Income Tripler

Long-Term Investment Goals: Answers to The Top 3 Investing Questions Right Now

by Louis Basenese, Advisory Panelist, Investment U
Associate Investment Director, The Oxford Club
Thursday, October 16, 2008: Issue #872

With Investment U having over 360,000 members and The Oxford Club with over 70,000, Alex Green and I always get a steady stream of questions. But in recent weeks, as the market has accelerated its descent, they’ve become increasingly alarmist.

As I’ve learned, when we give into panic, we act hastily. And often undermine our long-term investment goals.

So today, let’s put to rest some of your pressing concerns. And make sure that doesn’t happen.

Long Term Investment Goals: Is My Cash Safe?

When my grandfather died, my grandmother found $17,000 lying around the house. He was Italian. So yes, some was stashed under mattresses. Some was in coffee cans behind the refrigerator in the basement. And more still was found in his sock drawer.

Forget the terrible investment implication of earning no interest on this money. My father almost burnt the house down when he was 12. And my great uncle was convicted of arson. So an “accidental” fire, not inflation, was a bigger threat to his savings.

My point: There’s a lot of fear in the market. Banks continue to go under. Many people are trying to predict the next collapse, and move their assets in advance. (I can empathize because I bank with Washington Mutual, now JP Morgan.) But whatever you do, be smarter than us Italians. The mattress is not a safe or smart place for cash.

In all seriousness, if we take a few simple steps, we can keep all our cash in the bank, and make sure every penny is insured.

The rescue package increased the FDIC limits up $250,000 per qualified account. This increase alone brings almost 75% of deposits in the United States under coverage. The expanded coverage remains in effect until December 31, 2009.

If you have more than $250,000 in cash, you don’t have to move it to another bank to get an additional $250,000 in coverage. Simply set up another account under a different ownership category (single, joint, IRA, revocable trust, corporation, etc.). For most banks, this can even be done online.

For those interested in insuring large deposits, up to $50 million, you might want to consider EverBank’s Insured Advantage Certificates of Deposit (CDARS)*.

Long Term Investment Goals: Should I Worry About Mutual Fund Companies Going Bankrupt?

No. We’re protected here, too. The Investment Act of 1940 requires each fund to be set up as an individual corporate entity, with a board of directors. That entity then hires the mutual fund company to manage its assets. So if the mutual fund company goes belly-up, its creditors can’t touch the fund’s assets. And the board of directors simply hires a new manager, after getting shareholder approval.

The only way your mutual fund can go bankrupt is if the actual value of all the stocks or bonds in the portfolio drop to zero.

Long Term Investment Goals: What if My Broker Goes Out of Business?

Again, we’re covered. Brokerage firms are restricted from co-mingling funds by SEC Rule 15c3-3 - the Customer Protection Rule. Or as they used to tell us at summer camp - boys are blue, girls are red. And we don’t want any purple running around here.

As the Financial Industry Regulatory Authority (FINRA) explains, “In virtually all cases, when a brokerage firm ceases to operate, customer assets are safe and typically are transferred in an orderly fashion to another registered brokerage firm.”

But we all know that Wall Street doesn’t always abide by the rules. That’s where SIPC insurance comes in. Created in 1970 as a non-profit, non-government membership corporation, funded by member broker-dealers, the SIPC’s primary role is to return funds and securities to investors if the broker-dealer holding these assets becomes insolvent.

SIPC coverage is limited to $500,000 per customer, including up to $100,000 for cash. But again, we can easily increase coverage by establishing multiple accounts under different ownership structures.

Good investing,

Lou

P.S. If you’re looking to put your money back to work, or if you’re looking for some ideas of what to do with your cash holdings, take a look at our Perpetual Income Portfolio. It’s yielding over 17% right now.

* Disclaimer: The publisher of Investment U maintains a marketing relationship with EverBank, but it’s important to note that we’d recommend their products and services anyway.

Louis Basenese 2008 Archives, Investment Strategies, Louis Basenese, The Truth About Investing future investing goals, long-term investment goals

Closed-End Income Funds: Why It’s Time to Buy Them

by Louis Basenese, Advisory Panelist, Investment U
Associate Investment Director, The Oxford Club
October 09, 2008: Issue #868

Pick a stock. Any stock. And invariably, one investor will argue it’s cheap. Another will say it’s expensive. Even in this panic-driven sell off. The problem, of course, is that no foolproof, infallible metric exists to determine who is right. Until it’s too late.

But the same is not true of closed-end income funds.

A first grader with a good grasp of addition and subtraction can tell whether one is cheap. Or expensive. Right now, they’re ridiculously cheap.

Since closed-end income funds issue a fixed number of shares, supply and demand determines market prices. That means it’s possible for such funds to trade at a price that’s greater than (a premium) or less than (a discount) the actual value of the securities in the portfolio (net asset value).

Average Closed-End Income Fund Discount

Currently, the average closed-end income fund is selling at a 13.7% discount. Almost double the average of three weeks ago, according to research firm Lipper. That means if the fund’s manager sold all of the fund’s holdings, investors would earn an instant 13.7% profit.

What’s more, almost 200 closed-end funds trade at more than a 20% discount. And more than 20 trade at discounts of 30% to 40%. Not to mention, many sport double-digit yields.

Have you ever complained about buying something at 40% off? Me either. And that’s the attitude we need to embrace when it comes to closed-end funds. We’re witnessing a once in a lifetime buying opportunity. But, don’t just take my word for it…

• “I’ve been in the industry for 25 years and I’ve never seen [discounts]… this wide,” declares Cecilia Gondor, Executive Vice President at Thomas J. Herzfeld Advisors Inc.
• “Discounts have gotten to levels perhaps never seen before, certainly not for years,” according to Jonathan Issac, Vice President at Eaton Vance Corp.
• “I’ve been through [market crises] six times in my 40-year career, and this is as nasty as I’ve seen it,” explains the President of Thomas Herzfeld Advisors.

A skeptical bent, especially in this market, doesn’t hurt…

Are Closed-End Income Fund Bargains Too Good to Be True?

Yet, when it comes to closed-end income funds, the bargains aren’t too good to be true. They’re a result of fearful investors. Not a breakdown in the underlying fundamentals.

You see, when investors are scared, they sell indiscriminately. Companies with stellar earning growth and fundamentals get tossed just as quickly as companies with terrible fundamentals.

If you have any doubt, consider that as of the close on October 6, 80% of the stocks in the Russell 3000 were down for the year. Obviously, not every one of those 2,400 stocks sports terrible fundamentals.

My point. Good stocks are getting thrown out with the bad. So, too, are many solid closed-end income funds. It’s especially true among the 400 or so income-based closed-end funds. Because investors are extremely leery of anything credit related, they’re selling income funds more aggressively.

For investors that value solid income (in some cases paid monthly), with the potential for double-digit appreciation, too, I’m convinced no better opportunity exists. Here’s why…

The widespread panic in the markets is doing more than sending discounts to the moon. It’s also depressing asset prices, leading to declines in the NAV. But remember, unlike stocks, fixed-income investments have a predetermined value at maturity.

So despite the wild swings, and even dips in NAV, valuations will recover as maturity draws near. Even better, so will the historic discounts.

The Premium/Discount History of Closed-End Income Funds

If you have any doubt, pull up the premium/discount history for any closed-end income fund with at least a five-year track record. You’ll notice, time and time again, that the fire sale prices don’t last.

By no means am I suggesting all the funds are immune to losses. No investments are. Not even money market funds.

Some closed-end income funds will inevitably pay the price for using too much leverage. Or overdosing on toxic fixed-income investments. But countless others will not.

Unfortunately, simple math won’t help us distinguish between the good and the bad. But it’s not an impossible task. I’m convinced you can single out some inevitable winners and enjoy steady double-digit yields and capital appreciation…

All you have to do is avoid the funds with the highest yields. Or the biggest discounts to NAV. Such extreme levels indicate higher risk. Whether it’s justified or not, it’s best to steer clear of these outliers.

And instead, focus on funds with slightly above average yields (9% to 12%) and discounts to NAV of 15% to 25%. At the same time, I’d focus on funds with…

• Less than 10% exposure to the “toxic” financial sector.
• A reasonable amount of leverage (up to 25%). Or none at all. This will minimize the impact of any poor investment choices.
• No investments in mortgage-backed securities. Or only agency mortgage-backed securities (the ones backed up by the full faith and credit of the government).
• A dividend that hasn’t been cut since the beginning of the credit crunch (August 2007). A dividend cut often confirms deterioration in the underlying assets.
• Minimal or no exposure to auction-rate securities. Funds relying on this type of financing remain hamstringed, as the auction-rate market is still not functioning properly.

These two websites - www.cefa.com and www.etfconnect.com - should help you find all the necessary information. (If you want to skip the hassle, here are the eight closed-end funds we highly recommend right now.)

In the end, we’ll look back at this period in amazement over the extraordinary buys available in closed-end income funds. The last thing I want is for your amazement to be soured with regret over not taking advantage of them.

Good investing,

Lou Basenese

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