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Long only, closed-end funds, deep value, long-term horizon
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The results are in on my own IRA portfolio for 2011. Having subjected readers to several articles on my investing philosophy throughout the past year, let me now share the results and analyze how I did.

In 2011 the overall return on my IRA was – drum roll, please – a positive 7.8%. While that doesn’t knock anybody’s socks off, it seems like a pretty reasonable result in a “new normal” environment where the broad market S&P 500 (NYSEARCA:SPY) and Wiltshire 5000 indices were both essentially flat for the year, in terms of capital appreciation, and earned about 2% if you include dividends. The Dow Jones Industrial Average (NYSEARCA:DIA), which is higher-yielding than either of the broad S&P or Wiltshire indices, did much better than the Wiltshire and the S&P 500, and slightly better than I did, earning a total of 8.2%, of which 5.5% was capital appreciation and 2.7% was dividend income.

Of my 7.8% overall return, 7.5% of it was from cash income – dividends and interest – and only 0.3% was from capital appreciation. One could say that I didn’t do a very good job picking winners if all I got was 0.3% in capital appreciation. On the other hand I slept pretty well knowing that my assets were going to churn out 7.5% in income regardless of how the market valued them while they were doing that. Someone who invested in the Dow Jones Industrials, for example, would have earned 0.4% more than I did, but with only 2.7% of it coming from dividends, they had to endure a lot more of a white-knuckles ride throughout the year to earn that extra increment. I would prefer to know, as I start the year, roughly what income (i.e. hard cash dividends and interest) I can look forward to, and that regardless of whether the market value of my portfolio goes up or down, there is a foreseeable income stream that is largely fixed. For me, capital appreciation is the icing on the cake. Dividends and interest are the cake itself.

That sets me up for a bit of a “win-win” regardless of which way the market goes. If my holdings go up, as they did – slightly – this year, then I can enjoy the warm feeling we all get when our investments appreciate. But if they go down, then I can reinvest my earnings at an even higher yield, since I’m buying more of the same investments I already own, but at a lower price, thus improving the incremental yield on the whole portfolio. The key to this entire approach is not to focus on what my assets are worth – which is an arbitrary value that is set and reset every day by a not always rational market – but rather to concentrate on what income the assets are generating, and to work to constantly increase that income stream by re-investing and re-balancing from assets that may seem temporarily high (and whose yields have correspondingly dropped) to assets that may have temporarily dropped (and whose yields are correspondingly higher.) I described this investment goal and philosophy in an earlier article.

Of course, I’m looking for some growth as well as high yields, since – as a 64-year old retiree with kids still in school and parents and grandparents who lived into their 90s – I plan (or at least, I hope) to live on my investments for another 25-30 years. To that end, I divide my portfolio into what I call “growth income” holdings and “fixed income” holdings. I will settle for a lower current return – 4% or 5% – on the growth income holdings because I also expect the dividends to grow over time, adding an additional 4%-5% or sometimes more to my overall return. The fixed income holdings are investments on which the coupon or dividend is high enough – typically 7% or 8% and up – that I am content to just receive it – with no anticipated increase – indefinitely.

Here are my most significant current holdings, grouped by “growth income” and “fixed income.”

GROWTH INCOME

Yield Price performance (last 52 weeks) 12 Mo. total return (Yield + Price perf.)
AT&T (NYSE:T) 5.8% 6.4% 12.2%
Verizon (NYSE:VZ) 5.1% 10.0% 15.2%
Royal Dutch Shell (RDS/B) 4.6% 2.2% 6.9%
Seadrill (NYSE:SDRL) 8.2% 4.3% 12.5%
Cohen & Steers Closed End Opportunity Fund (NYSE:FOF) 8.4% -6.6% 1.8%
Reaves Utility Income Fund (NYSEMKT:UTG) 6.0% 14.4% 20.4%
SPDR Index Int'l Dividend ETF (NYSEARCA:DWX) 7.0% -16.3% -9.4%
First Trust Specialty Finance Oppty Fund (NYSE:FGB) 9.4% -15.2% -5.8%
Tortoise MLP Fund (NYSE:NTG) 6.3% 5.0% 11.3%
SPDR Utilities ETF (NYSEARCA:XLU) 3.9% 9.83% 13.8%
Vanguard Hi-Div Yield (MUTF:VHDYX) 3.2% 10.4%

FIXED INCOME

Yield Price performance (last 52 weeks) 12 Mo. total return (Yield + Price perf.)
Vanguard Hi-Yld Corporate Bond Fund (MUTF:VWEAX) 6.2% 7.2%
Third Avenue Focused Credit Fund (MUTF:TFCVX) 8.4% -4.6%
Pimco Income Oppty Fund (NYSE:PKO) 8.4% 0.6% 9.0%
Eaton Vance Limited Duration Fund (NYSEMKT:EVV) 8.1% -3.0% 5.2%
ING Prime Rate Fund (NYSE:PPR) 6.6% -10.4% -3.8%
BlackRock Floating Rate Strategies Fund (NYSE:FRA) 6.8% -9.7% -2.9%
Eaton Vance Floating Rate Income Trust (NYSE:EFT) 6.8% -10.7% -3.9%
Blackstone GSO Floating Rate Fund (NYSE:BSL) 6.9% 5.2% 12.2%
Annaly Mortgage (NYSE:NLY) 13.9% -7.6% 6.3%
Consolidated Communications (NASDAQ:CNSL) 8.4% -0.32% 8.1%

The tables list the current yield, the last 12-month price movement, and – putting both together – the total 12-month return. (Obviously this is not exact to the penny, since yields change as the price changes, but it’s close enough to allow us to see basically what the total return is, and where it has come from in terms of cash income and capital appreciation/depreciation. Open-end funds, of which there are three, two Vanguard and one Third Avenue, only publish yield and total return, without breaking out market price movement separately.)

Some of the assets, like the floating rate loan closed-end funds, show losses for the year as a whole. I’m a big fan of loan funds, particularly the closed-end variety, but you have to watch them closely in terms of the relationship between their net asset value and their market value. Many loan funds appreciated earlier in the year and sold at premiums just before the market correction in August. By the fall they were back at a discount and a terrific buy, as I pointed out at the time.

I bought the SPDR International Dividend Index (DWX) midway through the year as a way of betting that good-quality international stocks were down more than they should have been because of excessive pessimism about prospects in Europe. My own position just turned positive, in terms of price appreciation, this week and is paying me a 7% dividend while I wait to see how it plays out.

Note that some of the holdings labelled “Growth Income,” like Seadrill or the Cohen & Steers Closed-End Opportunity Fund, yield more than some of the “Fixed Income” holdings. But the rationale for putting them in one category or another is not how much they yield, but whether there is a reasonable expectation that their dividend will grow over time. Obviously if a company has a high yield and the prospect for growth, that’s ideal. Most of the holdings in the fixed-income category are high yield bond or loan funds, as one might expect. The equities in this category are stocks like Annaly and Consolidated Communications, with dividends that are high but unlikely to grow (and in Annaly’s case, is likely to move around a lot over the long term.)

Currently my portfolio is divided between “fixed income” and “growth income” in a ratio of 70% fixed and 30% growth. Both categories provide “growth” to the portfolio, but in different ways. I look to the fixed income holdings to provide growth by throwing off excess income above what a reasonable pension distribution would be. If, for example, it were reasonable to pay myself 4% annually as income from my portfolio, then the fixed-income portion of my holdings that was earning a current yield of, say, 8%, would be contributing to the growth of the portfolio by the excess 4% (8% earned minus 4% spent) that was being re-invested. The growth-income portion of the portfolio that was earning a current coupon of only 4%-5% (and therefore not throwing off much excess current income to be re-invested) would have to contribute to growth by growing its dividend stream over the years.

Either one is a legitimate source of growth, and I don’t feel the need to maintain a rigid formula of so much growth and so much fixed. I’d rather be opportunistic about which assets are available at favorable prices throughout the year. As suggested above, a fixed-income asset with no prospect of growth can still provide plenty of growth to a portfolio if you buy it at a price to yield enough to plow sufficient current earnings back into the portfolio to compound at an attractive rate. Likewise a high-growth asset that is priced so high that its yield doesn’t carry its weight in the portfolio and has to be subsidized by some other slower growth asset is not necessarily going to contribute as much to portfolio growth in the long term.

(Anyone with questions or comments or the desire to discuss any specific holdings or ideas, make a comment or send me a message and I’ll be happy to respond.)

You call this conservative??!!#%&!!?? I know what some of you are thinking. How can he call this a conservative IRA portfolio? There are no government or investment grade bonds, but lots of high-yield bonds and loans, MLP and other closed-end funds that can be thinly traded and move around a lot. How does he expect 60-plus year old retirees to hold this portfolio and sleep at night?

Those are good questions. The answer is that you have to decide what is worth worrying about. Should I worry about what my portfolio is “worth,” that is, how it is valued on a given day by the market place? Or should I worry about what level of income it is providing me, and whether that income can be sustained and grown throughout the next 10, 20 or 30 years? I manage the income production capability of my portfolio, and don’t worry quite so much about how much the market values the assets producing the income. For example, if you put together a well diversified portfolio of stocks and funds that provided you a steady stream of dividends worth, say, $100,000 per year, what would it matter if at the beginning of the year the assets generating that stream were worth $1,400,000, but three months later they had dropped to $1,300,000? The important thing is whether the income stream remains intact. You could even argue you are better off if you can re-invest the portion of your income that you don’t spend back into the market when it is at a lower price. So for me, the key is to continue to work on re-investing and re-balancing that portfolio to increase that income stream year-by-year. The assets only have value to me as the producer of that income stream.

Somebody who focuses all his or her attention on maintaining the value of the assets, perhaps by putting them in Treasuries or short-term government and investment grade bonds, will always be able to predict what his assets will be worth, but the price of that certainty is he will have relatively little income. So which is safer, ensuring the value of your income stream, or ensuring the value of your assets? (See my heretical articles on the inability of bonds to provide the safety and security to a portfolio that they once did.

Source: Results Are In For 2011: 7.8% Return On Conservative IRA Portfolio