'Savvy Senior' Conservative IRA Portfolio Returns 16.4% In 2012

by: Steven Bavaria

The year 2012 turned out to be a good year for our "savvy senior" IRA portfolio, with a total return of 16.4%, of which almost half - or 8% - was from dividend income.

Readers of my other articles know that my goal is to focus as much as humanly possible on growing my portfolio's income stream steadily over time, since that's the cash flow that I plan to live on in retirement, and not to focus on short-term fluctuations in market value. In fact, decreases in the market value of the stocks, closed end funds, and other income earning assets that I own (or are on my target list for potential purchase) represent opportunities to (1) buy in cheaper and at a higher yield, and (2) reshuffle the portfolio by selling assets that have gone up in price and re-investing in assets that have dropped in price and represent a better relative value and yield.

I believe this strategy gives me an advantage over investors who focus mostly on changes in the market value of their portfolios, with current income being secondary. For example, someone who invested in the S&P 500 in 2012 would have had about the same total return as I did - 16% - but they would have received most of it (about 13%) in the form of capital appreciation and only about 3% in cash income. I would much prefer to receive 7 or 8% in cash income, knowing that if that were all that I received that year, I'd still be reasonably happy, and regard whatever market appreciation I receive on top of it as icing on the cake.

By keeping the focus on the cash income being generated by the portfolio, and relentlessly taking steps to grow it, this approach allows me to avoid fixating on the constant movement in market prices that attract the attention of our 24/7 news media and too many of our fellow investors. As I wrote late last year when the "fiscal cliff" malaise had many investors shaking in their boots, sometimes the best strategy can be to just "turn off the TV" (see article here).

As part of my income maximization strategy, I divide my portfolio into what I call "growth income" (lower yields - 4 or 5% - but potential for dividend growth over time) and "fixed income" (higher yields - 7 or 8% and up - with little or no prospect for future growth). As interest rates continued to come down and/or remain low throughout 2012, many investors stretched for yield by moving out the risk curve, pushing yields down on high yield bonds and other risk assets. As some of my "fixed income" investments - especially high-yield bonds - rose in price and dropped in yield, I took the opportunity to harvest those gains and re-invest in other assets with yields no greater but offering greater potential growth.

For example, I sold my Vanguard Corporate High Yield Bond Fund (MUTF:VWEAX), which I had owned for years, accumulating it when even the relatively conservative high-yield bonds it buys were yielding in the 7-8% range. Once its yield fell below 5% I figured it was time to take the profits (remember in an IRA I am indifferent to capital gains tax considerations) and reinvest in more attractive opportunities.

So I reinvested in utilities and infrastructure, like PPL Corp. (NYSE:PPL), Southern Company (NYSE:SO), Spectra Energy (NYSE:SE), AT&T (NYSE:T), Royal Dutch Shell (NYSE:RDS.B) and Pembina Pipeline (NYSE:PBA) which currently pay dividends equal to or greater than Vanguard's high-yield fund, but offer potential growth as well. I also rotated out of other high-yield funds, like closed end funds Wells Fargo Advantage Multi-Sector Income (NYSEMKT:ERC), MFS MultiMarket Income (NYSE:MMT), Eaton Vance Limited Duration Fund (NYSEMKT:EVV) and Eaton Vance Floating Rate (NYSE:EFT), and bought into closed end funds with higher yields, higher discounts and/or more growth potential, like Cohen & Steers Infrastructure Fund (NYSE:UTF), Reaves Utility Income fund (NYSEMKT:UTG), Duff & Phelps Global Utility Income Fund (NYSE:DPG) and Cohen & Steers Closed End Opportunity Fund (NYSE:FOF).

I also looked for other closed end funds that were still available at discounts and high yields, and was happy to see a number of equity funds from Eaton Vance that look very attractive from both perspectives, specifically Eaton Vance Tax Managed Buy Write (NYSE:ETV), Eaton Vance Tax Managed Global (NYSE:EXG) and Eaton Vance Tax managed Global Buy Write (NYSE:ETW), all of which I added to my portfolio late in the year and which have distributions in the 9-10% range. (Hats off to Seeking Alpha contributor Douglas Albo for putting me - and others - on to a number of these funds. See his article here.)

All the stocks and funds that I mentioned here, including the ones I sold, continue to be on my "target list" of investments I would rotate back into if their prices dropped and yields improved relative to other securities in the portfolio. One advantage of closed end funds for this sort of strategy is the relative inefficiency of the closed end fund market, where one's favorite funds can typically move up and down, along with their premiums and/or discounts, for reasons totally unrelated to the fundamental value of the stock (e.g. some investor may decide to sell a block for tax or estate planning reasons.) This can drive short-term traders and investors crazy, but doesn't bother long-term investors, who see the downdrafts as accumulation opportunities, and the updrafts as a chance to unload and rotate into an alternative investment.

In addition, as I have mentioned in earlier articles (here), closed end funds are one of the few opportunities that ordinary investors have to leverage their investments at margin interest rates available to large institutions (currently 1% to 1.5% if you read the literature of most leveraged closed end funds.) This can add another 1.5% to 2% to the yield on a closed end fund compared to a cash investment or the same holding in a non-leveraged open-end mutual fund. That's basically how I can earn 7-8% yields investing in assets that would only yield 5-6% if held in a non-closed end fund vehicle.

Finally, a word about "risk." Some readers will react to this and say, "How can you call this a 'conservative' portfolio? You have high yield bonds, equities…..and where are the Treasuries and other investment grade bonds that all the investment literature tells us should be in 'conservative' portfolios?" I'll address this in another article, but for now just remember: With interest rates at all time lows, when you buy a fixed rate bond all you're really guaranteeing yourself is: (1) a substandard yield for the 10, 15 or 20 year term of the bond, and (2) a huge capital loss if rates rise and you decide to sell it before maturity. So the choice for a conservative investor becomes: Which do I try to protect: (1) the income stream that I need to live on, or (2) the market value of that income stream? I made my choice. Worry about protecting (and growing) the income stream, not the theoretical value that the market puts on it.

Disclosure: I am long DPG, UTF, FOF, UTG, SE, SO, PPL, EVV, ETV, EXG, ETW, T, RDS.B, PBA. 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.