Thoughts On MLPs

A few of the dividend sites that I visit (like Dividend Growth Investor  and Dividend Growth Stocks) will frequently post lists of stocks: stocks they have recently bought, stocks they are looking at, and stocks that have recently increased their dividends.

Sometimes these stocks will include companies that are master limited partnerships. An MLP is a different legal structure for a company. Unlike a corporation, its members share some liability.

My issue is that many of these sites (and lots of articles around the web) will mention MLPs without really explaining some of the differences from regular stocks. One example is here.

One of their main features is they do not pay income taxes at the company level. For this reason, they are sometimes called “pass-through entities“. They must send a certain amount of their profits to their investors. Investors buy and hold “units” instead of shares, and they get “distributions” instead of dividends. (I think some REITs are also pass-through entities.)

They tend to be in the energy industry, and have “LP” at the end of their name. A couple of the bigger, more famous ones are Kinder Morgan Energy Partners, L.P. (KMP) and Enterprise Products Partners L.P. (EPD).

Because they are taxed differently, you get a different tax form called a K-1. I have heard it is a beast to deal with.

My impression is since they are pass-through entities they should only be held in taxable accounts. You could pay tax on the MLP income even if you hold it in a Roth IRA. I think there are a lot of people in the USA for whom the $5500 they put in their Roth IRA is the entirety of their retirement savings. Right now, I am one of those people. If you want to go with an MLP, I think an ETF would be the best bet.

Dividend investors need to be aware of the different tax treatment. And some of us who have been doing this for a while need to let beginners know that there are a few gotchas with MLPs. I think most people should avoid investing in them directly and just go with an MPL ETF.

Another point about MLPs is that they tend to have higher percentage yields than most stocks. Many of them have yields above 6%. Many dividend investors would consider anything above 6% yield for a corporation to be a serious red flag if not a reason for elimination. But for MLPs it is not necessarily a cause for concern. When I was first looking into dividend investing I found this a bit confusing until I learned a bit more about MLPs. One week a writer would say I should avoid a stock with a yield of 7% since yields that high are considered a sign a company is having trouble. But then the next week the same writer would say that some other stock (an MLP in this case) was a good investment because it had a 7% yield. If you do not know the distinction between a corporation and an MLP, those mixed signals can be a bit confusing.

They also may have higher payout ratios than stocks. I have neither a degree nor any experience in accounting, but from what I have gathered MLPs track things differently. So a higher payout ratio is not a cause for concern.

Once again, I think for most people an ETF is the best way to invest in MLPs.

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Post created on 2013-10-24_0:46:12, last modified on 2018-02-09_0:22:00

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