What your advisor told you about income investing, AQ and A.

One of the biggest mistakes investors make is ignoring the “earnings purpose” part of their investment portfolio … many people don’t realize that there should be such a thing. The second biggest mistake is to test the performance of income securities in the same way that they treat “growth purpose” securities (equity).

The following quizzes assume that portfolios are built around these four great financial risk minimizers: all securities meet high quality standards, generate some form of income, diversify “classically”, and sell when the “reasonable” goal is to make a profit. .

1. Why would an individual invest for income; Aren’t equities a better growth process?

Yes, the purpose of equity investing is to produce “growth”, but most people think of growth as an increase in the market value of the securities they own. I think of growth in terms of the amount of new “capital” that is generated through profit making, and compounding income when new capital is reinvested using “expense-based” asset allocation.

Most advisers don’t see profit with the same warm and vague feeling as I do … maybe it’s a tax code that treats loss more favorably than profit, or a legal system that allows people to sue advisers if retrospect is a wrong turn suggestion May be taken. Honestly, there is no such thing as a bad profit.

Most people would not believe that, in the last 20 years, a 100% earnings portfolio will “exclude” the three major stock market averages on “Total Returns” … Conservatively uses an annual distribution number as 4%: Percentage Profit per year :

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

  • * Note: In the last 20 years, the taxable CEFs were actually about 8%, tax-free, just under 6% … and then there was the opportunity to raise all the capital from 2009 to 2012.

Try viewing it this way. If your portfolio generates less revenue than you raised, then you need to sell something to cover the cost. Most financial advisers will agree that no less than 4% (payable in monthly increments) is required at the time of retirement regardless of travel, education of grandchildren and emergencies. This year alone, most of that money had to come from your principal.

  • Like the basic fixed annuity program, most retirement plans assume an annual reduction in principal. A “retirement-ready” income program, on the other hand, leaves the key for heirs while increasing the annual spending money for retirees.

How much income should an investment portfolio focus on?

At least 30% for those under the age of 50, then increasing the allocation at leisure … The size of the portfolio and the spending requirements should determine how much the portfolio may be at risk in the stock market. Generally, no more than 30% in equity for retirees. Larger portfolios may be more aggressive, but isn’t the real asset the knowledge that you no longer have to take significant financial risks?

As an added security measure, all equity investments should be in a diversified group of investment grade value stocks and equity CEFs, thus ensuring cash flow from the entire portfolio, at all times. But the key from day one is to calculate the allocation of all assets on the basis of location costs rather than market value.

  • Note: When the price of equity is very high, equity CEFs offer significant returns and excellent diversification in a managed program that allows individuals to participate in the stock market with less risk than individual stocks and even earn significantly higher returns from mutual funds and earnings ETFs.

Using the total “working capital” instead of the current or periodic market value, allows the investor to know exactly where the new portfolio additions (dividends, interest, deposits and trading income) should be invested. This simple step will guarantee that the total portfolio revenue increases year by year and accelerates significantly towards retirement, as the asset allocation itself becomes more conservative.

  • Asset allocation should not change based on market or interest rate forecasts; The primary problem is the reduction of the estimated income demand and financial risk ready for retirement.

3. There are many different types of income security, and

There are a few basic types, but lots of variations. To keep it simple, and in the increasing order of risk, there are US government and agency debt instruments, state and local government securities, corporate bonds, debt and preferred stocks. These are the most common variations, and they usually provide a certain level of half-yearly or quarterly payable income. (CDs and money market funds are not investing, their only risk is “opportunity” diversification.)

Variable income securities include mortgages, REITs, unit trusts, limited partnerships, etc. And then there are the countless estimates of Wall Street with incomprehensible “trench”, “hedges” and other techniques that are too complex to understand … the amount needed for prudent investment.

Generally speaking, higher yields reflect higher risk in personal income securities; Complex maneuvering and adjustment quickly increase the risk. The current yield varies by type of security, the basic quality of the issuer, the length of time until maturity, and in some cases, the conditions of a particular industry … and of course the IRE.

4. H.How much do they pay?

Short-term interest rate expectations (IRE, aptly), shake the current yield pot and keep things interesting as yields on existing securities fluctuate with “inversely proportional” price movements. Yields vary significantly, and at the moment “no risk” means between 1% for market funds to 10% for oil and gas MLPs and 10% for some REITs.

Corporate bonds make up about 3%, preferred stocks about 5%, while most taxable CEFs make up around 8%. Tax-free CEFs earn an average of about 5.5%

  • There is a wide range of income possibilities, and every investment type, quality level, and duration of investment is conceivable … there are investment products not to mention global and index opportunities. But without exception, closed end funds offer significantly higher returns than ETFs or mutual funds … it’s not even close.

Buying and selling all types of individual bonds is expensive (no need to disclose the mark-up of the bonds and new issue preferences), especially in small quantities, and it is virtually impossible to add to the bonds when prices fall. Preferred stocks and CEFs behave like equities and are easier to transact as prices move in both directions (i.e., easier to sell for profit, or buy more to reduce the cost base and increase yields).

  • During the “financial crisis”, CEF yields (tax-free and taxable) almost doubled … almost all could have been sold more than once before returning to their normal levels, at “one-year-interest-advance” profits. 2012.

5. How do CEFs create these high income levels?

There are several reasons for this huge difference in profits for investors.

  • CEF is not a mutual fund. They are individual investment companies that operate a portfolio of securities. Unlike mutual funds, investors buy shares of the company’s stock and there is a limited number of shares. Mutual funds issue an unlimited number of shares, the value of which is always equal to the net asset value (NAV) of the fund.
  • The price of a CEF is determined by market strength and can be above or below the NAV … Thus, they can, at times, be purchased at a discount.
  • Income Mutual Fund Total Return Focus; CEF investment managers focus on spending money.
  • The CEF raises cash through an IPO, and invests the proceeds in a portfolio of securities, from which the bulk of the proceeds will be paid to shareholders in the form of dividends.
  • Investment companies can also issue preferred shares at a guaranteed dividend rate that they know they can get in the market. (E.g., they could sell a callable, 3% preferred stock issue and invest in a bond that pays 4.5%.)
  • Finally, they negotiate very short-term bank loans and use the proceeds to buy long-term securities that offer higher interest rates. In most market conditions, the short-term rate is much lower than the long-term, and the loan period is short enough to allow for IRE conditions …
  • This “leverage lending” has nothing to do with the portfolio, and, in the event of a crisis, managers can close short-term debt until a stable interest rate environment is restored.

As a result, the actual investment portfolio contains significantly higher yielding capital than IPO earnings. Shareholders receive dividends from the entire portfolio. For more, read my article “Investing Under the Dome”.

Keywords: Annual, Fixed Price Fund, Personal REIT, Income ETF, and Retirement Income Mutual Fund

Annuals have a number of unique features, none of which make them a good “investment”. These are excellent safety blankets if you do not have enough capital to make enough income on your own. Adding market risk to the “variable” diversification equation (at some additional cost) destroys the actual fixed amount of annual policy.

  • They are the “mother of all commissions.”
  • They charge fines that, in effect, lock up your money for up to ten years, depending on the size of the commission.
  • They guarantee a minimum interest rate that you will get because they give you your own money back on your “actual life” or actual lifetime, if it is long. You push by a truck, pay off.
  • You can pay extra (i.e., reduce your payments) either to benefit others or to ensure that your heirs will receive something when you die; Otherwise, the insurance company gets the full balance whenever you check out the program.

The Stable Price Fund assures you that you can get the lowest possible yield in a fixed income market:

  • They include short-term bonds to limit price volatility, so in some cases, they may actually yield less than money market funds. Those who have a slightly higher yielding paper have an insurance “wrapper” that guarantees price stability at an additional annual cost.
  • These are designed to reinforce the misleading Wall Street over market price volatility, interest rate sensitive securities’ innocence and normal personality.
  • If money market rates ever return to “normal”, these bad trick products will probably disappear.

Private REITs are the “father of all commissions”, ineffective, mysterious portfolios, far inferior to the variety traded publicly in various ways. Take the time to read this Forbes article:
“An investment choice to avoid: personal REIT” By Larry Light.

Income ETFs and Retirement Income Mutual Funds are the second and third best way to participate in the fixed income market:

  • They provide a diverse portfolio of individual securities (or mutual funds) (or track prices).
  • ETFs are better because they look and feel like stock and can be bought and sold at any time; The most obvious downside is that they are designed to track indicators and not to generate revenue. Some of the things that seem to be produced above 4% (for information only and not recommended at all) are: BAB, BLV, PFF, PSK, and VCLT.
  • In the case of Retirement Income Mutual Funds, the most popular (Vanguard VTINX) has a 30% equity component and yields less than 2% of actual money spent.
  • There are at least 100 “experienced” tax-exempt and taxable income CEFs and forty or more equity and / or balanced CEFs that pay more than any income ETF or mutual fund.

More questions and answers in the second part of this article …