What is a Royalty Trust?
You may have heard a tip from a friend that she has a great oil and gas royalty trust for you to invest in. First, we should point out that by the time a stock tip reaches you, it's usually to late. Do your own research, and inform yourself as to what your best investment is based on your financial needs, investing time horizon, etc. Second, royalty trusts aren't always all they're cracked up to be, especially when it comes to the oil and gas industries.
A royalty trust is a financing vehicle (not a company), that holds operating assets for shareholders. Cash, instead of being reinvested, as would be the case with a company, is passed directly down to the shareholders, usually in the form of dividends. There's plenty of royalty trusts out there today that have had stellar performances the past couple years, and yield fat dividends at the same time. But never forget the little disclaimer always printed at the bottom of financial marketing pamphlets - past performance is not an indicator of future returns. That's never more true than with royalty trusts, and especially oil and gas royalty trusts.
Royalty Trust Dividends - Not All They're Cracked up to be
The dividend statistics on a royalty trust should be continuous, and have a consistent history of payouts in line with the current advertised rate. With a royalty trust, a dividend is simply paid out as a percentage of income - there are no decisions by management factored in based on the company's performance. That means whatever a company is earning, it's paying out. The problem with oil and gas royalty trusts is that they're invested in depleting assets.
The Depleting Assets of Oil and Gas Royalty Trusts
In other words, your oil trust might be invested in an oil field that has produced steady income over the past decade based on a steady supply of oil. The problem with an oil field investment, unlike other types of royalty trust assets, is that the oil will eventually run out. And if the trustees decide to buy into more oil fields as a result of the depletion in current oil fields, your current income will be depressed.
The final issue to be mindful of when considering an oil and gas trust investment is the volatility of the assets. When you're investing in natural resources and raw materials, your income is subject to the whims of the commodity markets. Just like your car is paying at the pump, your investments will pay on the stock market if you're not careful. We're not trying to completely discourage you from investing in oil and gas royalty trusts - as history shows it is possible to make a nice chunk of change on them, but we want to make sure you're informed as to the risks involved, and as to the true nature of what commodity based royalty trusts are all about.