The Pure Logic of Income Investing

Investment portfolios perform best over the long term when cost based ( working capital) asset allocation is used to keep the investment management decision maker (the investor) focused on specific targets.

  • Important "secondary" considerations are strict selection quality, income generation and diversification rules plus reasonable profit taking targets for every security in the portfolio... the four great "investment risk minimizers".

So how does any of that apply to income investing?

Proper asset allocation divides the portfolio into two purpose defined "buckets" of securities: growth and income. The primary focus of the former is growth through profit taking on equity investments, and that of the latter is the generation and compounding of income. At least 40% of the portfolio's total working capital (the cost basis of all securities + cash) should be invested for income generation.

Typically, the older (or wealthier) a person becomes, the larger the income bucket target should be. Income investing can be sane, logical, intellectually pure, purposeful, manageable, predictable, and incredibly easy to understand. Yet, more investment mistakes are made in this area than in stock market investing... particularly as a result of using market value and/or total return performance evaluation.

  • Performance expectations for income purpose securities need to focus exclusively on income production... particularly when Closed End Funds are the investment vehicle of choice.

Most income securities represent some form of debt. One party has borrowed money from another and has agreed to pay back the debt at some future date, and to pay interest for the use of the money until the debt is repaid. Mortgages, preferred stocks, and most real estate are also considered income purpose investments. There are many forms of debt, and each will have a lawyer's dream of complicated provisions requiring schools of financial experts to understand thoroughly.

Fortunately, there is no need for investors to deal with this contractual messiness. It's enough to understand that debt securities are less liquid for trading than equities and that the "contractual" dividend or interest rates are generally "fixed". This fixed income feature leads to changes in market value when interest rate expectations move in either direction.... while the income remains the same. Yes, in almost all quality investment circumstances, the income will remain the same!

  • This in and of itself makes the use of "total return" analysis pretty much pointless when there are income purpose securities within a portfolio... so that's never, right?

Over one hundred years ago, open end mutual funds opened the markets to the masses. Years later, after self-direction of personal and corporate savings plans poisoned the "internal" fund management process, Wall Street developed a no-management-at-all breed of passive (unmanaged) investment products. ETFs first appeared in 1993, one hundred years after the first Closed End Funds (CEFs).

  • Interestingly, the sales pitch for indexed investing was the demonstrated failure of mutual fund managers --- simply ignoring the fact that managers must do what the shareholder "mob" dictates. "Mutual fund management" is, perhaps, the ultimate oxymoron.

School is still out on ETF investment products and, although they have captured the speculative zeal of the masses, aren't they managed by the same mob of non-professionals that repeatedly destroys the value of open end mutual funds? Neither vehicle, by the way, prepares adequately for the retirement income needs of investors.

CEFs hit the scene in 1893, twenty three years before the first mutual fund. If one selects thoughtfully, diversifies properly, and assesses the risks prudently, CEFs are inherently less risky than their passive ETF cousins.... for either asset allocation "bucket"... either are light years safer than individual security positions.

CEFs remain managed by investment professionals; they remain influenced by the same economic forces that have gyrated market prices since forever; they spit out monthly income at a rate far in excess of anything else on the entire Wall Street investment product menu. And perhaps most importantly, their NAV is not tinkered with periodically to produce a manufactured parity with share price.

Unlike ETFs and mutual funds, their price (theoretically) is tied to the demand for the skills of the manager and the inherent risk/reward assessment of the cash flow produced by the securities inside. The Net Asset Value (NAV) worshipped so ardently by ETF and mutual fund investors is allowed to follow interest rate cycles, equity, and credit market conditions, and economic realities.

  • CEFs are the only investment vehicles anywhere that frequently allow you to buy portfolios of securities, both growth and income purpose, at discounts to the portfolio Net Asset Value (net asset value being the total market value of the securities inside the portfolio)!

Most experienced investors know that investing is inherently a contact sport... passivity ( no "buy-sell-hold" decision making) doesn't grow the income generating power of an investment portfolio. That requires an understanding of what's inside, and an appreciation of how to trade securities and reinvest both income and profits to grow capital and increase income.

ETF and mutual fund portfolios are typically low income generators; few generate the kind of yields produced by managed CEF portfolios. ETFs and mutual funds these days, like individual equities, grow on speculative greed more than on expectations of improved fundamental values. Their inflated prices tend to disintegrate rapidly during market corrections... "working capital" is not a familiar concept to the average bulls and bears on Wall Street, and actual yield on investment is rarely mentioned in fund and ETF descriptive documents

  • Only CEFs recognize "yield on invested capital" as a valid investment concern. You can spend income folks, total return... not so much.

Inflated market values routinely, and repeatedly, get decimated as panic takes hold of inflated ETF and mutual fund prices and brings valuations back to fundamental realities... and there never was any "base income" to put a floor under declining security prices. Income focused portfolio building creates an environment where the income keeps on coming (growing even) during a "break" in market values.

CEF portfolio managers are professional investors who run their portfolios with an emphasis on the income that they generate. Yes, you can even find equity portfolio CEFs with bond-breaking yields. Of course there is market price volatility in the CEF marketplace... that's part of the magic, where lower prices = higher yields for adding to already owned securities to reduce cost per share while increasing yield on invested capital...

Where else in the income investing milieu can you buy more of previously issued corporate and municipal bonds, and government securities without a mark-up induced nosebleed? Just as surely as private, individually managed,
Investment Grade Value Stock portfolios should consistently outperform managed-by-the-mob equity mutual funds and ETFs cycle to cycle, income CEFs are a sure fire way to control portfolio "breakage" during cyclical market downturns.

  • CEF growth and income portfolios allow you to create an environment where you never have to sell securities to meet (non-emergency) expense needs during a general market downturn.

Wall Street would have us believe that market volatility is always a bad thing; that higher prices are always good and lower prices always bad; that passive speculation strategies using multiple ETFs can somehow hedge your "bets" and reduce your pain during downturns. Flattening the curve if you will, until the next upturn... with "Mad Portfolio Theory" on your side all the way.

  • Since when have bets and hedges become investment terms?

Closed End Fund investing keeps it much more simple. A just over a 7% annual income stream will double portfolio working capital (and hence your income) in about ten years... imagine how much better it can be when (like right now) yields on income CEFs are in the 8% to 9% range! And then, toss in some profit taking at half a year's interest in advance levels and the compounding of both income streams... all without the inherent risks and low yields of the stock market.

That being said, the equity (growth bucket) of a CEF portfolio can also be a powerful income producer with equally high yields and even more abundant reasonable profit taking opportunities. CEFs give you the opportunity to take advantage of volatility by buying selectively during the downturns, and selling for reasonable profits at every opportunity.... hmmmm

  • Trading diversified portfolios of income and equity portfolios can help you produce what I call a "Retirement Ready Income Portfolio", one where (except for unforeseen emergencies) you should be able to grow your spendable income quarter to quarter regardless of what is going on in the financial markets, by following just two manageable rules:
  • Have at least 40% of portfolio working capital in the income purpose asset allocation bucket from inception; as you approach retirement, reduce portfolio risk by increasing the income purpose asset allocation, and
  • Keep your regular distributions from the portfolio below 70% of the "base income" being produced.


Steve Selengut
Author of: "The Brainwashing of the American Investor"


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