More Than Dad Forgot to Tell You About Income Investing: Questions and Answers

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

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

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

All three are income producers, and once they are “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 has existed for any kind of growth vehicle.

Income mutual funds and ETFs can create shares at will, with a market value equal to the 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… income is rarely mentioned in their product descriptions.

A security for income purposes can stay in the same price range for years, only spending 6% to 10% in income to fund college education, a retirement lifestyle, and world travel. But most investment advisers, passive ETFs, and mutual fund managers rate themselves on the annual “total return” their portfolios or indices produce…income programs just don’t generate year-end trips or six-figure bonuses.

• I myself was laid off a few times, just before the dot-com bubble burst, because my 10% to 15% “yield” on high-quality, income-producing stocks simply couldn’t compete with the speculative rush that fueled the NASDAQ at 5000…
• But when the markets crashed in 2000, the “no NASDAQ, no IPO, no mutual funds = no problem“The operating creed produced significant growth and revenue.

Another problem is the compensation of brokers/advisers at Wall Street firms…based entirely on the sale of proprietary products and “investment committee” recommendations. There is no room for slow growth based on high-quality dividend-paying stocks and closed-end funds for income-generating purposes.

Finally, the government’s myopia of market value and cost performance precludes any inclusion of CEF in 401k and other employer-sponsored investment programs. Vanguard’s VTINX Retirement Fund pays less than 2% after a minimum fee; Much better diversified CEF hundreds pay 7% and better after 2% or more in fees. However, the DOL, FINRA, and the SEC have somehow determined that 2% of spending money is better than 7% in what they have incorrectly labeled “retirement income programs.”

• You’ll never see a CEF, not even a Balanced Portfolio or Stock CEF, on a 401k stock selection menu. Public REITs and MLPs probably don’t exist either.

8. How many different types of CEF are there; what investors pay for them; And are there penalties for exchanging them frequently?

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

A partial list of types and sectors includes: Biotech, Commodities, Convertible Bonds, Covered Calls, Emerging Markets, Energy, Stock Dividends, Financials, General Stocks, Government Securities, Healthcare, High Yield, Limited Duration Bonds, MLPs, Bonds mortgage, multi-sector revenue, diversified national municipal, preferred stock, real estate, senior loans, 16 different single-state municipal, tax-advantaged stock, and utilities.

CEFs are purchased in the same manner and at the same cost as individual stocks or ETFs, and there are no additional penalties, fees, or charges for frequent selling…they are traded for free on managed, paid-only accounts, and they always pay more income than their ETF and mutual fund peers.

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 positions above the original cost base.
• I don’t like to shop when demand is artificially high.
• I prefer to pool my monthly income and select reinvestment opportunities that allow me to reduce the cost of the position and increase the yield at the same time.
• Investors rarely add portfolios to falling markets; just when I need flexibility to add new positions.

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

Actually, if an investor can focus their mind on 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 financial risk.
• The prices of income securities vary inversely with interest rate change expectations (IRE)
• Income securities should be evaluated based on the amount and reliability of the income they produce.

Let’s say thirty years ago we bought a 4.5% IBM bond, a 2.2% 30-year Treasury note, and 400 5.7% P&G preferred shares, all at par, and We invested $10,000 in each. The annual income of $1,240 has been accumulated in cash.

In this time period, interest rates have ranged from a high of over 12% to recent lows of around 2%. They have made no less than fifteen significant changes of direction. The market value of our three “fixed income” securities has been above and below “cost basis” dozens of times, while the portfolio’s “working capital” (cost basis of holdings of the portfolio) grew every quarter.

• And every time the prices of these securities fell, their “current yield” increased while paying the same dividends and interest.
• So why does Wall Street make such a fuss when prices fall? Why actually.

Over the years, we have accumulated $37,200 in dividends and interest; the bond and treasury note matured at $10k each, and the preferred stock still pays $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 doesn’t make sense to view it in the same way as stock investing.

Investors must be reprogrammed to focus on producing income from investments for income purposes and earning reasonable returns when produced through securities for growth purposes.

• What happens if we reinvest the income each quarter in similar securities? Or he sold the stock when it went up 5% or so… and reinvested the proceeds in portfolios of similar securities (CEF), rather than individual entities, for diversification and higher returns?
• Assuming a profit of just $500 per year and an average interest rate of 5%, the portfolio’s “working capital” would grow to $168,700…a profit of approximately 462%. The income would be $8,434…a profit of 680%

I hope these conservative income numbers get you a little more excited about having a serious income purpose allocation in your “eventually a retirement income portfolio”…particularly income CEF. Don’t let his adviser talk you out of it; Stock market investments are not designed to do the job of income… reliably, over the course of our retirement lives.

• CEFs allow anyone to invest in diversified portfolios of fixed-income securities and, by design, always at higher rates than individual securities.
• CEFs provide a single liquid entity that allows investors to benefit from price changes caused by IRE in either direction. Yes, that’s what I meant.

eleven Why take profit if a security’s earnings haven’t changed?

Compound interest is the “holy grail” of income investing. A 5% profit made and reinvested today will work much better than the 5% received over the course of the next few months. Also, when interest rates are rising, profit opportunities are slim and income can be used 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 have held it for 8 months, so we have already received 4.5% and can sell it today for a 4% profit. So we can make a nifty 8.5% (actually a bit more since we’ve reinvested previous earnings), in just eight months.

We can then compare prices to the earnings of a new CEF yielding 6% or more and hope to do a similar trade soon with another of our holdings.

A second reinvestment strategy is to aggregate multiple positions that are priced below the current cost basis and are yielding more than the CEF we just sold. This is a great way to improve the “current yield” on existing positions while ensuring that you have more opportunities to profit when interest rates decline.

12. How do you keep “working capital” growing?

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

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 capital of work.

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, either scenario is more likely to allow me to grow both my income and working capital even faster.