In this volatile, slow growth market, dividends are one way to ensure your returns do not remain stagnant in the months and years to come. As investors seek more dividend income, a number of low quality closed-end funds are showing up in recommendations. Dividends are great but you do not want to couple them with price change loses. The downturn in price can blow up a great dividend investment in days. I avoid this by selecting the highest quality CEFs that pay monthly dividends and have a total return that beats the S&P 500 (NYSEARCA:SPY) index over the last year.
The S&P 500 is frequently used as a proxy for the full U.S. market and as an indicator of the economic health of the nation. The S&P 500 has taken a beating over the past 10 years, up only 2.7% on an annualized basis. The S&P 500 in mid-2011 is trading at the same level it hit in 1998.
You can think of the monthly distribution as a paycheck, so if you own 4 CEFs you receive 4 paychecks each month.
My CEF scan starts with monthly dividend CEFs that have a 1 year total return greater than SPY. Then, I use the Morningstar CEF rankings to omit any CEF rated 3 stars or lower.
Next, I weed out any CEFs selling at extreme premiums as some are selling at a 50% or more premiums to NAV today. The table above shows a select list of CEFs fitting these criteria.
As you can see, the higher yielding CEFs are trading at a significant premium to the lower yield CEFs. You should wait for a pullback in price before you enter these investments.
To invest in the lower yielding CEFs, you must think about total return as your objective rather than just dividend income. Having both total return and monthly dividends can increase you chances of not only beating the SPY but also of getting a double digit return over the next year.