Submitted by The Investment Shadow
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I've heard a lot of discussion lately, pressing the idea that rising interest rates are something to be feared, and prepared for by: accepting the lower rates now, buying the shortest duration positions, or even liquidating the income portfolio entirely.
Who's Afraid of Higher Interest Rates?
A rising interest rate environment is super good news for investors... up to a point. When we loan money to someone, is it better to get the lowest possible rate for the shortest period of time? Stop looking at income investing with a "grow the market value" perspective. That's not what it's all about. Lower market values or growing discounts to NAV don't have to be problems... they can be benefits.
The purpose of income investments is the generation of income. YOU are NOT a bond trader. Control the quality selected, diversify properly, and compound that part of the income that you don't have to spend. Price is pretty much irrelevant with income purpose securities; you don't spend the market value.
Long, long, ago, many bonds were of the "bearer" variety; my father never owned any others. Each month, he went to the bank, clipped his coupons, cashed them in, and left the bank with a broad smile. If interest rates went up, he knew he could go out and buy new bonds to put larger coupon dollars in his pocket.
He had no reason to even consider selling the bonds he already owned --- they were, after all, income purpose securities that (in his experience) never failed to do their job. Market value never fluctuates (visually) if the securities are kept in the (mental) safe deposit box.
No, that's not at all what I'm recommending... And, even when your brokerage statement shows that your bond prices have risen to chest-pounding wealth levels, just try to convert those numbers into spending money. Despite the profit-taking-temptation your statement reports, the bid you get on your smallish positions is never even close to the "insider" market value...
The thing dear old Dad thought about least was the market value of his bonds. This was his tax free retirement plan. He bought them for income, and the coupons were always redeemed without question. The only problem (actually, no longer a problem) with the periodic decreases in market value was the inability to add to existing positions. The small position bond market has limited liquidity.
Before I move on to the simple solution to this non-problem, a word or two on the only real benefit of lower interest rates --- there is no benefit at all if you don't already own individual, income producing, securities. If you own interest rate expectation (IRE) sensitive securities in a downward interest rate cycle, you will have the opportunity for what I call "income-bucket-gravy".
This is the opportunity to sell your income purpose securities at a profit, over and above the income you've already banked. Income investors rarely are advised to do this, which is why they lament the thievery occasioned by higher interest rates. They didn't sell at a premium, so now they just sit and watch the premiums disappear.
The only thing this behavior accomplishes is bestowing on investors the lowest possible yields while pushing them into an overpriced market for short duration debt securities. A gift that keeps on stealing investor profits.
The solution is simple, and has been used successfully for decades.Closed End Funds (scoff, laugh, and say "leverage makes them volatile" all you like) solve all the liquidity and price change problems... in a low cost, much higher income, environment.
Answer me one question before you throw stones at these remarks. Is 7% or more on a diversified, transparent, income portfolio, compounded over the past ten years and still growing income, better or worse than the 3.5% or less that most investors have realized in individual securities during the same time period... and then there are the profits that non-bond traders seldom realize can be realized.
Of course CEF market values fell during the financial crisis (the 3nd greatest buying opportunity ever), but at their peak in November 2012, they had gained nearly 65% since March 9, 2009, or 17.7% per year.... nearly outperforming the S & P 500.
But speaking of "drawdowns", what do you think the economic activity drawdown of near zero money market rates has been, particularly for "savings account" Baby Boomers. Did the Fed's messing around with short term interest rates help or hurt your retired relatives... really, think about it.
Rising interest rates are good for investors; so are falling rates. Fortunately, they routinely move in both directions, cyclically, and now can be traded quickly and inexpensively for exceptional results from a stodgy old income portfolio. So much for Total Return, short duration, and leverage-phobic thinking.
What if you could buy professionally managed income security portfolios, with 10+ years income-productive track records? What if you could take profits on these portfolios, say for a year's interest in advance, and reinvest in similar portfolios at higher yields? What if you could add to your positions in all forms of debt securities when prices fall, thus increasing yield and reducing cost basis in one fell swoop?
What if you could enter retirement (or prepare for retirement) with such a powerful income engine? Well, you can. but only if you are able to add both higher and lower interest rates to you list of VBFs.
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