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Earn Income of Up to 11% by Investing in Energy MLPs

Yields are high, but remember that the fortunes of Master Limited Partnerships are tied to oil prices.

The crash in energy prices devastated MLPs, most of which run pipelines to transport oil and gas. From August 2014 through early February 2016, the Alerian MLP index lost almost 60% of its value, including reinvested dividends, before beginning a recovery. The good news: The slump in share prices pushed up MLP yields to a lush 8.7%, on average. That makes them more attractive than most other income investments. But settle in for a bumpy ride with these stocks.

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Risks to your money. Many MLPs have shaky balance sheets and may need to raise capital to fund their expansion plans. If the recent rebound in oil prices fails to take hold, some domestic energy producers could go belly-up or try to renegotiate pipeline contracts, reducing revenues for MLPs. Firms may cut distributions (which are like dividends) or lower the growth of future payouts. Investors who own individual MLPs receive K-1 tax forms, which can be a headache at tax time.

Hire a pro. Alerian MLP ETF (AMLP, $11, 11.0%) bundles major pipeline firms into one package. Investors receive a standard 1099 tax form rather than a K-1, and distributions are treated as tax-deferred return of capital. But the ETF is required to pay corporate taxes on MLP distributions before they’re paid out to investors; that reduces its income and total returns, making it an inefficient way to invest. The iPath S&P MLP ETN (IMLP, $17, 8.0%), an exchange-traded note, is a bit more tax-efficient because it’s set up to avoid owing corporate taxes. But the ETN mainly distributes ordinary income, which is taxed at an investor’s ordinary-income rate. In addition, keep in mind that an ETN is an unsecured debt security (in this case, issued by Barclays) that could theoretically default on its obligation to pay. (All prices and returns are as of March 31.)

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Do it yourself. Enterprise Products Partners (EPD, $25, 6.3%) owns a vast network of pipelines, storage depots and other income-producing assets. Prudently managed, the firm recently hiked its quarterly payout by 5.4%, to 39 cents per unit (equivalent to a share). Spectra Energy Partners (SEP, $48, 5.3%), which runs natural gas pipelines, also looks solid. It raised its quarterly distributions by a total of 8.3% in 2015 and is developing more than $8 billion worth of projects that should help it continue to boost its payout. (For more on Spectra, see 8 Stocks Buffett Is Buying … or Should Be.)

One higher-yielding MLP that should fare well is Western Gas Partners (WES, $43, 7.4%). A natural gas pipeline firm controlled by energy producer Anadarko Petroleum, Western has been steadily hiking its distributions and should continue to boost its payout as Anadarko funnels more pipeline and gas-processing assets to the partnership.

 

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