Want $1,000 in annual dividend income? Invest $9,550 in these 2 ultra-high yielding stocks

If you’re worried about having enough money in your retirement years, you’re not alone. A recent AARP survey found that 61 percent of Americans over 50 worry they won’t have enough to support themselves in retirement.

Buying rental properties is a popular way to set yourself up with more passive income, but every new tenant comes with significant risks. Additionally, property management is not as passive as most retirees would like.

If individual investors want to build a truly passive income stream, buying dividend paying stocks is the way to go. The capital city of Ares (NASDAQ: ARCC) and PennantPark Floating Rate Capital (NYSE: PFLT) offers an average yield of 10.5% at recent prices. With such high yields, an investment of about $9,550 spread across them is enough to provide $1,000 in annual dividend payments.

Before you invest every penny you can find in these two stocks, it’s important to note that a particularly high yield means the market is concerned that the underlying business can’t continue to meet and grow its commitment of dividends. Here’s why these two stocks might be a lot 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 almost all of its profits to shareholders as dividends. At recent prices, its dividend yields 9.3%.

For decades now, American banks have been increasingly reluctant to lend money directly to medium-sized businesses. Because they are starved of capital, mid-sized companies are willing to accept interest rates much higher than the BDC’s cost of capital.

Individual borrowers with a job and a decent credit rating can get unsecured personal loans at lower interest rates than Ares gets from mid-sized businesses, some of which have annual sales of more than $1 billion. The average return Ares received on its debt portfolio was 12.2% in the second quarter.

Ares Capital is not just any BDC; it is the largest with shares traded on a major exchange. With 525 companies already in the portfolio, its team of experienced underwriters receives a lot of new loan applications from companies they are already familiar with.

Selecting the best borrowers from a huge pool of applicants has resulted in attrition rates in the industry. For example, approximately 1.07% of BDC’s first lien loans have gone unpaid over the past 20 years. For Ares Capital, however, less than 0.05% of its first lien loans have resulted in a loss.

The story continues

2. PennantPark Variable Rate Capital

As the name suggests, PennantPark Floating Rate Capital is a BDC that makes middle market companies borrow at floating interest rates. At recent prices, it offers a yield of 11.7% and monthly dividend payments.

PennantPark’s dividend yield is much higher than Ares Capital’s because its smaller portfolio is arguably riskier. While PennantPark is a smaller BDC, a portfolio of 151 different companies is large enough to produce economies of scale. The average yield on its debt securities was 12.1% at the end of June.

PennantPark Floating Rate Capital has been operating since before the global financial crisis. It has managed to maintain or increase its payout since starting a dividend program in 2011, with a brief exception in 2018.

The average underwriter at PennantPark Floating Rate Capital has over 26 years of experience and it shows. The portfolio has been through the higher interest rate environment we’ve been in since 2022 and barely got a scratch. At the end of June, only 1.5% of the total portfolio at cost was in non-consumption status.

There are no guarantees, but this BDC’s track record of success suggests it can continue to provide plenty of dividend income for many years to come. Adding stocks to a diversified portfolio seems like a smart way to grow your income stream.

Should you invest $1,000 in Ares Capital right now?

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Cory Renauer holds positions in Ares Capital. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

Want $1,000 in annual dividend income? Invest $9,550 in These 2 Ultra-High-Yield Stocks was originally published by The Motley Fool