The Extremely Good News About Higher Interest Rates

What!

Yes, market values of existing income purpose securities will certainly move lower… BUT, the income you’ve contracted for will likely remain the same, AND, you will be able to invest in new paper at higher yields.

This is a good thing, and you should not be so easily convinced that it is not. Even if your “guaranteed” paper falls in price, there need never be a loss of “principal”.

If I’m borrowing money, higher rates are bad news; for investors, higher rates mean more spending money while lower market values just mean lower market values.

The purpose of income securities is income, and a reasonably safe “more” has always been better than any “less”. The problem is simply the negative perception of a lower portfolio “total market value”. OMG!

In our financial lives, what we can spend or reinvest is the important detail, and when dealing with income-purpose investments, 99% of the time, change in market value has no impact on income received.

This was most clearly demonstrated during the financial crisis:

More than 90% of borrowers remained current on their mortgages, yet all mortgage backed securities were deemed nearly valueless under absurd “mark to market” regulations.

Even with monthly payments pouring in, many financial institutions failed to meet regulatory “market value” reserve requirements and were forced to close their doors.

At the same time, even at lower market values, virtually all non-mortgage securities, particularly managed Closed End Funds, continued to pay the same levels of interest like clockwork, while a “clockwork orange-esque” nightmare played out in financial institutions.

This focus on market value is a financially inappropriate attempt to equate the nature of debt securities to that of equities… one that could never, ever, have happened without multiple levels of ill conceived and misguided regulation.

It’s like time, tide, and gravity; you just don’t mess with Mother Nature. Price varies inversely with interest rate expectations, and this is a good thing… end of discussion.

By using Closed End Income Funds, investors can benefit from lower rates on older holdings, even as market values tumble… and this should be exciting , not scary at all.

Buying additional shares of existing bond portfolios at lower prices. Eureka!

As Yogi would say, 95% of income investing is half mental.

LinkedIn financial group members debate the impact of higher interest rates… but to income investors, there should be no debate at all. Both higher and lower rates are good for investors.

Here’s an example of where this is coming from.

I’m intimately familiar with many closed end income funds, diversified in every conceivable way, over 100 issues, with varying durations, etc. The “purpose” of the funds is twofold: (1) grow the income generated by the portfolio, while at the same time (2) distributing what individuals need to pay their monthly bills.

Income CEFs (both tax free and taxable) moved down in market value during the financial crisis, back up again (at a faster pace than stocks, actually) through November 2012, down again through the end of 2013, and now up again at a pace about the same as the S & P 500, or a bit better, through May.

During this seven years of market value direction change and short term volatility, there has been: (1) an upward move in total portfolio income, due to reinvestment of excess income; (2) never an instance of dipping into principal for a properly planned payment; (3) and hundreds of opportunities for “one-year’s-interest-in-advance” profit taking.

During seven years of historically low interest rates, income Closed End Funds have produced multiples more spending money than any other comparably safe source of income…. taxable funds are in the 7% range (net of fund expenses including interest) right now.

What negative impact has the change in market value had on the monthly income produced for Closed End Fund Investors throughout the past seven years? A resounding… NONE!

What positive impacts? Growth in income produced, growth in portfolio yield, and growth in “Working Capital” (the amount invested in the total portfolio), and not only in the income “bucket” when cost-based asset allocation is used.

Meanwhile, how have investors fared in shorter duration, stable value paper? What’s better for the economy, retirees receiving 6% tax free or less than 2%, taxable?

When investing for income, go long, emphasize experience and quality, diversify properly, and focus ( I mean really focus) only on the income you receive.

Ask your advisor:  Why is 2% better than 7%?