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

Retirement Income Investing: The Dreaded RMD

All of us are approaching retirement, many of us are already there, and some of us (myself included) are thinking about the ultimate IRS slap-in-the-face… The Required Minimum Distribution. It’s time to make sure that your retirement income program is actually ready.

Every investment program becomes a retirement income program eventually.

First off, you need to get to a place where you can say:

“a stock market downturn will have no significant impact on my retirement income”

This applies to everyone; income development is always important, and Tax Free Income (outside the IRA or 401k) is The Very Best. Only private “safe haven” 401k plans are capable of focusing on income development.

Retirement readiness requires active consideration of your asset allocation, your overall diversification, and most importantly, the quality of your holdings. Those of you who are relying on 401k assets to fund your retirement income requirements need to look inside the program.

If you are within five years of retirement, repositioning at the top of a stock market cycle (now) is essential; if you are in retirement, get your portfolio out of any employer plans and into your IRA… you just can’t protect yourself  (and especially, your income) in Mutual Funds or ETFs.

If you are approaching 70, the RMD is “in your face”… here’s how to handle it:

• Position the portfolio to produce slightly more income than you must take from the program.

• Take the income monthly and DO NOT pay the taxes in advance. Lump sum withdrawals require uninvested cash reserves and/or untimely sell transactions.

• Move the RMD disbursements into an individual or joint account and reinvest at least 30% in Tax Free Income CEFs.

• If you hold equities (in addition to the RMD income producers you need), set your profit taking targets lower than usual… and maintain the Cost Based Asset Allocation.

I’m relatively sure that some of you are currently dealing with the RMD incorrectly… with “lump sum + the taxes” distributions.

Some of you have been to my ongoing series of “live SRS portfolio review, Income Investing Webinars”.

Follow this link to the recording of the January 22nd private presentation and don’t hesitate to post it where ever you like… wouldn’t it be cool to have this presentation show up on YouTube.

https://www.dropbox.com/s/28ty6z5dkgn5ulu/Retirement%20Income%20Webinar.wmv?dl=0

Year End Review 2014 and 2015 Preview

Let’s Talk About the Market Numbers…

Note that this report pertains most directly to portfolios operated under the guidelines, rules, and disciplines of Market Cycle Investment Management (MCIM). MCIM produces disciplined “High Quality Growth & Income Portfolios”, designed to maintain and/or to grow income regardless of the direction taken by markets or interest rates.

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Both markets have been good to MCIMers this year: Investment Grade Value Stock Index (IGVSI) equities produced plenty of profits and dividend income, while the income Closed End Funds (CEFs) produced much higher yields than many “experts” would admit even exist… and occasional profits.

On the negative side, new equity investment opportunities were scarce, and many income CEFs reduced their payouts slightly, reflecting more than six years of historically low interest rates. I suspect that both conditions will be reversed soon.

A recent (unaudited) review of known MCIM “Working Capital” produced some interesting numbers, even without including year end dividends:

• Roughly 35% of total realized income was disbursed
• Nearly 25% of growth purpose capital remained in “smart cash” reserves for scheduled disbursements… and anticipated lower prices on equities. (Smart cash comes from income and profits)
• Roughly 65% of total earnings was reinvested in new and old securities
• New “Working Capital” was produced at a rate somewhere between 9% and 10%
• Less than 20% of investors made additions to investment programs, eschewing income yields in excess of 6%
• None ot selected MCIM portfolios lost Working Capital… even after culling “poorest performers” throughout the year.

Working Capital” (total cost basis of securities + cash) is a realistic performance evaluation number…. it doesn’t shrink either during corrections or as a result of spikes in interest rates. It continues to grow so long as dividends, interest, profits and deposits exceed realized losses and disbursements.

Using the “Working Capital Model” facilitates preparation for future income needs with every decision made throughout the history of an investment program… MCIM working capital grows every month, regardless of changes in market value, so long as the investor disburses less than the portfolio is producing.

Year end is always a good time for investors to review asset allocation and projected income needs… if you are over 50 and haven’t considered the subject, it’s time to do so. If you expect to start withdrawing from your portfolios in the next few years, you need to determine if asset allocation changes are necessary.

If your income allocation is not generating at least 6% in spending money, or 401k balances are subject to shrinkage when the stock market corrects, it’s time to deal with these problems.

If you are not taking advantage of 6%+ tax free yields (and a higher range in taxable CEFs), you owe it to yourself to investigate the opportunities.

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So is there a “Grinch” in your 2015 portfolio performance future? What’s likely to happen?

The Stock Market is about to finish 2014 at the highest year end number ever recorded, and with each new “ATH”, the likelihood of a market correction increases… this 6.75 year rally is the longest, broadest, and most stubborn in stock market history.

So long as income investors are abused with artificially low rates, a gradual reduction in yields is likely to hold income CEFs around current prices… higher future rates are already anticipated in current market values.

Once higher rates become reality, there are several reasons why CEF prices should firm and, over the longer term, rise, with increased income production…

But even if the correction starts tomorrow, what has nearly 40 years of financial history taught us about the MCIM “much-higher-quality-and-income-than-any-other-form-of-investment-portfolio” methodology?

The IGVSI universe, high quality ADRs, REITS, MLPs, Royalty Trusts, plus Equity and Income CEFs should logically have been expected to fare better than the stock market averages during the three financial crises of our lifetimes. Many MCIM users can attest to this, but the logic is clear.

Every security produces income, and reasonable profits are always realized. New equity investments are only made when prices have fallen 20% or more; income securities are added to at lower prices to reduce cost basis and increase yield. Not to mention the fact that MCIMers invest only in the highest S & P quality ranked companies, filtered further by dividend history, NYSE, and profitability.

MCIM users were low on equities in August 1987 but fully invested by November; they owned no mutual funds, no NASDAQ securities, and no IPOs in 1999; they lost virtually no working capital, reinvested all earnings, and rebounded quickly from the financial crisis.

Most investors, particularly Mutual Fund owners and 401k participants were blindsided, not once, but on all three occasions. The S & P 500 has gained only 3% per year in the 15 it has taken to get to its current level!

So if the rally continues, Working Capital growth will continue right along with it. But when the correction comes along, cash reserves and continued income will likely be available to takes advantage of new opportunities that arise in the MCIM select group of potential investment securities.

The longer the correction (the financial crisis took roughly 20 MCIM months to reach bottom on March 9 2009), the more Working Capital will be available when the next round of stock market all time highs is upon us.

And again, most importantly I believe, all programmed income payments will be made on time and without dipping into capital…

2014 Resolutions – is it too early?

2014 Resolutions – is it too early to plan ahead?

Yes, it is only late October. No, no-one likes to make resolutions as most people fear the self-recriminations if they fail. So let’s call them guiding principles for 2014 instead!

1. Avoid credit to the greatest extent possible. Special offers arrive weekly in our mail box – many from institutions with which we already have a business relationship but also some of the “Dear Occupant” variety. And they all sound so tempting. Loans, lines of credit, new credit cards – the choices seem endless – and sooooo easy. For lifestyle items (toys, vacations, etc.), the wanton use of credit can be a death knell for your financial well-being. It is tough realising you are still paying for that vacation 6 months after you return and that 60 inch flat screen is rapidly losing its attraction a year later and the “interest free” purchase is starting to cause cash-flow problems.

2. When you decide you absolutely MUST borrow, shop around and keep your calculator handy. Of course, it is difficult to completely avoid debt. HOWEVER, when you do have to borrow, generally, the lower the interest rate the better it is for you – but beware of the so-called “interest-free” payment plans. NOTHING in life is free – don’t be fooled. The vendor isn’t making that offer without covering all of their costs in some manner. Maybe it is an “arrangement” or “set-up” fee; maybe the actual price is higher than normal. The seller has costs that have to be covered and they aren’t in business to intentionally lose money.

3. Pay off debts as quickly as possible. Especially credit card balances! In some cases, they can carry a rate as high as 2.4% per month compounded. That is nearly 33% annually –and yes, it is a usury rate as far as I am concerned – but tell that to our Federal politicians! To put that in real terms, a $1,000 purchase carried on a credit card for a year will actually cost nearly $1,300 in total. For a home mortgage, the shorter the amortisation period, the better off you will be. Go to www.mortgagecalculator.org and play with some numbers yourself – this site also produces some nice graphs for picture-lovers.

4. First, pay YOURSELF, not everyone else. Usually, we have too much month left over after our pay-cheque. If we wait to save money until everything else is paid, there’s never anything left. If we don’t see it, we don’t spend it. Talk to HR (yes, I know they are sometimes interesting people) and arrange to have something deducted from each pay cheque to buy Canada Savings Bonds – this is just one alternative. Some businesses will split your cheque and deposit part into one account and another sum into a different account – perhaps a savings account. Make sure you contribute monthly to your RRSP or TFSA. We make loan payments each month so why not make financial future payments the same way?

5. Plan for your future. If good things are to happen to us, we have to plan – the future will not take care of itself. We have to plan for long term goals such as education, retirement and major purchases. And let’s not forget emergencies such as unemployment, a falling economy, disability or death. We can’t rely on our employer and certainly not any level of Government – which leaves only a Fairy God-Mother. We must take action ourselves.

Talk to a financial advisor about your plans today!

A ridiculous idea – but profitable!

My mind works in strange ways as my readers know – so here is another slightly off-beat idea on RRSPs – for children!

I took the time recently to confirm a long-held belief – most people selling RRSPs aren’t aware of all of the possibilities – and neither am I for that matter – however, here is an idea that no-one I asked had the slightest understanding of that which I was asking. My question was simple (or at least I thought so anyway): “What is the earliest age at which a person can purchase an RRSP?”

Without exception, I received answers that fell within this brief summary – “the year after they have earned income.”

I found this a bit disconcerting, particularly coming from many professional advisors. The correct answer, of course, is the same day the receive their SIN from the Federal Government. In other words, within 3 to 6 weeks after they are born.

But wait you say – they don’t have any earned income so how can they contribute?? My response – what about the lifetime $2,000 over-contribution limit? I usually receive a puzzled look from the person with whom I am speaking and then they say: “what about it?”

Let’s be a wee-bit creative here – I am NOT a rocket scientist I assure you – my mind just works somewhat differently than most other peoples’!

These days, parents and grandparents spend literally thousands of dollars on toys and other gadgets that have life spans counted in days and weeks and maybe months – but that’s it. What about a gift that will GROW with each passing year?

Rather than all of the toys and related odds and sods, put $2,000 into an RRSP for the baby as soon as the parents receive an SIN. The actual source of the money is irrelevant of course – but the concept is sound.

If a baby has an RRSP with $2,000 in it at age zero and leaves it until age 65, it will grow to $18,713.40 assuming a compound growth rate of 3.50% and as much as $25,597.47 with a compound growth rate of 4.00%. I will leave it to my readers to play with other assumptions – my purpose here is just to get people thinking about the possibilities of acting on this idea.

The $$ amount doesn’t sound like a lot – and it really isn’t – but it is certainly worth a lot more than the toys and gadgets that are generally purchased for a new-born child in their first year of life. What a special Christmas gift (oops – don’t want to be politically incorrect!) – holiday season gift – for the new one in your life!

All the best to everyone for a wonderful and SAFE holiday season and a prosperous 2013! Cheers Ian