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24 February 2010

Income Investing Selecting the Right Stuff

When is 3 percent better than 6 percent? Yes, we all know the answer, but only until the prices of the securities we already own begin to fall. So, logic and mathematical insights disappear, and we are exposed to all kinds of special treatments for the regular outbreaks of higher interest rates. We will be told to sit in cash until rates stop rising, or to sell securities that we own now, before they lose even more of their precious market. Other gurus will suggest the purchase of more short-term bonds or CDs (ugh) to stem the perceived erosion in portfolio values. There are two important things that your mother never told you about Income Investing: (1) Higher interest rates are good for investors, even better than lower prices, and (2) Selecting the right securities to take advantage of the interest rate cycle is not particularly difficult.

Higher interest rates are the result of government efforts to curb a growing economy in hopes of preventing an appearance of the three headed inflation monster. A quick glance over his shoulder can recall the last time, when the government tried to heal the wounds of a misguided Wall Street attack on traditional investment principles by lowering interest rates. The strategy worked, the economy rebounded, and Wall Street tries to climb back to where it was almost six years ago. Think about the impact of changing interest rates on your returns over the past five years. Bonds and Preferred Stocks, government and municipal Securities; they all moved higher in market value. Make sure you felt wealthier, but the increase in your annual income Spendable got smaller and smaller. Your total income could have declined during the period as higher interest holdings were called away (at face value), and reinvestments were made at lower yields!

How many of you have mental bruises from the realization that you could have made a profit in the downward trajectory of the bike at the very securities that you now lament over. The nerve that lies below the price you paid for them years ago. But revenues at these turncoats are the same as it was in 2004 when their prices were ten or twenty percent higher. It is the work of Mother Nature's financial twin sister. It's like acorns, snowfalls, and crocuses. You have to dress properly for seasonal changes and invest properly for cyclical changes. Remember the days bearer bonds? There was never a whisper about Market Value erosian. Was it the IRS or Institutional Wall Street that took them away?

Higher rates are good for investors, especially when retirement age is a factor in your investment decisions. The more you get for your reinvestment dollars, the more likely it is that you will not need a second job to maintain your standard of living. We know of no retail entity, from grocery to the Cruise Line that will accept the market value of your portfolio as payment for goods or services. Income to pay bills, more is always better than less, and only increased income can protect you from inflation! So, you say, how can a person take advantage of the cyclical nature of interest rates to assemble the best possible return on the investment quality securities? You can also ask why Wall Street makes such a fuss about the dismal bond market and offers more of their patented Sell Low, Buy High counseling, but that there should be quite obvious. An unhappy investor is Wall Streets best customer.

Selecting the right securities to take advantage of the interest rate cycle is not particularly difficult, but it requires a change in focus from the statement bottom line ... and the use of a few security types that you can not be 100% comfortable with. We will assume that you are familiar with these investments, each of which could be considered (from time to time) for a place in well diversified income portion of your asset allocation: (1) The traditional individual Municipal and corporate bonds, financial centers, government Agency Securities, and Preferred Shares. (2) Eyebrow raising Unit Trust varietals, closed end funds, Royalty Trusts, and the REIT. [Intentionally excluded: CDs and money market funds, which are not investment definition, market mechanisms and zeros, mutations developed by some Sicko MBAs, and Open End Mutual Funds, who just can not work because they are really " managed by the mob. " .. i.e. investors.] market rules that apply to all of these are fairly predictable, but the ability to create a safer, more powerful and flexible portfolio varies considerably within the security types. For example, wind most people who invest in individual bonds up with a laundry list of odd lot positions, with short maturities and low yields, which are designed for the benefit of that smiling guy in the big corner office. There is a better way, but you have to focus on income and be willing to trade occasionally.

The larger the portfolio, the more likely it is that you will be able to buy round lots of a diversified group of bonds, preferred stocks, etc. But regardless of size, individual securities of all kinds have liquidity problems, higher risk than the level is necessary and lower yields spaced out over inconvenient periods. Of the traditional types listed above are only preferred stock holdings easily be added to the rising interest rate movements, and cheap to take profits on when rates fall. The downside of all this is their maturity, the best yield-first order. Wall Street loves these securities because they command the highest trading costs ... costs shall not be disclosed to the consumer, especially on the issue. Investment funds are traditional securities set to music, a melody, which generally ensures the investor a higher yield than is possible through personal portfolio creation. There are several additional advantages: instant diversification, quality, and monthly cash flow, which may include principal (better in rising rate markets, ya follow?), And insulation from the end of the year swap scam. Unfortunately, the funds are not managed, so there are few capital gains distributions to smile, and when all the securities are redeemed, the party is over. Trade Opportunities, heart and soul of successful Portfolio Management, is virtually nonexistent.

What if you could own ordinary shares in companies that manage the traditional income securities and other recognized income producers like real estate, power generation, mortgage, etc.? Closed end funds (CEFS), REIT, and Royalty Trusts need your attention ... and do not let the idea of "leverage" spook you. AAA + insured corporate bonds, and Utility Preferred Stocks are "leverage". The sacred 30-year Treasury Bond is "gearing". Most corporations, all governments (and most private citizens) use leverage. Outside influence, most people would be commuting to work on bicycles. Each CEF can be examined as part of your selection process to determine how much influence is involved, and the benefits ... you will not be happy when you realize what you have been talked out of! CEFS, and the other Investment Company said securities managed by professionals who do not take their direction form that mob (also mentioned earlier). They allow you to have a properly structured portfolio with a significantly higher yield, even after management fees that are inside.

Although a REIT or Royalty Trust is more risky than a CEF consists of Preferred stocks or corporate bonds, but here you have a way to participate in the largest selection of fixed and variable income alternatives in a much more manageable form. When prices rise, profit taking is routine in a liquid market, when prices fall, you can add to your position, increase your returns and reduce your costs at the same time. Now do not start to drool over the prospect of throwing all your money in real estate and / or gas and oil pipelines. Diversify properly, as you would with any other investment, and make sure that your living expenses (actual or projected) are taken care of by the less risky CEFS in the portfolio. In bond CEFS, you can get un-leveraged portfolios, state-specific and / or insured Municipal portfolios, etc. Monthly income (often enhanced by capital gains distributions) at a level that often is far better than your broker can obtain for you. We have told you that you will be angry!

Another feature of Investment Company shares (and remember to stay away from gimmicky, passively managed, or indexed types) is somewhat surprising and difficult to explain. The price you pay for the shares frequently represents a discount from the market value of securities contained in the managed portfolio. So instead of buying a diversified group of illiquid individual securities at a premium, you will gain from a portfolio of (quite possibly the same) securities at a discount. In addition, and contrary to ordinary mutual funds that can issue as many shares as they want without your approval, CEFS will give you the first shot at any additional shares they intend to distribute to investors.

Stop, put the phone. Move into these securities calmly, without taking unnecessary losses on good quality holdings, and never buy a new question. We would have said absolutely never buy a new problem for all the usual reasons. As with individual securities, is due to abnormally high or low yields, like too much risk or poor management. No matter how well managed a junk bond portfolio, it is still just junk. So do a little research and spread your U.S. dollars around the many management companies that are out there. If your advisor tells you that all this is risky, unwise stupidity ... well, it is Wall Street, and the baby needs shoes.

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