Bonds Are A Form Of Equity Financing That Pays Interest More That Dad Forgot To Tell You About Income Investing: Q & A

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More That Dad Forgot To Tell You About Income Investing: Q & A

Just the other day, I was discussing “preparation for retirement” with a small group of people, several of whom were already retired. None of them owned, or even heard of, either closed-end equity or income funds (CEFs)… vehicles I’ve been using in professionally managed portfolios for decades.

Readers are assumed to have read all six questions and answers covered in Part One.

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7. Why does Wall Street, the media, and most investment advisors seem to ignore CEFs, public REITs, and master limited partnerships?

All three are income producers, and once they’re “out there” in the market, they trade like stocks… on their own fundamental merits and at a price that depends solely on supply and demand. Unfortunately, income programs have never attracted the kind of attention and speculative zeal that any type of growth vehicle has.

Income mutual funds and ETFs can create shares at will, maintaining a market value equal to NAV (net asset value). But the sole purpose of each is to increase market value and produce a comparable “total return” number on the stock market…revenues are rarely mentioned in their product descriptions.

An income-oriented security can stay at the same price for years, only spitting out 6% to 10% of income to fund college education, a retirement lifestyle, and world travel. But most investment advisors, passive ETFs, and mutual fund managers call the annual “total return” produced by their portfolios or indexes … income programs simply don’t generate year-end trips and six-figure bonuses .

  • I myself was fired a few times, right before the dot.com bubble burst, because my 10% to 15% “return” on high-quality, income-producing stocks simply couldn’t compete with the speculative fever that drove the NASDAQ to 5000…

  • But as the markets fell apart in 2000, the “no NASDAQ, no IPO, no mutual funds = no problem” The operating credo has produced significant growth and revenue.

Another problem is broker/advisor compensation at Wall Street firms…entirely based on selling proprietary products and “investment committee” recommendations. There is no room for slow growth based on high quality dividend paying stocks and income oriented closed-end funds.

Finally, government cost and market value return myopia precludes any inclusion of CEFs in 401k and other employer-sponsored investment programs. Vanguard’s VTINX retirement fund pays less than 2% after a minimal fee; hundreds of much better diversified CEFs pay 7% and better after 2% or more in fees. However, the DOL, FINRA, and SEC have somehow determined that spending 2% of your money is better than 7% in what they mislabeled as “retirement income programs.”

  • You will never see a CEF, not even a balanced portfolio or equity CEF, in a 401k security selection menu. Public REITs and MLPs are also unlikely to exist.

8. How many different types of CEF exist; what investors pay for them; and is there any penalty for trading them frequently?

CEFConnect.com lists 163 tax-free, 306 taxable, 131 US equity and 204 non-US and other funds.

A partial list of types and sectors includes: Biotech, Commodities, Convertibles, Covered Calls, Emerging Markets, Energy, Equity Dividends, Financials, General Stocks, Government Bonds, Healthcare, High Yield, Limited Duration Bonds, MLPs, Bonds mortgages, sector income, diversified national municipalities, preferred stocks, real estate, senior loans, 16 different state municipalities, tax-advantaged stocks and utilities.

CEFs are bought the same way and at the same cost as individual stocks or ETFs, and there are no penalties, fees or additional charges for selling them frequently… they trade for free in managed accounts, commission only and always pay more income than your ETFs and mutual funds.

9. What about DRIPs (Dividend Reinvestment Programs)?

There are at least four reasons why I choose not to use DRIP.

  • I don’t like the idea of ​​adding posts above the original cost.

  • I don’t like shopping when demand is artificially high.

  • I prefer to pool my monthly income and select reinvestment opportunities that allow me to reduce the cost base of the position and increase yield at the same time.

  • Investors rarely add to portfolios in bear markets; just when I need flexibility to add new positions.

10. What are the most important things investors should understand when it comes to investing income?

In fact, if an investor can wrap their mind around just three things, they can become a successful income investor:

  • The change in market value has no impact on the income paid and rarely increases the financial risk.

  • The prices of income guarantees vary inversely with interest rate change expectations (IRE)

  • Income securities should be evaluated based on the amount and reliability of the income they produce.

Say, thirty years ago, we bought a 4.5% IBM bond, a 2.2% 30-year Treasury bond, and 400 shares of a 5.7% P&G preferred stock, all at par, and we invested $10,000 in each. Annual income of $1,240 has been accumulating in cash.

In this time period, interest rates have fluctuated between a high of over 12% and recent lows of around 2%. They made no fewer than fifteen major changes in direction. The market value of our three “fixed income” securities was above and below the “cost basis” dozens of times, while the portfolio’s “working capital” (cost basis of the holdings in the portfolio) was growing every quarter

  • And every time the prices of these securities fell, their “current yield” rose while paying the same dividends and interest.

  • So why does Wall Street make such a fuss when prices go down? Because yes.

Over the years, we have accumulated $37,200 in dividends and interest; the bond and the treasury note matured at $10,000 each, and the preferred stock continues to pay $142.50 per quarter.

So our cash account is now $57,200 and our working capital has increased to $67,200 while we haven’t lifted a finger or spent a moment worrying about fluctuating market values. This is the essence of income investing, and precisely why it does not make sense to look at it in the same way as equity investing.

Investments should be reprogrammed to focus on income-producing investments for income purposes and to earn reasonable profits when produced by growth securities.

  • What if we reinvested the proceeds each quarter in similar securities? Or sold the stocks when they went up 5% or so… and reinvested the proceeds in portfolios of similar securities (CEFs), rather than individual entities, for diversification and higher performance?

  • Assuming only a profit of $500 per year and an average interest rate of 5%, the “working capital” of the portfolio would grow to $168,700… a gain of approximately 462%. Revenue would be $8,434… a 680% gain

I hope these conservative income numbers get you a little more excited about having a serious income purpose allocation in your “retirement income portfolio”…especially income CEFs. Don’t let your counselor fail you; Stock market investments are not designed to do the job of income…reliably, throughout our retirement lives.

  • CEFs allow anyone to invest in diversified portfolios of fixed income securities, and by design, always at higher rates of safety than individual securities.

  • CEFs provide a uniquely liquid entity that allows investors to benefit from price changes caused by IRE in either direction. Yes, that’s what I meant.

11. Why take profits if a security’s income hasn’t changed?

Compound interest is the “holy grail” of income investing. A 5% profit realized and reinvested today will work much better than 5% received over the next few months. Also, when interest rates are rising, opportunities for profit are scarce, and income can work more productively than in stable or falling interest rate environments.

So let’s say we have a “limited duration” CEF bond with a 6% yield. We’ve held it for 8 months, so we’ve already received 4.5% and can sell it today at a 4% profit. So we can achieve a nifty 8.5% (actually a little more since we reinvested the previous earnings), in just eight months.

So we can buy with the proceeds for a new CEF yielding 6% or more and hope to make a similar trade soon with another of our holdings.

A second reinvestment strategy is to add to several positions that are priced below the current cost basis and yield more than the CEF we just sold. This is a great way to improve the “current yield” of existing positions while at the same time ensuring that you will have more opportunities for profit when interest rates fall.

12. How “working capital” continues to rise.

Total working capital, and the income it produces, will continue to grow as long as the income exceeds all withdrawals from the portfolio. Note that capital losses have no impact on income if the income can be reinvested at a higher “current” return…but working capital has a temporary impact.

Portfolios stay on their asset allocation “track” with each batch of monthly reinvestment decisions, but the larger the income purpose “bucket,” the easier it is to ensure consistent growth in both income and working capital.

13. What is retirement income preparation?

It is the ability to make this statement, unequivocally:

  • Neither a stock market correction nor rising interest rates will have a negative impact on my retirement income. In fact, it’s more likely that either scenario will allow me to grow my income and working capital even faster.

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