A Do It Yourself Income Fund

This week's issue of Barron's cover story is titled 10 Terrific Dividend Stocks.  It talks about how the market's recent drop has made it possible for investors to purchase "high quality dividend paying and dividend growing stocks" at a discount.

That got us thinking.  With money market yields miniscule -- the average money market account is yielding just 0.31 percent -- why not use those dividend stocks to create an income fund on your own?  Of course, unlike a money market account, the principal amount will fluctuate, as the stocks in that portfolio will change in value.  But if you're looking to generate income from your stocks and not as concerned about day to day fluctuations in the price, then you can use high quality dividend stocks as a proxy for a money market account.

What we did here is look at the companies that Barron's listed as its ten best dividend stocks, and we also looked at the additional ten that they provided.  We wanted to make sure that anyone putting this together would get income every month.  That meant we had to make sure we had stocks paying their first dividend in January, February, and March.  Then the cycle would repeat throughout the year and investors will get receive dividend income every month.

This would mean that we need a minimum of three stocks.  However, in order to diversify our portfolio, we chose six.  These are all high quality companies who can easily pay their dividends from the cash flows they generate.

We took the list of 20 that Barron's generated and we narrowed it down further.  We used several criteria to make this happen.  First, we wanted to make sure we had a portfolio that would generate income every month.  Then, in order to keep us from overpaying for the stocks we selected, we chose stocks with lower price earnings ratios when possible.  We also wanted some diversification.  For example, three of the top yielding stocks are telephone companies, so we scratched one from our list.

When we were done, the stocks we selected were AT&T, Verizon, Merck, Chevron Texaco, Lockheed Martin, and Johnson & Johnson.  These stocks all yield at least 3.1 percent, so investors purchasing these stocks will get a yield that's ten times higher than that of a money market account.  Of course, in order to get that additional yield, investors are accepting the risk that they may lose money on the underlying investment.

Verizon and Merck pay out on a January cycle.  AT&T and Chevron Texaco pay out on a February cycle.  And Lockheed Martin and Johnson & Johnson pay out on a March cycle.  That means every month, investors will get a two dividends from their stocks.  These stocks are also reasonably prices, with Johnson & Johnson's 12.7 price earnings ratio the highest among the group.  The average for the S&P 500 is close to 20 times earnings.

Furthermore, investors can boost their income from these stocks by selling covered calls on them.  This allows them to generate even more income from their positions.

All in all, this self created and managed income portfolio will allow investors to generate income from their stocks through dividends and covered calls.  These are also solid, secure companies that can cover their dividends and who will likely raise them in the future.  Investors looking for a relatively safe and low cost method to generate income may want to look into this.

NOTE:  THIS DOES NOT CONSTITUTE A RECOMMENDATION TO PURCHASE ANY OF THESE EQUITIES.  INVESTORS SHOULD DO THEIR OWN RESEARCH BEFORE PURCHASING ANY STOCK.