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Income Investing --- Selecting ONLY The Good Stuff
Bonds, CEFs, REITs, MLPs, and Preferreds
The larger the portfolio, the more likely it is that you will be able to buy round lots of a diversified group of bonds, preferred stocks, etc. But regardless of size, individual income securities have liquidity problems, higher risk levels, and lower yields spaced out over inconvenient time periods.
Of the traditional types listed above, only preferred stock holdings are easily added to during upward interest rate movements, and cheap to take profits on when rates fall. The downside on all of these is their callability, in best-yield-first order. Wall Street loves these securities because they command the highest possible trading costs --- costs that need not be disclosed to the consumer, particularly at issue.
Unit trusts are traditional securities set to music, a tune that generally assures the investor of a higher yield than is possible through personal portfolio creation. There are several additional advantages: instant diversification, quality, and monthly cash flow that may include principal (better in rising rate markets, ya follow?), and insulation from year-end swap scams.
Unfortunately, the unit trusts are not managed, so there are few capital gains distributions to smile about, and once all of the securities are redeemed, the party is over. Trading opportunities, the very heart and soul of successful portfolio management, are practically non-existent.
What if you could own common stock in companies that manage the traditional income securities and other recognized income producers like real estate, energy production, mortgages, etc.? Closed end funds (CEFs), REITs, and royalty trusts demand your attention --- and don’t let the idea of “leverage” spook you.
AAA corporate bonds, and utility preferred stocks are “leverage”. The sacred 30-year treasury bond is “leverage”. Most corporations, all governments (and most private citizens) use leverage. Without leverage, most people would be commuting to work on bicycles.
Every CEF can be researched as part of your selection process to determine how much leverage is involved, and the benefits --- you’re not going to be happy when you realize what you’ve been talked out of.
CEFs, and the other investment company securities mentioned, are managed by professionals who are not taking their direction from the IRA & 401(k) mob. They provide you the opportunity to have a properly structured portfolio with a significantly higher yield, even after the management fees that are inside.
Certainly, a REIT or royalty trust is more risky than a CEF comprised of preferred stocks or corporate bonds, but here you have a way to participate in the widest variety of fixed and variable income alternatives in a much more manageable form. When prices rise, profit taking is routine in a liquid market; when prices fall, you can add to your position, increasing your yield and reducing your cost basis at the same time.
Now don’t start to salivate about the prospect of throwing all your money into real estate and/or gas and oil pipelines. Diversify properly as you would with any other investments, and make sure that your living expenses (actual or projected) are taken care of by the less risky CEFs in the portfolio.
In bond CEFs, you can get un-leveraged portfolios, and state specific municipal portfolios, etc, plus monthly income (frequently augmented by capital gains distributions) at a level that is most often significantly better than your broker can obtain for you. I told you that you’d be angry!
Another feature of investment company shares (and please stay away from gimmicky, passively managed, or indexed types) is somewhat surprising and difficult to explain. The price you pay for the shares frequently represents a discount from the market value of the securities contained in the managed portfolio.
So instead of buying a diversified group of illiquid individual securities at a premium, you are reaping the benefit of a portfolio of (quite possibly) the same securities at a discount. Additionally, and unlike regular mutual funds that can issue as many shares as they like without your approval, CEFs will give you the first shot at any additional shares they intend to distribute to investors.
Stop, put down the phone. Move into these securities calmly, without taking unnecessary losses on good quality holdings, and never buy a new issue. I meant to say: absolutely never buy a new issue, for all of the usual reasons.
As with individual securities, there are reasons for unusually high or low yields, like too much risk or poor management. No matter how well managed a junk bond portfolio is, it’s still just junk. So do a little research and spread your dollars around the many management companies that are out there.
If your adviser tells you that all of this is risky, ill-advised foolishness --- well, that’s Wall Street for you, and the baby needs shoes.
Click for Details --> The Right Stuff - Part One
Risk Management: Income, 401k, and IRA Programs
Take a tour of a professional investment managers' private SEP IRA program during ten years surrounding the financial crisis:
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.
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.