About Income Investing, A Q & A

One in the biggest mistakes investors make is usually to ignore the “income purpose” percentage of their domain portfolios… many don’t even recognize that there ought to be such a thing. The second biggest mistake should be to examine the performance of revenue securities very much the same as they do “growth purpose” securities (equities).

The following Q & A assumes that portfolios are designed around these four great financial risk minimizers: All securities meet excellent standards, produce some form of revenue, are “classically” diversified, and they are sold when “reasonable” target income is achieved.

1. Why should anyone invest for income; aren’t equities significantly better growth mechanisms?

Yes, the intention of equity investments would be the production of “growth”, but the majority people visualize growth because the increase in cost of the securities they own. I think about growth in terms in the amount of new “capital” that is certainly created by the realization of profits, plus the compounding in the earnings when that new capital is reinvested using “cost based” asset allocation.

Most advisors don’t view profits concentrating on the same warm and fuzzy feeling that I do… should it be a tax code that treats losses more favorably than gains, or perhaps a legal system which allows people to sue advisors if hindsight demonstrates that a wrong turn was taken. Truth be told, there is no such thing like a bad profit.

Most people wouldn’t think that, in the last 20 years, a 100% income portfolio might have “outperformed” all three from the major stock exchange averages in “total return”… using as conservative once a year distribution number as 4%: The per annum percentage gains:

NASDAQ = 1.93%; S & P 500 = 4.30%; DJIA = 5.7%; 4% Closed End Fund (CEF) portfolio = 6.1%

*NOTE: during the past two decades, taxable CEFs have actually yielded around 8%, tax frees, less than 6%… then there were every one of the capital gains opportunities from 2009 through 2012.

Try investigating it that way. If your portfolio is generating less income than you might be withdrawing, something has to be sold to deliver the extra cash. Most financial advisors would agree that at the very least 4% (payable in monthly increments) is required in retirement… without considering travel, grandkids’ educations and emergencies. This year alone, nearly all of that money was required to come from your principal.

Similar on the basic fixed annuity program, most retirement plans assume a once a year reduction of principal. A “retirement ready” income program, conversely, leaves the key for the heirs while growing the annual extra cash for the retirees.

2. How much connected with an investment portfolio really should be income focused?

At least 30% for any individual under 50, a growing allocation as retirement looms larger… portfolio size and to spend requirements should dictate how much in the portfolio may be at risk in the wall street game. Typically, at most 30% in equities for retirees. Very large portfolios may well be more aggressive, but isn’t true wealth the ability that you don’t have to take significant financial risks?

As an added added provision, all equity investments needs to be in Investment Grade Value Stocks as well as a diversified gang of equity CEFs, thus assuring cashflow from the entire portfolio, all with the time. But the key from day one is always to make all asset allocation calculations using position cost basis instead of cost.

NOTE: When equity cost is very high, equity CEFs provide significant income and excellent diversification in the managed program that permits stock market participation with less risk than individual stocks and considerably more income than even income mutual funds and income ETFs.

Using total “working capital” rather than current or periodic market values, allows the investor to understand precisely where new portfolio additions (dividends, interest, deposits and trading proceeds) must be invested. This simple step assures that total portfolio income increases year over year, and accelerates significantly toward retirement, because asset allocation itself gets to be more conservative.

Asset allocation ought not change dependant on market or monthly interest prognostications; projected income needs and retirement ready financial risk minimization will be the primary issues.

3. How many different types of greenbacks securities are available, and

There are some basic types, though the variations a wide range of. To keep it simple, as well as in ascending order of risk, you will find US Government and Agency Debt Instruments, State and Local Government Securities, Corporate Bonds, Loans and Preferred Stock. These include the most common varietals, and so they generally offer a fixed level of revenue payable either semi-annually or quarterly. (CDs and Money Market Funds will not be investments, their only risk being the “opportunity” variety.)

Variable income securities include Mortgage Products, REITs, Unit Trusts, Limited Partnerships, etc. And then you will discover a myriad of incomprehensible Wall Street created speculations with “traunches”, “hedges”, along with other strategies which are much too complicated to learn… for the extent essential for prudent investing.

Generally speaking, higher yields reflect greater risk in individual income securities; complicated maneuverings and adjustments improve the risk exponentially. Current yields vary by form of security, fundamental quality with the issuer, period of time until maturity, plus some cases, conditions in a very particular industry… and, needless to say IRE.

4. How much would they pay?

Short term interest expectations (IRE, appropriately), stir the latest yield pot and things interesting as yields on existing securities change with “inversely proportional” price movements. Yields vary considerably between type, and at this time are between below 1% for “no risk” money market funds to 10% for oil & gas MLPs and many REITs.

Corporate Bonds remain 3%, preferred stocks around 5%, alot of taxable CEFs are generating near to 8%. Tax free CEFs yield typically about 5.5%.

Quite a spread of greenbacks possibilities, and you will discover investment products for every single investment type, level of quality, and investment duration imaginable… let alone global and index opportunities. But without exception, closed end funds pay much more income than either ETFs or Mutual Funds… it isn’t even close.

All varieties of individual bonds are very pricey to buy and also to sell (mark ups on bonds and new issue preferreds don’t need to be disclosed), especially in small quantities, and it’s also virtually impossible to enhance bonds when prices fall. Preferred stocks and CEFs work like equities, and so are easy to trade as prices come in either direction (i.e., it’s very easy to sell for profits, or buy more to lessen cost basis and increase yield).

During the “financial crisis”, CEF yields (tax free and taxable) almost doubled… many could have been sold more often than once, at “one-year’s-interest-in-advance” profits, before their regained normal levels in 2012.

5. How do CEFs produce these higher income levels?

There are some reasons for a great differential in yields to investors.

CEFs aren’t mutual funds. They are separate investment firms that manage a portfolio of securities. Unlike mutual funds, investors buy shares of stock from the company itself, high is a finite variety of shares. Mutual funds issue unlimited varieties of shares whose pricing is always equal to your Net Asset Value (NAV) on the fund.
The price of a CEF will depend on market forces and is usually either above or below the NAV… thus, they will, from time to time, be obtained at a discount.
Income mutual funds target total return; CEF investment managers concentrate on producing spending cash.
The CEF raises cash via an IPO, and invests the proceeds in a very portfolio of securities, most on the income where will be paid within the form of dividends to shareholders.
The investment company could also issue preferred shares in a guaranteed dividend rate well below the things they know they could obtain inside market. (e.g., they might sell a callable, 3% preferred stock issue, and purchase bonds that happen to be paying 4.5%.)
Finally, they negotiate very short-term bank loans and employ the proceeds to purchase longer term securities which are paying a better rate interesting. In most market scenarios, quick rates less difficult lower than lasting, plus the duration in the loans can be as short since the IRE scenario will permit…
This “leverage borrowing” has nothing about the portfolio itself, and, In crisis conditions, managers can stop the short-term borrowing until a stable rate environment returns.

Consequently, the specific investment portfolio contains much more income producing capital than that offered by the IPO proceeds. Shareholders obtain dividends through the entire portfolio. For more, read my “Investing Under The Dome” article.

6. What about Annuities, Stable Value Funds, Private REITs, Income ETFs, & Retirement Income Mutual Funds

Annuities have several unique features, none ones make them good “investments”. They are excellent security blankets without having enough capital to create adequate income by yourself. The “variable” variety adds market risk for the equation (at some additional cost), bastardizing original fixed amount annuity principles.

They are “the mother coming from all commissions”.
They charge penalties that, in essence, freeze your money for approximately ten years, dependent upon the size in the commission.
They guarantee a small interest rate that you just receive when they give you back your money over your “actuarial life expectancy” or actual lifetime, whether it is longer. If you get hit by way of a truck, the installments stop.
You will pay extra (i.e., eliminate payments) with the idea to benefit others as well as to assure that your heirs get something once you die; otherwise, the insurance company provides the entire remainder regardless of if you check out with the program.

Stable Value Funds assure you in the lowest possible yield you can obtain within the fixed income market:

They add the shortest duration bonds to limit price volatility, so in certain scenarios, they may actually yield lower than Money Market Funds. Those that have slightly higher yielding paper provide an insurance “wrapper” that assures price stability, at additional cost to your annuitant.
They are designed to reinforce the misguided Wall Street emphasis on cost volatility, the harmless and natural personality of rate sensitive securities.
If money market rates ever go back to “normal”, these bad joke products will more than likely disappear.

Private REITs are “the father of commissions”, illiquid, mystery portfolios, far inferior to your publicly traded variety in a very number of ways. Take the time to check this out Forbes article: “An Investment Choice To Avoid: The Private REIT” by Larry Light.

Income ETFs & Retirement Income Mutual Funds are definitely the second and third ideal way to participate inside the fixed income market:

They provide (or track prices of) diversified portfolios of human securities (or mutual funds).
ETFs are better simply because they look and feel like stocks and could be bought and sold whenever you want; the most obvious downside of most is that they are created to track indices and not to create income. A few that seem to provide above a meager 4% (merely for information and not a recommendation) are: BAB, BLV, PFF, PSK, and VCLT.
As for Retirement Income Mutual Funds, the most popular of the (the Vanguard VTINX) incorporates a 30% equity component and yields below 2% in actual to spend.
There have least a hundred “experienced” tax free and taxable income CEFs, and forty or maybe more equity and/or balanced CEFs that pay a lot more than any income ETF or Mutual Fund.

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