Retirement Ready Income Programs

Forming Valid Income Investing Expectations - Part One

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I've come to the conclusion that the stock market is an easier medium for investors to understand (to form behavioral expectations about) than the fixed income market. As unlikely as this sounds, experience proves it, irrefutably. Few investors grow to love volatility as I do, but most expect it in the market value of their equity positions.

When dealing with income purpose securities however, neither investors nor their advisors are comfortable with any downward movement at all. Most won't consider taking profits when prices increase, but will rush in to accept losses when prices fall.

Here are the important characteristics of income securities:

1. They are negotiable securities that generate a relatively stable stream of interest or dividend income, and include bonds, income CEFs, preferred shares, Unit Trusts, Federal and Municipal issues, income real estate, etc.

2. They, or the securities they hold, normally have specific payment dates and amounts.

3. Income securities are issued by governments or corporations, and have a maturity date when the issuer plans to repay all remaining principal and any unpaid interest.

4. Risk will vary, depending on the type, quality, and maturity of the security, but income securities are considered far less risky than equities.

5. They fluctuate in market price, and mostly as a function of changes in interest rate expectations (IRE).

Theoretically, income securities should be the ultimate "buy and hold" --- their primary purpose is income generation, and return of principal is typically a contractual obligation. I like to add some seasoning to this bland diet, through profit taking whenever possible, but losses are almost never an acceptable, or necessary, menu item.

Still, Wall Street pumps out products and Investment experts rationalize strategies that cloud the simple rules governing the behavior of what should be an investor's retirement blankie. I shake my head in disbelief, constantly. The investment gods have spoken: "The market price of income securities absolutely shall vary inversely with interest rates, both actual and anticipated --- and it is good."

It's OK, it's natural, and it just doesn't really matter. You have to understand how these securities react to interest rate expectations and take advantage of it. There's no need to hedge against it, or to cry about it. It's simply the nature of things.

There are several reasons why investors have invalid expectations about their income investments:

  • They don't experience this type of investing until retirement planning time and they view all securities with an eye on market value, as they have been programmed to do by Wall Street.
  • The combination of increasing age and inexperience creates an inordinate fear of loss that is prayed upon by commissioned sales persons.
  • They have trouble distinguishing between the income generating purpose of income securities and the fact that they are negotiable instruments whose market value is a function of current, as opposed to contractual, interest rates.
  • They have been brainwashed into believing that the market value of their portfolio, and not the income that it generates, is their primary weapon against inflation.

Really, Alice, if you held these securities in a safe deposit box instead of a brokerage account, and just received the income, the perception of loss, the fear, and the rush to make a change would simply disappear. Think about it.

Every properly constructed portfolio will contain securities whose primary purpose is to generate income (fixed and/or variable), and every investor must understand some basic and "absolute" characteristics of interest rate sensitive securities.

These securities include Corporate, Government, and Municipal Bonds, Preferred Stocks, many Closed End Funds, Unit Trusts, REITs, Royalty Trusts, Treasury Securities, etc. Most are legally binding contracts between the owner of the securities (you, or an investment company that you own a piece of) and an entity that promises to pay a fixed rate of Interest for the use of the money.

They are primary debts of the issuer, and must be paid before all other obligations. They are negotiable, meaning that they can be bought and sold, at a price that varies with current interest rates. The longer the duration of the obligation, the more price fluctuation cycles will occur during the holding period. Typically, longer obligation securities also have higher interest rates.

Two things are accomplished by buying shorter duration securities: you earn less interest and you pay your broker a commission more frequently.

Defaults in interest payments are extremely rare, particularly in investment grade securities, and it is very likely that you will receive a predictable, constant, and gradually increasing flow of Income. (The income will increase gradually only if you manage your asset allocation properly by adding proportionately to your income purpose holdings.

So, if everything is going according to plan, all that you ever need to look at is the amount of income that your income portfolio is generating --- period, head for the golf course. DONE!

Dealing with variable income securities is slightly different, as market value will also vary with the nature of the income, and the economics of a particular industry. REITs, Royalty Trusts, Unit Trusts, and even CEFs (Closed End Funds) may have variable income levels and portfolio management requires an understanding of the risks involved.

A municipal bond CEF, for example will have a much more dependable cash flow and considerably more price stability than an oil and gas royalty trust. Thus, diversification in the income-generating portion of the portfolio is even more important than in the growth portion --- income pays the bills. Never lose sight of that fact and you will be able to go sky diving more frequently in retirement.

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Retirement Ready Income Programs
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Steve Selengut is registered as an investment adviser representative. His assessments and opinions are purely his own. None of the information presented here should be construed as an endorsement of any business entity; the information is only intended to be educational and thought provoking.

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Risk Management: Income, 401k, and IRA Programs

Take a free tour of a professional investment managers' private SEP IRA program during ten years surrounding the financial crisis:

CLICK HERE

In developing the investment plan, personal financial goals, objectives, time frames, and future income requirements should all be considered. A first step would be to assure that small portfolios (under $50,000) are at least 50% income focused.

At the $100,000 level, between 30% and 40% income focused is fine, but above age 50, the income focus allocation needs to be no less than 40%... and it could increase in 10% increments every five years.

The "Income Bucket" of the Asset Allocation is itself a portfolio risk minimization tool, and when combined with an "Equity Bucket" that includes only Investment Grade Value Stocks, it becomes a very powerful risk regulator over the life of the portfolio.

Other Risk Minimizers include: "Working Capital Model" based Asset Allocation, fundamental quality based selection criteria, diversification and income production rules, and profit taking guidelines for all securities,

Dealing with changes in the Investment Environment productively involves a market/interest rate/economic cycle appreciation, as has evolved in the Market Cycle Investment Management (MCIM) methodology. Investors must formulate realistic expectations about investment securities--- by class and by type. This will help them deal more effectively with short term events, disruptions and dislocations.

Over the past twenty years, the market has transitioned into a "passive", more products than ever before, environment on the equity side...  while income purpose investing has actually become much easier in the right vehicles. MCIM relies on income closed end funds to power our programs.

To illustrate just how powerful the combination of highest quality equities plus long term closed end funds has been during this time... we have provided an audio PowerPoint that illustrates the development of a Self Directed IRA portfolio from 2004 through 2014.

Throughout the years surrounding the "Financial Crisis", Annual income nearly tripled from $8,400 to $23,400 and Working Capital grew 80% $198,000 to $356,000.

Total income is 6.5% of capital and more than covers the RMD.

https://www.dropbox.com/s/b4i8b5nnq3hafaq/2015-02-24%2011.30%20Income%20Investing_%20The%206_%20Solution.wmv?dl=0

Managing income purpose securities requires price volatility understanding and disciplined income reinvestment protocals. "Total realized return" (emphasis on the realized) and compound earnings growth are the key elements. All forms of income secuities are liquid when dealt with in Closed End Funds. 



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Please read this disclaimer:
Steve Selengut is registered as an investment advisor representative. His assessments and opinions are purely his own and do not represent the views of any other entity. None of his commentary is or should be considered either investment advice or a solicitation of business. Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be or should be construed as an endorsement of any entity or organization. The reader should not assume that any strategies, or investments mentioned are any more than illustrations --- they are never recommendations, and others will most certainly disagree with the thoughts presented in the article.