By David Goodboy
"I just don't have enough money to start investing."
I often hear this statement from friends who are interested in investing in the stock market, but truly believe they don't have the capital to start. Many erroneously believe that you need a bare minimum of five figures just to dip your toe into the markets.
Some of these people are very knowledgeable about dividend reinvestment or savings strategies for their retirement, but are convinced they can't start investing since they don't have enough money.
Well nothing could be further from the truth.
It doesn't matter that you only have $1,000. The bottom line is the sooner you start investing, the better.
With proper management, sensible stock selection and consistent addition of capital over time, small accounts can easily grow into large ones.
Investors on a budget should look for investments that provide the best bang for their buck in terms of relative safety. This means low-priced, high-yielding securities. My rule of thumb is to stick with investments that cost less than $10 per unit or share if you want to maximize your portfolio.
Sometimes, it requires looking at unexpected places to find investment instruments best suited for small investors.
Investing through closed-end funds (CEFs) can provide the small investor an entry into the high-yield investing community at a low relative cost and higher safety margin than similarly priced investments.
Let me explain...
During the past three years, the average medium-term bond mutual fund returned 7% annually compared with more than 11% for CEFs, according to Standard & Poor's.
This is because CEFs issue a limited number of shares to trade on the stock exchange, while mutual funds can issue an unlimited number shares. In addition, CEFs can use leverage to boost returns, while regulations limit the ability of mutual funds to use leverage.
Most CEFs have a leverage ratio of 30%, which means the manager can borrow up to 30% of the fund's assets either from banks or by issuing preferred shares to buy more assets. For example, in today's ultra-low interest rate environment, managers are able to borrow at 1.3% and invest in bonds that yield 4%. The extra gain lifts the CEF's yield and total return.
And if you believe, as I do, that interest rates will stay low throughout 2013, then CEFs will likely continue to be strong performers.
Here are my two favorite low-priced, high-yielding CEFs for your consideration.
1. Aberdeen Asia- Pacific Income Fund
Aberdeen Asia- Pacific Income Fund (NYSE: FAX) is a CEF that invests in Australian, Korean and Indonesian bonds. It yields more than 5% and has returned more than 12% annually in the past five years. About 84% of the fund's assets are investment-grade government bonds, leaving the remaining 16% to higher-yielding, but a bit riskier bonds.
Fidelity Investments recently published the "2013 Global Bond Outlook," which lists low-beta emerging markets and structurally improving economies that have investment opportunities. These factors fit Aberdeen perfectly. The CEF just announced payment of monthly distribution, but warned that it distributed more than its income and capital gains, so some of the distributions may be a return of capital. This is important to keep in mind before investing. As you can see on the chart below, there can be tremendous volatility in CEFs. They are thinly traded and have sharp reactions to events. I like this CEF at the current price of about $7.75 a share.
2. ING Prime Rate Trust
The stated purpose of the ING Prime Rate Trust (NYSE: PPR) CEF is to seek high current income with capital preservation through investment in secured senior loans. It's leveraged at 28% and currently yields close to 7% with an expense ratio of about 1.7%.
The variable rate of the CEF adjusts every 30 to 90 days and is currently trading at about $6.66 a share. It suffered the same fate as Aberdeen with the election-related flash crash in November 2012, but has since entered a solid uptrend. Buying into the current uptrend makes technical sense right now.
Risks to Consider: These instruments are built on sub-investment-grade bonds, therefore they are very risky. They are also thinly traded, making them susceptible to flash-crash behavior as witnessed this past November. Always position size properly and use stops when investing.
The low-entry level prices combined with the high yields make these CEFs ideal tools for investors lacking substantial capital. However, it's critical to understand that in exchange for the high yields, comes correspondingly higher risks.
Having said that, I think these CEFs will continue to offer solid performance throughout 2013 and thus will make superlative investments, particularly for those with on a smaller investment budget.