially for income investors. REITs are companies that own or finance income-producing real estate across a range of property sectors. Business Development Companies (BDCs) normally invest in small companies, start-ups and distressed companies. By investing in small companies and start-ups, BDCs are helping them grow in the initial stages of their development. In the case of distressed companies, BDCs help companies regain solid financial footing. In either case, BDCS are helping to create jobs and grow the economy. As an investor, this is win-win because, as previously mentioned, investors enjoy superior returns, and they are helping grow the economy. That’s another fascinating aspect of investing in these types of companies’ investors normally don’t think about.