'Savvy Senior IRA Portfolio' Earns 14.9% For 9 Months

 |  Includes: DPG, EMO, ERC, FOF, MMT
by: Steven Bavaria

As part of my policy of "putting my money where my mouth is" as a financial writer, I am pleased to report that my "savvy senior" IRA portfolio earned a total return of 14.9% for the nine months ending September 30. This compares with a total return (dividends plus price appreciation) of 12.2% on the Dow Jones Industrial Average and 16.4% on the S&P 500 for the first three quarters.

Total returns (9 months to 9/30/12):

  • "Savvy senior" IRA14.9%
  • Dow Jones Industrial Average12.2%
  • S&P 50016.4%

Although I am happy that my return compares well with these two indices, it is well to remember the wise words of a recent reader of my "How Savvy Seniors Beat Hedge Funds" article, who cautioned me not to "confuse a bull market with brains." For that reason I continue to take with a grain of salt the capital appreciation component and focus mostly on the actual cash return. My IRA portfolio currently yields 6.8%, which means that about 5.1% (i.e. 9/12ths of 6.8%) of the 14.9% nine-month total return was actual cash received, with capital appreciation (i.e. paper profit) of almost 10% accounting for the remainder. (The 6.8% "yield" is a little fuzzy, since it includes some closed end fund return-of-capital that may - or may not - actually represent current income. See below.)

As a long-term IRA investor, my main focus is on growing the actual income (i.e. yield or cash flow) from the portfolio. While income is up by about 16% from a year ago, most of it is NOT as a result of internal growth in the yield of the actual securities (i.e. my securities did NOT increase their dividends by 16%), but rather from a conscious decision to switch over to a higher-yielding portfolio. I have gradually been shifting the portfolio mix from what I called "growth income" (lower yields, higher growth potential) to "fixed income" (higher yields, but little growth potential). I still hold both types, but now I am skewed more to the fixed income side, with 63% of my current income coming from "fixed income" securities, and 37% coming from "growth income" stocks.

In switching from lower yielding but theoretically faster-growing stocks to higher yielding and slower-growing securities (stocks and bonds) I am taking a calculated risk that the extra current income, all of which I am re-investing in the portfolio (since I have not begun withdrawals from my IRA), along with whatever modest capital appreciation I get, will equal or exceed the total return I'd receive from a possibly faster growing but lower yielding portfolio.

So far it has paid off in the sense that while my current yield (6.8%) is considerably higher than the yields of the Dow Jones Industrials (2.9%) and the S&P 500 (2%), I haven't had to pay a penalty in terms of lower total return in order to enjoy the security that comes from having such a higher yield. But success (or luck) creates its own challenges in long-term investing, as the run-up in market value has made some of my current holdings - especially the "fixed income" ones - a bit pricey to be attractive re-investment vehicles for new money.

If you scan the list of my current holdings (below), this will become apparent. My biggest holding, the Vanguard High Yield Corporate Bond Fund, is a great example. This has been a wonderful long-term investment, returning a strong equity-like 17.8% return for the past year, and 12.1% for three years and 8.5% for 10 years (not bad given that the crash occurred during that period!) But the price appreciation has driven the yield down from the 7% and higher of a few years ago to 4.8% currently. My unofficial dividing line between candidates for my "fixed income" portfolio and my "growth income" portfolio is about 5%. If I'm going to make less than 5% on a holding, then I want there to be likely growth in the dividend stream of another 3-5% or more, bringing the total return prospects up to a minimum of 8%. For my "fixed income" portfolio candidates, where I don't expect any additional growth, I like to see a current cash yield of 6% to 8% and higher. The goal is that, all together, this will result in a long-term portfolio return in the 8% range.

Security Symbol Yield % of total income Growth Income or Fixed Income
Vanguard High Yield Corporate Bond Fund VWEAX 4.80% 11.2% Fixed
Nuveen Credit Strategies Fund JQC 8.2% 9.5% Fixed
Third Avenue Focused Credit Fund TFCIX 6.2% 7.0% Fixed
Eaton Vance Limited Duration Fund EVV 7.4% 6.2% Fixed
Cohen & Steers Infrastructure Fund UTF 7.9% 6.1% Growth
Cohen & Steers Closed End Oppty Fund FOF 8.0% 5.5% Growth
Reaves Utility Income Fund UTG 6.2% 5.5% Growth
Wells Fargo Advantage Multi Sector Income ERC 7.4% 4.5% Fixed
MFS MultiMarket Income Trust MMT 7.0% 4.2% Fixed
Duff & Phelps Global Utility Income Fund DPG 7.6% 4.1% Growth
Clearbridge Energy MLP Opportunity Fund EMO 6.4% 3.5% Growth
ING Prime Rate Trust PPR 6.3% 3.2% Fixed
Annaly Capital Management NLY 12.9% 3.1% Fixed
Calamos Convertible & Hi Income Fund CHY 8.1% 3.1% Fixed
First Trust Specialty Financial Oppty Fund FGB 8.2% 2.9% Growth
Calamos Global Dynamic Income Fund CHW 8.2% 2.9% Fixed
Windstream Corp. WIN 9.9% 2.5% Fixed
Royal Dutch Shell PLC RDS.B 4.82% 2.3% Growth
Vanguard High Dividend Yield Index Fund VHDYX 3.2% 2.1% Growth
Pimco Income Oppty Fund PKO 7.5% 2.0% Fixed
Seadrill Ltd. SDRL 8.2% 1.4% Growth
Fidelity High Income Fund SPHIX 4.9% 1.3% Fixed
Eaton Vance Floating Rate Income Trust EFT 6.1% 1.2% Fixed
Kinder Morgan Management LLC KMR 6.4% 1.1% Growth
Kinder Morgan Management Inc. KMI 3.9% 1.0% Growth
Enbridge Energy Mgmt EEQ 6.9% 0.9% Growth
Consolidated Communications CNSL 9.0% 0.9% Fixed
Nuveen Floating Rate Income Oppty Fund JRO 7.1% 0.5% Fixed
Conoco Philips COP 4.6% 0.3% Growth
Fidelity Telecom & Utilities Fund FIUIX 3.8% 0.2% Growth
Petroleum & Resources Corp. PEO 1.5% 0.03% Growth
Click to enlarge

So I'll be lightening up on Vanguard HY Corporate Bond Fund. Similarly the Fidelity High Income Fund, another high-yield bond fund whose own success has now made it less attractive for new money. Third Avenue Focused Credit Fund is another one I'm keeping an eye on. Its 6.2% yield is right on the border of what I consider acceptable for a "non-growth" holding. But the Third Avenue team has stated its intention for this fund is to find turn-around and distressed situations (and the firm has a bit of a track record in that regard), so I'm hoping the fund will provide some ongoing capital gains along with its 6% dividend, and so far it has.

My other high-yield bond funds - Wells Fargo Advantage Multi-Sector (NYSEMKT:ERC) and MFS MultiMarket (NYSE:MMT) - are closed-end funds. They have not run up in price as much as some of the larger open-end high-yield bond funds, so they still provide reasonable yields, especially with the extra boost of leverage that closed end funds can avail themselves of during this time of Fed-guaranteed low borrowing rates. (For more info see here)

The two Calamos funds (CHY and CHW) hold high-yield bonds as well as other assets like equities and convertible securities, so what I've labeled as "yield" actually contains some capital gains and other occasional return of capital as well. That is something to be monitored on all closed-end funds, to be sure that any so-called "capital gains" being returned to stockholders are actually being earned. In many cases - like Clearbridge Energy (NYSE:EMO) and other MLP funds, or funds like Cohen & Steers Fund of Funds (NYSE:FOF) and Duff & Phelps Global Utility (NYSE:DPG) that own MLP and similar funds - I regard the distributions as mostly representing actual "yield" although they are legally returns of capital, which is how MLPs and similar business structures avoid making taxable distributions. So it is sometimes hard to determine what is a truly dilutive, value-destroying "return of capital" and what is virtually current yield but in a different name.

However one slices and dices one's portfolio, clearly it is more challenging to find attractive re-investment opportunities, whether growth income or fixed income, than it was a year ago. That's why portfolio appreciation (paper profits) are a mixed blessing to long-term investors who are focused on building a permanent income stream, rather than just maximizing the total value of their portfolio. In general, if I have to "overpay" for yield, I'd rather pay up for dividend growth investments (what I call "growth income") where at least you have a chance over the medium to longer term of the investment growing into more of a bargain. If you overpay for a "fixed income" security, where the upside is fixed, you can never recoup your premium price.

As an IRA investor who doesn't have to worry about short-term taxes on gains and losses, I will continue to manage my portfolio so as to maximize the current cash income, trading out of assets that seem to be up more than usual and replacing them with assets whose income stream seems solid but are temporarily out of favor with the market. Inefficient markets, like closed-end funds, will undoubtedly continue to provide opportunities to smaller investors to do that, which are not available to large institutional players.

Disclosure: I am long JQC, EVV, UTF, FOF, UTG, ERC, MMT, DPG, EMO, PPR, NLY, CHY, FGB, CHW, WIN, PKO, SDRL, EFT, KMR, KMI, EEQ, CNSL, JRO, COP, PEO, RDS.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.