Do you sometimes question the performance of your investment
portfolio? If you are like most investors you have your income
producing assets thrown in together with your equity portfolio.
You look at the total mix of dividend paying stocks, bonds,
mutual funds and equities, and you're confused as to why they're
not producing enough income or growing your portfolio value
sufficiently.
I have found that part of the reason is the nearly universal
propensity of investors to ignore the long-term implications of
their income investment decisions while they focus on short-term
effects.
Because fixed income investing simply isn't regarded as being as
exciting as other stock market investing, it has often been
relegated to the "ho-hum" category by writers and not as much ink
has been devoted to its ins and outs as has been expended on
other types of investing. I think that's a disservice to those
interested in this type of investment.
Investing for income, be it taxable or tax-free, -- and, for the
record, my preference for generating tax-free income for clients
is the use of CEETBFs (Closed End Exchange Traded Bond Funds) as
described in my free e-book "How to earn 5% - 6.5% tax-free
income." -- has some common denominators, which I have broken
down into 10 rules. These will help you make better decisions
and, at the same time, view income oriented investments with the
correct mindset, so that you don't constantly try to second guess
yourself.
1. It's important to consider the performance of the Fixed Income
portion of a portfolio separately from the equity portion. Why?
Because the objectives are entirely different.
Equity investments are for growth, while the primary purpose of
owning fixed income securities is to generate a secure cash
flow—either for spending or reinvesting until it is needed. For
most people, the long-term goal of an Investment program is to
generate enough income to live on, without having to touch the
principal.
To most effectively analyze and manage your investments, keep
your equity account separate from your income generating account.
2. All fixed income securities are "interest rate sensitive."
Because of this their market price will always "vary inversely"
with the anticipated direction of interest rates. Interest rates
on the rise, prices will fall. Interest rates thought to be
headed south, investment prices will move higher.
This applies to all Bond, Preferred Stock, & REIT prices. Accept
it and live with it! The variables for the movement in price are
the quality rating of the issuer, the length of time until
Maturity, or the Call Date.
Do remember that price changes in Fixed Income Securities are not
an indicator of, and have little impact on, the ability of the
issuer to pay interest. So instead of beating yourself up when
interest rates start to rise, take advantage of higher yields.
3. Because of what they are, Fixed Income Securities are
generally held for the long term. The factor to consider is the
amount of income being received. There is no benefit in trying to
predict the future direction of interest rates, and I strongly
suggest you avoid that—along with constant monitoring of changes
in portfolio value.
Remember, fixed income investing works in a way like your day-to-
day personal finances. You pay your expenses from your income,
not from your net worth.
4. Buy only fixed income instruments where the costs are
transparent. In other words, many new issues sold by brokers can
carry hidden costs. While commissions have to be disclosed mark-
ups don't.
There are often extremely large mark ups—3% or more is not
uncommon—on new issues. Buyer beware.
5. Seek out instruments with the longest duration and only those
that are Investment Grade. If you're conservative, you can find
many closed end funds that are insured and use no leverage,
though they offer a slightly lower yield.
6. All Interest Rate Sensitive Securities follow the same rules!
This means the value of everyone's bonds will be going in the
same direction as yours at any given time. Don't submit to
temptation. Emotions, fear, or other non-objective motives are
not good reasons to switch from one Fixed Income fund to another.
Focus on diversification and avoid investments with yields that
seem too good to be true. In that aspect, Fixed Income investing
and Equity investing share a couple common guidelines: (1) if it
seems too good to be true, it probably is, and, (2) no matter how
good the hype, you can't make a silk purse out of a sow's ear.
7. Income production is the primary reason to purchase Fixed
Income Securities. Once you truly understand that you will
realize that the only thing you need to pay attention to on your
monthly statement is the "Income Received" number. I suggest you
ignore the others.
8. To become a successful Income investor, you must also
understand the following points and agree with them:
* Higher interest rates are a boon to the Fixed Income
Investor; they put more money in your pocket.
* Lower interest rates also offer benefit for the Fixed
Income Investor; they give you the chance to add Capital
Gains to the total spending money your investments generate.
* Changes in the market value of Investment Grade Fixed Income
Securities should have absolutely no meaning to you 95% of
the time.
9. Open Ended Income Mutual Funds will not serve your objectives.
It is no secret that the fixed income variety almost never go up.
As interest rates cascaded downward over the last several years,
Open Ended Income Mutual Funds did not show the same degree of
gains enjoyed by individual securities—while Closed End Funds did
respond to these factors.
10. There are a number of reasons why it's to your benefit to
primarily use Closed End Exchange Traded Funds: Low acquisition
costs, complete liquidity, professional fund management and
monthly predictable cash flow. Additionally, you're offered the
opportunity to buy more when prices fall and to realize capital
gains when interest rates are on the downturn.
Why haven't you heard about these funds from your financial
professional before? Especially now when many are yielding around
6% tax-free? For the simple reason that there is no money to be
made for the financial professional recommending them. While
these funds may increase your monthly income, they won't do a
thing for the commission hungry salesman.
If you manage your portfolio, hopefully these 10 points will
assist you in more profitable investing. If you're unsure about
putting an income portfolio together by yourself, find a
professional who works with these types of funds and is aware of
the principles I have described, and let him or her assist you in
creating the income you need to enjoy a dignified retirement.
© Ulli G. Niemann
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