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If you're concerned about having enough money during your retirement years, you're not alone. A recent survey by the AARP found that 61% of Americans over 50 years old worry they won't have enough to support themselves in retirement.
Acquiring real estate to rent out is a popular way to set yourself up with more passive income, but each new tenant presents significant risks. Plus, managing properties isn't nearly as passive as most retirees want it to be.
If individual investors want to build a truly passive income stream, acquiring dividend-paying stocks is the way forward. Ares Capital (NASDAQ: ARCC) and PennantPark Floating Rate Capital (NYSE: PFLT) offer an average yield of 10.5% at recent prices. With yields this high, an investment of about $9,550 spread between them is enough to secure $1,000 in annual dividend payments.
Before you plow every penny you can find into these two stocks, it's important to remember that an especially high yield means the market is worried the underlying business can't continue meeting and raising its dividend commitment. Here's why these two stocks could be far less risky than their ultra-high dividend yields suggest.
1. Ares Capital
Ares Capital is a business development company (BDC), which means it can legally avoid paying income taxes by distributing nearly all its profit to shareholders as a dividend. At recent prices, its dividend offers a 9.3% yield.
For decades now, American banks have been increasingly hesitant to lend money directly to midsize businesses. Since they're starved for capital, mid-market companies are willing to accept interest rates that are way higher than this BDC's cost of capital.
Individual borrowers with a job and a decent credit rating can get unsecured personal loans with lower interest rates than Ares receives from midmarket businesses, some of which record over $1 billion in annual sales. The average yield Ares received from its portfolio of debt securities was a healthy 12.2% in the second quarter.
Ares Capital isn't just any BDC; it's the largest one with shares that trade on a major stock exchange. With 525 companies already in its portfolio, its team of experienced underwriters receives heaps of new loan applications from businesses they're already familiar with.
Selecting the best borrowers from a huge selection of applicants has led to industry loss rates. For example, about 1.07% of first-lien BDC loans defaulted over the past 20 years. For Ares Capital, though, less than 0.05% of its first lien loans resulted in a loss.