Unconventional Income From Uncommon Stocks – Royalty Trusts

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This is part I of the series, Unconventional Income From Uncommon Stocks. The series is meant to be an absolute beginner’s introduction to uncommon stocks. The focus of this post is on Royalty Trusts.

Investing For Income

The national average for interest on your savings account is about 0.17%. How would you like to get an yield of say 6.5% paid as quarterly dividends from royalties from oil wells in Alaska? Almost all of the profits are passed on to you in proportion of your share AND you can even factor oil well depletion as a tax write off! Sounds intriguing? Read on!

Investing In Royalty Trusts

There is a class of shares called Royalty Trusts that are neither stocks nor bonds but trade like shares. The above example was from a Royalty Trust called BPT, BP Prudhoe Bay Royalty Trust. First, take a look at some of the stats for BPT.

BPT BP Prudhoe Bay Royalty Trust MoneyCone Chart

BPT BP Prudhoe Bay Royalty 1 Year Performance Chart MoneyCone-1

BPT-MoneyCone-Chart

1 Employee

That’s no typo, that’s a characteristic of Royalty Trusts. Royalty Trusts don’t have any employees! There is just the trust manager which is usually a bank and any profits are passed on to the unit holders.

In the case of BPT, the trust is managed by Bank of New York.

What Exactly Are Royalty Trusts?

Royalty Trusts hold assets in natural resources like Coal, Oil, Minerals and Natural Gas.

Royalty Trusts don’t have any operation on their own. The resources are mined/drilled by a different company and pay royalties to the trust in return. By law, Royalty Trusts are required to pass on almost all the returns to unit holders and yields of 10% are not uncommon.

Royalty Trusts don’t pay any corporate tax. This is passed on to the unit holder as well.

So, What’s The Catch!

Sounds great right? But Royalty Trusts do have some drawbacks.

Natural resources are finite in nature and Royalty Trusts invest in them, which implies when these resources get depleted, the royalty trust has to shut down. And that’s exactly what happens to Royalty Trusts. Once the resources are depleted, the trust is closed. Keep this in mind when investing in Royalty Trusts. They are not forever. You should know when to get out!

Since a Royalty Trust doesn’t pay any corporate taxes, you bear the tax burden.

You also have to pay a state tax in the state where the assets are located.

Be prepared for decreasing distributions as the resources get depleted.

Is It Worth It?

Definitely! For some additional tax prep time, you get above average yields which are directly tied to commodity prices. If you invest in an Oil RT, your distribution is directly tied to the price of Oil. If the prices go up, so does your distribution.

Though a RT is not forever, they don’t shut down in a year or two. Usually they last for decades. Pick a trust that has not reached its end-of-life period.

You don’t pay taxes till you sell your shares and your distributions are taxed as capital gains and not as income which is a good thing since capital gains taxes are lower than income tax.

Ok, You Have Me Hooked! How Do I Invest In Royalty Trusts?

Royalty Trusts trade like stocks. Buying an RT unit is exactly like buying stocks. Enter symbol and number of shares and press ‘buy’!

Can I hold Royalty Trusts In A Retirement Account (ROTH, IRA, 401K etc.)?

Yes! Royalty Trusts are best suited for retirement accounts as they don’t generate UBTI unlike MLPs. Keeping Royalty Trusts in a tax-deferred account shields you from tax complications as well.

Anything Else I Need To Know?

Yes, one last thing. There are two kinds of Royalty Trusts, US based and Canadian based. Canadian Royalties are different and laws are changing in 2011. Taxes on Canadian Royalties are different as well. Know this before investing.

Why BPT?

This is not a recommendation to buy BPT! I own BPT and know more about this RT than others. There are many more. SJT, HGT and PBT are some other RTs worth considering.

Conclusion

RTs are a great way to add income component to a portfolio. The yields are some of the best and is a safer alternative to the futures market. For a little bit of extra tax prep time, you get great returns. If the price of the unit goes up (like BPT did) that’s an added bonus!

When I invested in BPT, I wasn’t looking for share price appreciation only income through dividends. Yet, BPT has been one of the best performing stocks of 2010!

Recommended Read:
Handling Royalty Trusts In TurboTax

This post is a part of a series of posts on Unconventional Income From Uncommon Stocks. Stay tuned for more investing ideas in the coming weeks! You can get the articles delivered straight to your inbox via email (you can unsubscribe any time you wish and your email id will not be used for any other purposes), or if you prefer, you can subscribe via RSS.

Don’t miss part I of the series – Unconventional Income From Uncommon Stocks – MLPs.

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27 thoughts on “Unconventional Income From Uncommon Stocks – Royalty Trusts

  1. Unconventional Income From Uncommon Stocks – Royalty Trusts http://bit.ly/eWT0SY

  2. Unconventional Income From Uncommon Stocks – Royalty Trusts … http://bit.ly/eWgOIi

  3. Unconventional Income From Uncommon Stocks – Royalty Trusts … http://bit.ly/eWgOIi

  4. Great call! RT’s are great. If you are looking for something like this, MLP (Master Limited Partnerships) are good as well!

  5. @Robert: Absolutely! MLPs are part of this series!

  6. Great post, Money Cone! I think RT’s are too often overlooked, and therefore become a great untapped investment resource.

  7. @Jessica: Very true! The tax part scares most, but the returns are worth the effort. I never thought a RT would be one of my best performing stocks for 2010!

  8. I have to admit, I’ve check this Royal Trust more than one. I didn’t know that it wasn’t a stock though!

    I’m a bit intimidated by the tax differences that you identified above.

    But other than that, it sounds and looks great!

  9. Loved your post! I usually just brushed over RT and never paid a lot of attention to it. Now, I might take a closer look.

  10. That is some nice return, I am glad you are invested in this one. I love them dividends especially when they’re paid on a monthly basis!

    That will be one of my objectives for 2011, increase the monthly dividends!

  11. Wow, pretty cool. I don’t know much about RT, but will keep that as an option now that I’m moving my portfolio toward yield in the next few years.

  12. Any ETFs available in this sector to spread the risk out?

  13. @Money Reasons: You should definitely check out RTs …most tax software can handle RTs if you are concerned.

    @Aloysa: Thanks! Give RTs a thought. They are great way to add income to your portfolio.

    @BeatingTheIndex: To be fair, that wasn’t *my* return – just one year returns on BPT. Mine was less than that, but still pretty high. Some RTs do provide monthly dividends. I hold PVX, but then it is Canadian and there is the withholding tax on it plus the laws are changing coming year.

    @retirebyforty: Definitely research this area.

  14. @Biz of Life: You bring up a good point! There are ETFs that specialize in canadian RTs (ENY comes to my mind) but none as far as I know that specialize in pure US RTs.

  15. Moneycone – this is a really interesting post. I haven’t spent time looking at this investment vehicle, so this was a good primer. As with anything, I would say that there’s no such thing as something for nothing. That said, even though there appear to be real risks here, those total returns seem really impressive. Thanks for sharing this!

  16. @Squirrelers: You are absolutely right – nothing is without risks. Due diligence should always be practiced. But it is good to be aware of the options! One shouldn’t invest in RTs expecting share price appreciation in the long run!

    Glad the post helps.

  17. Investing for income is a great way to increase return.

  18. You know what, I didn’t really think about Royalty Trusts when I was contemplating my saving allocations for next year. I am really glad I came across this post- I am going to look into them further.

    Thanks Moneycone!

  19. Unconventional Income From Uncommon Stocks – Royalty Trusts http://bte.tc/fZsX #RTW

  20. Unconventional Income From Uncommon Stocks – Royalty Trusts http://bte.tc/fZsX #RTW

  21. Interesting article. Have invested in the past in a variety of MLP’s. You must understand that after 100%+ appreciation, consider the volatility of commodities, principle depreciation will wipe out the advantage of the fat dividend. Proceed with eyes open.

  22. Unconventional Income From Uncommon Stocks – Royalty Trusts http://bte.tc/fZsX #RTW

  23. I knew nothing about royalty trusts, so I appreciate the intro. I am looking forward to your unconventional investment series.

  24. @First Gen American: You are welcome!
    @Barb: Oh yes Barb. This is not a capital appreciation stock!

  25. Interesting post. I would put 5% of investable assets in this sector and agree with Barb “…proceed with eyes open”. It would probably not be that difficult to hedge these with say a few (far out of the money) puts .
    As a matter of background I went to work for a wealth management firm a few years ago that had its fixed income portion of assets tied up in high yielding trust preferreds – mostly bank issues. They were hitting the ball out of the park and high fives around the office were pretty common. Then 2008 came along. Check a price graph on Royal Bank of Scotland trust preferreds to get the rest of the story.

  26. The Royalty Trusts seem to be really interesting as far as I can see from the charts. Good that I have found your post.
    Keep up the good work.
    Cheers

  27. Intriguing! I haven’t read much about royalty trusts before, so this is helpful to know. Interesting too that they will shut down eventually. Thanks MC.

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