Brave Old World: Market Cycle Investment Management

The Market Cycle Investment Management (MCIM) methodology is the sum of all the strategies, procedures, controls, and guidelines explained and illustrated in the “The Brainwashing of the American Investor” — the Greatest Investment Story Never Told.

Most investors, and many investment professionals, choose their securities, run their portfolios, and base their decisions on the emotional energy they pick up on the Internet, in media sound bytes, and through the product offerings of Wall Street institutions. They move cyclically from fear to greed and back again, most often gyrating in precisely the wrong direction, at or near precisely the wrong time.

MCIM combines risk minimization, asset allocation, equity trading, investment grade value stock investing, and “base income” generation in an environment which recognizes and embraces the reality of cycles. It attempts to take advantage of both “fear and greed” decision-making by others, using a disciplined, patient, and common sense process.

This methodology thrives on the cyclical nature of markets, interest rates, and economies — and the political, social, and natural events that trigger changes in cyclical direction. Little weight is given to the short-term movement of market indices and averages, or to the idea that the calendar year is the playing field for the investment “game”.

Interestingly, the cycles themselves prove the irrelevance of calendar year analysis, and a little extra volatility throws Modern Portfolio Theory into a tailspin. No market index or average can reflect the content of YOUR unique portfolio of securities.

The MCIM methodology is not a market timing device, but its disciplines will force managers to add equities during corrections and to take profits enthusiastically during rallies. As a natural (and planned) affect, equity bucket “smart cash” levels will increase during upward cycles, and decrease as buying opportunities increase during downward cycles.

MCIM managers make no attempt to pick market bottoms or tops, and strict rules apply to both buying and selling disciplines.

NOTE: All of these rules are covered in detail in “The Brainwashing of the American Investor” .

Managing an MCIM portfolio requires disciplined attention to rules that minimize the risks of investing. Stocks are selected from a universe of Investment Grade Value Stocks… under 400 that are mostly large cap, multi-national, profitable, dividend paying, NYSE companies.

LIVE INTERVIEW – Investment Management expert Steve Selengut Discusses MCIM Strategies – LIVE INTERVIEW

Income securities (at least 30% of portfolios), include actively managed, closed-end funds (CEFs), investing in corporate, federal, and municipal fixed income securities, income paying real estate, energy royalties, tax exempt securities, etc. Multi level, and speculation heavy funds are avoided, and most have long term distribution histories.

No open end Mutual Funds, index derivatives, hedge funds, or futures betting mechanisms are allowed inside any MCIM portfolio.

All securities must generate regular income to qualify, and no security is ever permitted to become too large of a holding. Diversification is a major concern on an industry, or sector, level, but global diversification is a given with IGVSI companies.

Risk Minimization, The Essence of Market Cycle Investment Management

Risk is compounded by ignorance, multiplied by gimmickry, and exacerbated by emotion. It is halved with education, ameliorated with cost-based asset allocation, and managed with disciplined: selection quality, diversification, and income rules— The QDI. (Read that again… often.)

Risk minimization requires the identification of what’s inside a portfolio. Risk control requires daily decision-making. Risk management requires security selection from a universe of securities that meet a known set of qualitative standards.

The Market Cycle Investment Management methodology helps to minimize financial risk:

  • It creates an intellectual “fire wall” that precludes you from investing in excessively speculative products and processes.
  • It focuses your decision making with clear rules for security selection, purchase price criteria, and profit-taking guidelines.
  • Cost based asset allocation keeps you goal focused while constantly increasing your base income.
  • It keeps poor diversification from creeping into your portfolio and eliminates unproductive assets in a rational manner.

One Person’s Bond Crash is Another’s Income Opportunity

Today’s “Investment News” headline (from Bloomberg) is designed to make you shiver in your income portfolio boots:

“Big fixed income shop prepares for the worst”…

The Bond Portfolio “Window Dressing” sell-off has begun.

Bond funds in general are now holding 8% of assets in cash, the article reports…highest since the financial crisis, and 1999, even. Professional Bond Traders certainly have reason to worry; closed end fund income investors not so much.

The article is reporting fear of lower market values with respect to existing bonds, particularly the higher yield variety…. big players in the bond market are hoarding cash (even selling existing holdings at losses in the process).

Bond Traders and Fund Managers look foolish as inventory market values fall. The cash hoard is their way of preparing to buy similar paper at higher yields sometime in the future and/or to buy back “old” bonds after the fall in price.

In the meantime, they are holding zero interest rate cash in anticipation of the higher yields… and could care less about the negative impact this behavior has on portfolio yields.

This is the result of what I call “Total Return Crossover”… the absurd application of market value growth analysis, instead of income development criteria, to primarily income security portfolios. (An analytical atrocity that is reinforced and encouraged by retirement plan regulators.)

So bond and Income Mutual Fund managers choose to actually lose your money now to look less foolish than the competition later. This “panic selling” by professionals leads to irrational, “knee jerk” reactions in amateurs.

What I did not read in the Bloomberg “disaster scenario” (and this should calm all the frayed nerves) was any indication or expectation of default on the interest paid by the bond issuers. This is the key issue with income investing…

Bonds are corporate and government debt securities, people… so long as they pay the interest why worry about the market value?

Wall Street is always more concerned about appearances than it is about income generation. And the Masters of the Universe really do have a problem… OMG, what this could do to those year-end bonuses…

But we (the average investors out here) can simply reinvest our current CEF income in any number of portfolios of bonds, preferred stocks, loans, notes, etc., selling at discounts, not only from their maturity value, but also from their combined Net Asset Values. Read that again please.

Remember, Closed End Income Fund portfolios aren’t influenced directly by either the fear (or greed) of individual investors… they are under a “protective dome”, if you will, that is subject to all forms of volatility for a vast array of reasons.

But an Income CEF, for example, becomes the totally liquid trading vehicle for a portfolio that could contain hundreds of totally illiquid individual securities… do you believe in magic? Be it Magic, or genius, who cares. We, mere mortals that we are, can jump on the lower prices that chill the blood of Wall Street’s Master Class.

Closed End Fund investors are uniquely positioned to take advantage of both the lower prices and the higher yields that exist right now. Market Cycle Investment Management users have done it before, right?

Remember the fall in CEF prices from early 2007 (higher rates caused these) through early March 2009 (even in the face of the lowest interest rates ever)… and the ensuing rise through October 2011?

Well, do you really think that the anticipated one percentage point rise in interest rates over the next year or so will cause Financial Crisis #2?

Isn’t it great when Wall Street’s pain becomes fuel for the small investor’s gain…. but only if you take advantage of the lower price, higher yield scenario that is staring you in the face as you read this message..

Yes, YOU can be the Master of this Universe!

Income Investing: “Feed Your Head… Feed Your Head”

Jefferson Airplane has never, ever, been mistaken for a band of financial advisors, but the White Rabbit lyrics can be incredibly instructional to the generation of investors who experienced the classic first hand — as a description of their own college days’ lifestyle. If only they had heeded the dormouse’s call to “feed your head.” For the sake of your retirement sanity and security, you just have to make income investing an intellectual exercise — not an emotional one.

The Brainwashing of the American Investor has its own tale of an Alice whose “logic and proportion” had “fallen sloppy dead”. Many years ago, when interest rates soared into double digits, elderly Alice was well advised to invest her stash in a portfolio of Ginnie Maes. Broadly smiling, she bragged to her friends about the federally guaranteed 13% interest she was receiving in regular monthly intervals — much more than she needed to cover her living expenses.

But interest rates continued to move higher, and the decreasing market value of her Ginnie Maes was more than she could tolerate. “If rates continue to go up, I’ll have nothing left” she cried to her White Knight financial advisor who suggested patience and understanding. The very same pill that made her income grow larger was also making her market value become smaller.

Yet the income kept rolling in, higher yielding unit trusts were purchased with the excess, and major redemptions were nowhere to be seen. The income kept growing, the market value kept shrinking, and Alice was seeing red from seeing red on her account statements.

So Alice went to her local bank and traded in her absolutely government guaranteed 13 per centers for some laddered, non-negotiable, 8.5% CDs. “No more erosion of my nest egg”, she toasted proudly with the hookah smoking bank caterpillar who orchestrated her move to lower income levels. Within a few months, she was liquidating CDs to pay the bills that never seemed to be a problem with those terrible Ginnie Maes.

Don’t let such uniformed thinking sabotage your retirement program; don’t let the selfish advice of a product sharpshooter send you chasing rabbits when IRE (interest rate expectations) or other temporary market conditions shrink the market value of your income portfolio. Feed your head; feed—your—head.

Income pays the bills, and if the income level is both steady and adequate, there is no need to change investments. Market value should be used to determine when to buy more (at lower prices) and when to take profits (at higher ones). It is almost never necessary to take a loss on a high quality (government guaranteed in Alice’s case) income security.

More recent experimenters in much more sophisticated potions have addressed the issue with similar results, reaching mind-numbing conclusions such as these:

  • I know the income hasn’t changed throughout the debacle in the financial sector but I don’t want to buy anymore of these securities until the prices go back above what I paid for them originally. Translation: I’d rather stick with my 4.5% tax-free yield than increase it by adding to my positions at lower prices.
  • Sure, I understand the relationship between IRE and the prices of income CEFs but individual bonds and Treasuries haven’t suffered nearly as much. That’s where we should have been. Translation: I would be much happier with a 3% than with an 8% rate of realized income.
  • I’m tired of seeing all the negative positions in my portfolio. Let’s keep all the income we receive in money market until we’re back in positive territory. Translation: I’d rather accept 0.5% or so, than reduce my cost basis and increase my yield by adding to my positions at lower prices.

Modern brokerage firm monthly statement “pills” were developed during the dot-com era, when Wall Street was trying to emphasize the brilliance of its speculative prescriptions by making us all feel ten feet tall, month after month after month.

But the geniuses on the institutional chessboard produced too many mushroom product varietals and the Red Queen of corrections lopped off many of their sacred heads. The papers that were designed to make our chests burst with pride have turned on us as a haunting reminder of the reality of markets and the cycles that push them in either direction.

It should be easy to navigate a quality income portfolio through whatever circumstances, cycles, and scandals come at you, but a clear head and a clearer understanding of what to expect is required. Most brokerage firm statements make it difficult to monitor asset allocation using any methodology, including the Working Capital Model, and I don’t think that it’s by chance.

Confusion breeds unhappiness, and unhappiness brings about change, and the masters of the universe encourage you to fritter around from mushroom to mushroom in perpetual motion. To whose benefit?

It would be wonderful if an investor’s monthly statement would organize his securities based on their class and purpose, but Wall Street doesn’t want such distinctions to be made easily. It would be great if the institutions would help investors formulate reasonable expectations about various types of securities under varying conditions, but that’s not likely to happen either.

It would be spectacular if the media would produce information and explanation instead of news bites and sensationalism, but you guessed it — not much chance of that.

Income investing can be easy. Ask your hookah-smoking caterpillar to give you the how?

Income CEF Price Volatility… No Problem at All

Market Cycle Investment Management portfolios are different from any others you may be analyzing, and all investors analyze their portfolios most intently when their “bottom line” market values begin to crumble. This focus on market value is part of Wall Street’s Brainwashing of the American Investor.

MCIM investing is more realistic. It recognizes that investment markets (both equity and income) are cyclical. Rarely do portfolio market values trend upward as long as they have since March of 2009, and most equity investors have forgotten the five month, 22%, mini-correction that ran from May through September 2011. When will we experience the real deal?

MCIM focuses on “working capital”, a measure of the total cost basis of the securities and cash contained in an investment portfolio. Managed properly, this measure should grow in all market, economic, and interest rate environments, irrespective of changes in “market value”… really.

MCIM portfolios include 30% Income Purpose securities (based on Working Capital), and never own non Investment Grade Value Stock equities. This translates into portfolios of high quality securities, each contributing to higher realized base income than that contained in market averages and blended Mutual Funds.

Embracing the cycles, MCIM portfolios strive to grow both total Working Capital and portfolio “Base Income”steadily, regardless of what is going on in the investment markets, in either direction.

MCIM portfolio “Working Capital” will be higher now than on January 1st; and “base income” will have risen in all portfolios where cash flow has remained positive… in spite of lower CEF market values. Long term, this is the single most important of all portfolio management issues.

Income Closed End Fund (CEF) prices have been moving lower since November 2012; the decline accelerated in May — but with barely any change in total income generated. In November 2012, you’ll recall, many CEFs were selling at premiums to NAV. The premiums are now gone, taking a whole lot of market value with them… but, again, with little or no change in income.

Stock market numbers have also weakened recently, and this 2.5 year divergence between equity and income security prices is quite normal; accelerated weakness in income security prices often signals an upcoming stock market correction, as it did in 2007..

The vast majority of income CEFs are now selling at significant discounts to the Net Asset Value of the security portfolios inside. The vast majority of income CEFs are selling at significant discounts to the market value of the securities they contain. (repetition intended)

Wall Street wants you to believe that higher prices and lower yields are better… how does that make any sense with no change in the portfolio content?

A selection universe of about one hundred taxable income CEFs and seventy tax free income CEFs is used in constructing MCIM portfolios. In the six plus years since the depths of the financial crisis, and in spite of the lowest interest rate environment in history, the vast majority of these CEFs have maintained their regular payouts to shareholders.

Lower prices now are as much a result of FED tinkering as threatened rate hikes.

Historically, in more “normal” interest rate environments, income increases have been more prevalent than income reductions. Overall, income CEF managers coped well with the lowest interest rates ever…. how have they been dealing with the specter of higher rates? Keep in mind that no actual interest rate change has yet occurred.

After six years of artificially low interest rates, many have been forced to reduce their payouts… very few have made significant dividend cuts.

Now the interesting part: at current prices, the average dividend yield on 57 taxable CEFs paying over 7.0% is approximately 8.5%; the average on 53 tax free CEFs paying over 6% is about 6.7%

The vast majority of all CEFs made their regular scheduled distributions throughout the financial crisis; more actually raised their payouts than reduced them; after six years of close-to-zero rates, higher “coupons” will eventually increase CEF dividend payouts to normal, pre-financial crisis, levels.

The current yield on the MCIM CEF Universe is well above 6% for tax free income and above 8% for taxable. Why is this bad news? Only, yes only, because professional bond traders have to realize losses when they trade… income investors do not have to sell at all…. they can take advantage of “discounts” to increase their spending money.

What’s lnside the CEFs:

• Each CEF portfolio contains hundreds of individual issues with varying qualities, maturities, call provisions, etc. The average duration is between 7 and 8 years

• Managers use short term borrowing to purchase additional securities; nothing forces them to borrow at higher rates if they can’t still invest profitably

• Managers capitalize on profit-taking opportunities; and are not forced to sell at losses.

• CEF share prices are completely “uncoupled” from NAV; shareholders are investing in the investment company as opposed to owning a piece of the investment portfolio itself.

As I see it, and this is no prediction or recommendation of any specific course of action, CEFs provide investors with the opportunity to take advantage of irrational price dislocations in the income securities market — an opportunity that is difficult for the average investor to capitalize upon using individual securities.

By adding to existing CEF positions, investors increase overall portfolio yield, increase yield on specific holdings, and reduce per share cost basis.

Thus, even if some reduced payouts are experienced, the overall level of income is likely to be at least stable, and possibly higher. Right now, the expectation of higher interest rates is probably the main force driving Closed End Fund prices lower.

BUT, particularly if the stock market corrects, higher interest rates and higher demand for safety may cause investors to seek out higher yielding and safer investments.

Never forget, all companies must pay their bond, note, and preferred stock investors BEFORE a penny goes to their Equity investors… income CEFs contain no equities, even though your (purposely) confusing Wall Street account statement tells you that they are equities…. hmmm

Is Your Investment Portfolio Prepared For Higher Interest Rates?

I’ve heard a lot of discussion lately pressing the idea that rising interest rates are something to be feared, and prepared for by: accepting the lower rates now, buying the shortest duration positions, or even liquidating the income portfolio entirely.

A rising interest rate environment is super good news for investors… up to a point. When we loan money to someone, is it better to get the lowest possible rate for the shortest period of time? Stop looking at income investing with a “grow the market value” perspective. That’s not what it’s all about. Lower market values or growing discounts to NAV don’t have to be problems… they can be benefits.

The purpose of income investments is the generation of income. YOU are NOT a bond trader. Control the quality selected, diversify properly, and compound that part of the income that you don’t have to spend. Price is pretty much irrelevant with income purpose securities; you don’t spend the market value.

Long, long, ago, many bonds were of the “bearer” variety; my father never owned any others. Each month, he went to the bank, clipped his coupons, cashed them in, and left the bank with a broad smile. If interest rates went up, he knew he could go out and buy new bonds to put larger coupon dollars in his pocket.

He had no reason to even consider selling the bonds he already owned — they were, after all, income purpose securities that (in his experience) never failed to do their job. Market value never fluctuates (visually) if the securities are kept in the (mental) safe deposit box.

No, that’s not at all what I’m recommending… And, even when your brokerage statement shows that your bond prices have risen to chest-pounding wealth levels, just try to convert those numbers into spending money. Despite the profit-taking-temptation your statement reports, the bid you get on your smallish positions is never even close to the “insider” market value…

The thing dear old Dad thought about least was the market value of his bonds. This was his tax free retirement plan. He bought them for income, and the coupons were always redeemed without question. The only problem (actually, no longer a problem) with the periodic decreases in market value was the inability to add to existing positions. The small position bond market has limited liquidity.

Before I move on to the simple solution to this non-problem, a word or two on the only real benefit of lower interest rates — there is no benefit at all if you don’t already own individual, income producing, securities. If you own interest rate expectation (IRE) sensitive securities in a downward interest rate cycle, you will have the opportunity for what I call “income-bucket-gravy”.

This is the opportunity to sell your income purpose securities at a profit, over and above the income you’ve already banked. Income investors rarely are advised to do this, which is why they lament the thievery occasioned by higher interest rates. They didn’t sell at a premium, so now they just sit and watch the premiums disappear.

The only thing this behavior accomplishes is bestowing on investors the lowest possible yields while pushing them into an overpriced market for short duration debt securities. A gift that keeps on stealing investor profits.

The solution is simple, and has been used successfully for decades. Closed End Funds (scoff, laugh, and say “leverage makes them volatile” all you like) solve all the liquidity and price change problems… in a low cost, much higher income, environment.

Answer me one question before you throw stones at these remarks. Is 7% or more on a diversified, transparent, income portfolio, compounded over the past ten years and still growing income, better or worse than the 3.5% or less that most investors have realized in individual securities during the same time period… and then there are the profits that non-bond traders seldom realize can be realized.

Of course CEF market values fell during the financial crisis (the 3nd greatest buying opportunity ever), but at their peak in November 2012, they had gained nearly 65% since March 9, 2009, or 17.7% per year…. nearly outperforming the S & P 500.

But speaking of  “drawdowns”, what do you think the economic activity drawdown of near zero money market rates has been, particularly for “savings account” Baby Boomers. Did the Fed’s messing around with short term interest rates help or hurt your retired relatives… really, think about it.

Rising interest rates are good for investors; so are falling rates. Fortunately, they routinely move in both directions, cyclically, and now can be traded quickly and inexpensively for exceptional results from a stodgy old income portfolio. So much for Total Return, short duration, and leverage-phobic thinking.

  • What if you could buy professionally managed income security portfolios, with 10+ years income-productive track records?
  • What if you could take profits on these portfolios, say for a year’s interest in advance, and reinvest in similar portfolios at higher yields?
  • What if you could add to your positions in all forms of debt securities when prices fall, thus increasing yield and reducing cost basis in one fell swoop?
  • What if you could enter retirement (or prepare for retirement) with such a powerful income engine?

Well, you can. but only if you are able to add both higher and lower interest rates to you list of VBFs.

The Investment Gods Are Furious

Market Cycle Investment Management (MCIM) is an historically new methodology, but with roots deeply embedded in both the building blocks of capitalism, and financial psychology— if there is such a thing.

The earliest forms of capitalism sprung from ancient mercantilism, which involved the production of goods and their distribution to people or countries mostly around the Mediterranean.

The sole purpose of the exercise was profit and the most successful traders quickly produced more profits than they needed for their own consumption. The excess cash needed a home, and a wide variety of early entrepreneurial types were quick to propose ventures for the rudimentary rich to consider.

There were no income taxes, and governments actually supported commercial activities, recognizing how good it was for “Main Street” — as if there was such a thing.

The investment gods saw this developing enterprise and thought it good. They suggested to the early merchants, and governments that they could “spread the wealth around” by: selling ownership interests in their growing enterprises, and by borrowing money to finance expansion and new ventures.

A financial industry grew up around the early entrepreneurs, providing insurances, brokerage, and other banking services. Economic growth created the need for a trained workforce, and companies competed for the most skilled. Eventually, even the employees could afford (even demand) a piece of the action.

Was this the beginning of modern liberalism? Not! The investment gods had created the building blocks of capitalism: stocks and bonds, profits and income. Stock owners participated in the success of growing enterprises; bondholders received interest for the use of their money; more and better skilled workers were needed — the K.I.S.S. principle was born.

As capitalism took hold, entrepreneurs flourished, ingenuity and creativity were rewarded, jobs were created, civilizations blossomed, and living standards improved throughout the world. Global markets evolved that allowed investors anywhere to provide capital to industrial users everywhere, and to trade their ownership interests electronically.

But on the dark side, without even knowing it, Main Street self-directors participated in a thunderous explosion of new financial products and quasi-legal derivatives that so confused the investment gods that they had to holler “’nuff”! Where are our sacred stocks and bonds? Financial chaos ensued.

The Working Capital Model was developed in the 1970s, as the guts of an investment management approach that embraced the cyclical vagaries of markets. This at a time when there were no IRA or 401(k) plans, no index or sector funds, no CDOs or credit swaps, and very few risky products for investors to untangle.

Those who invested then: obtained investment ideas from people who knew stocks and bonds, had pensions protected by risk-averse trustees, and appreciated the power of compound interest. Insurance and annuities were fixed, financial institutions were separated to avoid conflicts of interest, and there were as many economics majors as lawyers in Washington.

MCIM was revolutionary then in its break from the ancient buy-and-hold, in its staunch insistence on Quality, Diversification, and Income selection principles, and in its cost based allocation and diversification disciplines. It is revolutionary still as it butts heads with a Wall Street that has gone MPT mad with product creation, value obfuscation, and short-term performance evaluation.

Investing is a long-term process that involves goal setting and portfolio building. It demands patience, and an understanding of the cycles that create and confuse its landscape. MCIM thrives upon the nature of markets while Wall Street ignores it. Working Capital numbers are used for short-term controls and directional guidance; peak-to-peak analysis keeps performance expectations in perspective.

In the early 70s, investment professionals compared their equity performance cyclically with the S & P 500 from one significant market peak to the next — from the 1,500 achieved in November 1999 to the 1,527 of November 2007, for example. Equity portfolio managers would be expected to do at least as well over the same time period, after all expenses.

Another popular hoop for investment managers of that era to jump through was Peak to Trough performance —managers would be expected to do less poorly than the averages during corrections.

Professional income portfolio managers were expected to produce secure and increasing streams of spendable income, regardless. Compounded earnings and/or secure cash flow were all that was required. Apples were not compared with oranges.

Today’s obsession with short-term blinks of the investment eye is Wall Street’s attempt to take the market cycle out of the performance picture. Similarly, total return hocus-pocus places artificial significance on bond market values while it obscures the importance of the income produced.

MCIM users and practitioners will have none of it; the investment gods are furious.

Market Cycle Investment Management embraces the fundamental building blocks of capitalism — individual stocks and bonds and managed income CEFs in which the actual holdings are clearly visible. Profits and income rule.

Think about it, in an MCIM world, there would be no CDOs or multi-level mortgage mystery meat; no hedge funds, naked short sellers, or managed options programs; no mark-to-market lunacy, Bernie Madoffs, or taxes on investment income.

In MCIM portfolios, lower stock prices are seen as a cyclical fact of life, an opportunity to add to positions at lower prices. There is no panic selling in high quality holdings, and no flight to 1% Treasuries from 6% tax free Munis. In an MCIM portfolio, dividends and income keep rolling, providing income for retirees, college kids, and golf trips — regardless of what the security market values are doing.

Capitalism is not broken; it’s just been overly tinkered with. The financial system is in serious trouble, however, and needs to get back to its roots and to those building blocks that the Wizards have cloaked in obscurity.

Let’s stick with stocks and bonds; lets focus on income where the purpose is income; let’s analyze performance relative to cycles as opposed to phases of the moon; let’s tax consumption instead of income; and let’s not disrespect the gods, the “Bing”, or the intelligence of the average investor…

So sayeth the gods. Amen!

The “Total Return” Shell Game

No “Interest Rate Sensitive” Security is an Island…

Just what is this “total return” thing that income portfolio managers like to talk about, and that Wall Street uses as the performance hoop that all investment managers have to jump through? Why is it mostly just smoke and mirrors?

Here’s the formula:

  • Total Income + (or -) Change in Market Value – Expenses = Total Return — and this is supposed to be the ultimate test for any investment portfolio, income or equity.

Applied to Fixed Income Investment Portfolios, it is useless nonsense designed to confuse and to annoy investors.

How many of you remember John Q. Retiree? He was that guy with his chest all puffed up one year, bragging about the 12% “Total Return” on his bond portfolio while he secretly wondered why he only had about 3% in actual spending money.

The next year he’s scratching his head wondering how he’s ever going to make ends meet with a total return that’s quickly approaching zero. Do you think he realizes that his actual spending money may be higher? What’s wrong with this thinking? How would the media compare mutual fund managers without it?

Wall Street doesn’t much care because investor’s have been brainwashed into thinking that income investing and equity investing can be measured with the same ruler. They just can’t, and the “total return” ruler itself would be thrown out with a lot of other investment trash if it were more widely understood.

  • If you want to use a ruler that applies equally well to both classes of investment security, you have to change just one piece of the formula and give the new concept a name that focuses in on what certainly is the most important thing about income investing — the actual spending money.

We’ll identify this new way of looking at things as part of “The Working Capital Model” and the new and improved formulae are:

  • For Fixed Income Securities: Total Cash Income + Net Realized Capital Gains – Expenses = Total Spending Money!
  • For Equity Securities: Total Cash Income + Net Realized Capital Gains – Expenses = Total Spending Money!

Yes, they are the same! The difference is what the investor elects to do with the spending money after it has become available. So if John Q’s Investment pro had taken profits on the bonds held in year one, he could have sent out some bigger income payments and/or taken advantage of the rise in interest rates that happened in year two.

Better for John Q, sure, but the lowered “total return” number could have gotten him fired. What we’ve done is taken those troublesome paper profits and losses out of the equation entirely. “Unrealized” is “un-relevant” in an investment portfolio that is diversified properly and comprised only of investment grade, income producing securities.

Most of you know who Bill Gross is. He’s the fixed Income equivalent of Warren Buffett, and he just happens to manage the world’s largest “open ended” bond mutual fund. How was he investing his own money during other interest rate cycles?

Well, according to an article by Jonathan Fuerbringer in the Money and Business Section of January 11, 2004 New York Times, he’s removed it from the Total Return Mutual Fund he manages and moved it into: Closed End Municipal Bond Funds where he could “realize” 7.0% tax free.

(Must have read “The Brainwashing of the American Investor”.)

He doesn’t mention the taxable variety of Closed End Fund (CEF), now yielding a point or two more than the tax free variety, but they certainly demand a presence in the income security bucket of tax-qualified portfolios (IRAs, 401k(s), etc.).

Similarly, the article explains, Mr. Gross advises against the use of the non investment grade securities (junk bonds, for example) that many open-end bond fund managers are sneaking into their portfolios.

But true to form, and forgive the blasphemy if you will, Mr. Gross is as “Total Return” Brainwashed as the rest of the Wall Street institutional community — totally. He is still giving lip service validity to speculations in commodity futures, foreign currencies, derivatives, and TIPS (Treasury Inflation Protected Securities).

TIPs may be “safer”, but the yields are far too dismal. Inflation is a measure of total buying power, and the only sure way to beat it is with higher income levels, not lower ones. If TIPS rise to 5%, REITS will yield 12%, and preferred stocks 9%, etc.

No interest rate sensitive security is an Island!

As long as the financial community remains mesmerized with their “total return” statistical shell game, investors will be the losers.

  • Total Return goes down when yields on individual securities go up, and vice versa. This is a good thing.
  • Total Return analysis is used to engineer switching decisions between fixed income and equity investment allocations, simply on the basis of statements such as: “The total return on equities is likely to be greater than that on income securities during this period of rising interest rates.”

You have to both understand and commit to the premise that the primary purpose of income securities is income production. You have to focus on the “Income Received” number on your monthly statement and ignore the others… especially NAV.

If you don’t agree with the next three sentences; if they don’t make complete sense: you need to learn more about Income Investing:

  • Higher interest rates are the income investor’s best friend. They produce higher levels of spending money.
  • Lower interest rates are the income investor’s best friend. They provide the opportunity to add realized capital gains to both the total spending money and total working capital numbers.
  • Changes in the market value of investment grade income securities, Yogi says, are totally and completely irrelevant, 97% of the time.

How To Be Prepared for Rising Interest Rates

I’ve seen a lot of discussions lately that erroneously conclude: “rising interest rates are something to be feared and prepared for” by buying short duration bonds or by liquidating income purpose securities entirely. Have they all gone mad!

A rising interest rate environment is super good news for investors… up to a point. When we loan money to someone, is it better to get the lowest possible rate for the shortest period of time? Stop looking at income investing with a “grow the market value” perspective. That’s not what it’s all about.

The purpose of income investments is the generation of income, and that goes for all forms of bonds, preferreds, government securities, etc. Control the quality selected, diversify properly, and compound that part of the income that you don’t have to spend. Bond prices are pretty much irrelevant since you spend the income and not the  market value.

Long, long, ago, many bonds were of the “bearer” variety; my father never owned any others. Each month, he went to the bank, clipped his coupons, cashed them in, and left the bank with a broad smile. If interest rates went up, he knew he could go out and buy new bonds to put larger coupon dollars in his pocket.

He had no reason to even consider selling the bonds he held — they were, after all, income purpose securities that had never failed to do their job. Market value never fluctuates (visually) if the securities are kept in the (mental) safe deposit box.

No, this is not at all what I’m suggesting to you as an investment… this is a mindset you need to embrace to become a successful income investor.

Even when your statement shows bond prices at chest-pounding wealth levels, the income generated hasn’t changed. And the profits your statement reports… really just another Wall Street illusion.

The thing dear old Dad thought about least was the market value of his bonds. This was his tax free retirement plan (one way or the other). He bought them for income, and the coupons were always redeemed without question. The only problem with the periodic decreases in market value was the inability to add to existing positions.

Before I move on to the simple solution to this non-problem, a word or two on the only real benefit of lower interest rates — there is none if you don’t already own individual, income producing, securities. If you own interest rate expectation (IRE) sensitive securities in a downward interest rate cycle, you will have the opportunity for what I call “income-bucket-gravy”.

This is the opportunity to sell your income purpose securities at a profit, over and above the income you’ve already banked. Income investors rarely are advised to do this, which is why they lament the thievery of higher rates. They didn’t sell at a premium, and now “actionlessly” watch the profits disappear.

This behavior achieves the lowest possible yields while pushing scared-silly investors into an overpriced market for short duration debt… the ultimate Wall Street “markup” machine, where brokers literally make more than bondholders.

The solution is simple, and has been used successfully for decades. Closed End Funds (scoff, laugh, and say “leverage makes them volatile” all you like) solve all the liquidity and price change problems… in a low cost, much higher income, environment.

Read that again, and again, until you get mad at your advisor.

Answer this question before you throw stones. Is 7% or more on a diversified, transparent, income portfolio, compounded over the past ten years and still growing income, better or worse than the 3.5% or less that most investors have realized in individual securities during the same time period… and then there are the profits that you never realized you could realize so effectively.

Of course CEF market values fell during the financial crisis, but at their peak in November 2012, they had gained nearly 18% per year since 3/9/09…. nearly outperforming the S & P 500. But speaking of “drawdowns”, what do you think the economic activity drawdown of near zero money market rates has been, particularly for “savings account” Baby Boomers.

Did the Fed’s messing around with short term interest rates help or hurt your retired relatives… really, think about it.

Rising interest rates are good for investors; so are falling rates. Fortunately, they routinely move in both directions. They can be traded quickly for exceptional results from “stodgy” income CEF portfolios.

So much for Total Return, short duration, and leverage-phobic thinking.

What if you could buy professionally managed income security portfolios, with 10+ years income-productive track records? What if you could take profits on these portfolios, for a year’s interest in advance, and reinvest in similar portfolios at higher yields? What if you could add to your positions when prices fall, increasing yield and reducing cost basis in one fell swoop?

What if you could prepare for retirement with such a powerful income engine?

Well, you ca do all four. but only if you add both higher and lower interest rates to you list of VBFs.

Can’t attend the next Income investing Webinar? Contact Steve Selengut for a FREE video.

I Want Tax free Income

The LinkedIn discussion considered ROTH vehicles invested in equities and “cash value” Life Insurance as two ways to obtain Tax Free Income… something was missing.

Why not buy tax free muni bonds in the form of Closed End Funds (CEFs)…. more than 6% tax free, in monthly increments, plus the opportunity to take profits (taxable, yes) and compound the income until it is needed. Or spend it right away, for that matter.

The vast majority of Tax Free CEFs continued (raised even) their monthly payouts during the financial crisis, and no payments were missed.

ROTHs have a “lock up” period, and cash value life insurance…. someone please tell me how this provides tax free income and when.

If left in the ROTH vehicle, should one still be buying equities? or investing in income producers?

Experienced, taxable CEFs pay in the 7% to 8% range right now… and seemed to be financial crisis proof in 2008 through 2010.

Growing income portfolios is my business… can’t be done nearly as well with funds and insurance policies. For over 6% tax free income right now, create a diversified portfolio of tax free CEFs.

Yes, market value fluctuates, but with little or no impact on income production. I want tax free income too… and this is how I get it, both personally and for my managed portfolios.

The principles explained in this video webinar are equally applicable to the Tax Free Income building portfolio:

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

To Rollover 401k Plan Assets or Not To… That Is The Question

The major purveyors of 401k products, and those who benefit from using them remind me of politicians… they press the party line, and use their power to demonize the competition.

Their position and deep pockets allow them to get their message out while we who have neither can only shake our heads and whimper about the sacred purpose of retirement income programs.

But, in the simplest of terms, since when has 2% been better than 6% (both after expenses)? The DOL, fiduciaries, and plan sponsors are staring back at me, eyes wide shut.

LinkedIn discussion groups have been talking about the pros and cons of 401k rollovers to private IRA portfolios. Most of the articles, and not by a slim margin, are institutionally biased advertisements for low cost Mutual Funds and ETFs, despite the fact that have absolutely no “preparation for retirement income bones” in their mass marketed bodies.

When the market corrects, the results will be what they have always been for market-value-growth-only programs. This time though, the DOL will fine the Plan Sponsors (i.e., the corporations so bitterly hated by our government), for allowing plan participants to make investment judgment errors with their own money plus the matching contributions…. let hindsight reign in the 401k space!

The 401k “space” as they call it, has become a lucrative product shopping mall, totally out of touch with what should be the long run purpose of these “quasi” retirement programs: it’s the monthly retirement income that pays the bills, Charlie Brown, not the market value.

If a person were a conspiracy theorist, he or she could make a case for institutional/congressional manipulation of interest rates… keeping them near zero so that gurus will continue to predict that stock market “returns” will outpace those of income purpose securities. Hmmm.

None, absolutely none, of the products provided by the top institutional peddlers produce nearly as much after “expense-ratio” income as Closed End Income Funds. These outstanding (and income paying far longer than any income ETF) managed portfolios are never, ever, found in 401k Plans… except the Self Directed, “safe harbor” variety.

Interestingly, all the major 401k product providers, also manage Closed End Fund product lines that generate generous income, even after higher fees. These fees, so important to regulators and politicians, are never paid by the recipients of the much higher income.

CEFS paying 6% to 9% after expenses are commonplace, but not available in 401k plans. Similarly, there are no restrictions on speculation in the equity markets, where similar high quality managed equity portfolios have been available for decades.

The retirement plan (401k) community has gotten so paranoid over goose-stepping DOL auditors and other regulators armed with crystal clear hindsight, that they have completely lost site of “spending money” as the be all and end all purpose of retirement portfolios. They must “outperform” half their brethren, and be dirt cheap to boot.

Yeah, I know that 401k Plans are not retirement portfolios, but neither the regulators, plan sponsors, congressional leaders, POTUSs, fiduciaries, or plan participants seem able or willing to accept that reality… why should they?

Looking inside the multi-billion dollar Vanguard 2020 TDF, we find 60% invested in equities (no less than 7000 individual positions) and income of about 1.5%. Wake up regulators… the “unfairness” is in the “emperor’s new clothes” products provided to the plan sponsors for inclusion in employee product menus.

You the fiduciaries, you the regulators, you the witch hunters, and you the do-gooders need to look at the product providers instead of their victims.

If you insist upon looking at investment plans as retirement programs (ERISA = Employee Retirement Income Act), perhaps you need to mandate that an outside-the-mainstream, “Self Directed”, income program be a major part programs you supervise. Until the focus changes from market value and expense control to after expenses income, these plans cannot provide what is expected of them… retirement readiness.

So in answering the “To rollover the 401k or not to rollover the 401k” question, I would say: “Run like _ _ _ _, just as fast as you can, to get out of that 401k and never ever buy a low income or no income security in the Rollover IRA you move to.

As long as plain vanilla portfolios of high quality equity (IGVSI companies) and Income CEFs yielding an experienced average, net/net 6% or more, are banned from participating in the 401k marketplace by (possibly) illegal monopolistic practices, rollovers to IRAs should be a requirement, not an option.

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

As long as regulators are blaming generous employers for the investment mistakes of their employees, self-directed, income purpose, 401k plans are a much less scary, “almost a retirement plan”, option.