What you need to know about the investments we recommend
CLOSED END FUNDS - Never heard of these you say? One reason is that these funds trade like shares of stock and are purchased through a brokerage account. As a result, they are hidden among thousands of competing individual investments and they are hidden thanks to the noise of the publicity machinery of regular mutual funds we are used to - what are known as "open-end" funds.
There are many things to know about closed end funds, but in our view here are the most important things to understand.
The history of closed end funds dates back to 1893!
Many funds can be bought at DISCOUNTS to their actual fund value - what is known as a fund's "net asset value". A bond fund selling at a 5% discount provides you a chance to buy a basket of bonds for 95 cents on the dollar.
Many income closed-end funds will sacrifice volatility of principal in return for higher yields provided by leverage. Closed end fund managers can borrow money with some fund securities as collateral. This is known as "leverage" and it is how closed end funds can offer such dramatically higher yields than comparable open-end funds. We suggest you ride through the sometimes volatile ups and downs and hold long term -- because yields can be very handsome indeed, creating no pressure for you to have to sell in a market downturn for bonds, real estate, etc.
Closed-end fund managers don’t have the pressures of money flows and redemptions. Many closed end funds therefore stay fully invested at all times with stable portfolios with little turnover and lower overall expenses compared to open-end funds.
Closed-end funds are incredibly transparent. There is a wealth of information on funds provided by fund companies, by the Closed End Fund Association and independent web sites. We have chosen two web sites to provide you with information on the funds we have chosen in our portfolios.
They are:
Closed End Fund Association – www.cefa.com
ETF Connection – www.etfconnect.com
Each site provides you with a wealth of details on the funds we recommend in our portfolios. Here are the primary basis traits we look for when we choose funds for you to consider.
1) The fund has a long history or the company behind it has a long history.
2) Interest paid by the fund has been consistent.
3) The fund tends to have a low portfolio turnover and low annual expenses.
4) The fund is selling at a discount to NAV.
There are other traits we look for and we don't always demand adherance to all four traits just listed. For example, a good international bond fund may trade out of three countries and move into three others where opportunity is better. That creates turnover and additional expenses which at first glance seem to be a negative development. Careful examination finds though it is a positive and comparison to open-end funds shows turnover and expenses might still be less.
Also, you will note that open-end funds are not required to openly show you ALL expenses, so they limit their reporting to management fees. Closed-end funds typically disclose ALL expenses, which at first glance makes some of them appears to be abnormally expensive. In truth, a side-by-side comparison with ALL expenses of similar open-end funds will many times find the closed-end fund less expensive overall.
Check back later as we take you through all the things you need to know about closed-end funds.
OTHER INCOME INVESTMENTS YOU WILL SEE US RECOMMEND
TRUST STOCKS – In some higher dollar aggressive portfolios, we may recommend trust stocks. These are stocks that pay out at least 90% of the money they make and thus avoid a corporate income tax.
The best known trusts are:
REIT’s – Real Estate Investment Trusts
ERT’s – Energy Royalty Trusts
REIT’s are well known. They are simply real estate firms that own buildings and usually rent out space in those buildings. They can be apartment complexes, office buildings, shopping centers, etc.
ERT’s are not as well known. These stocks give a shareholders a cut of the money being made on the sale of whatever is being pulled out of the ground in a particular location. Most ERT’s provide generous dividends based on the sale of oil and natural gas.
An excellent article explaining the pros and cons of ERT’s has been written by Bill Mann of the Motley Fool. Click here to read his article.
MLP’s – Master Limited Partnerships – These relatively unknown securities are publicly traded stocks that combine the benefits of the much maligned limited partnerships of the past with the ability to buy and sell like any share of stock. Many MLP’s are in the pipeline or resource delivery business and many tend to provide stable income from the business of delivering natural gas, oil or gasoline.
There are two issues with MLP’s. Many experts point out that MLP’s have tax advantages that are lost inside tax-sheltered accounts like IRA’s. Other experts point out that the nice income is a good basic reason to have MLP’s inside an IRA and that outside an IRA there are complicated tax forms to file if you own such a stock that is not in a tax-sheltered account.
Trust Stocks, ERT’s and MLP’s are not for the faint of heart. They can soar dramatically in price up and down. They can provide very fat income and then cut dividends without warning. Long term though, we believe for aggressive investors and even for some moderate investors that owning such investments makes sense.
When it comes to asset allocation, you often hear experts talk about having some money in investments outside stocks and bonds. Much of the hype is for you to have gold and commodities.
INCOME PLANNER feels that having a commodity position is fine, but the main benefit should be income and that is where these investments come in.
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