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Managing the Income Portfolio - 201

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Controlling, or Implementing, the Investment Plan will be accomplished best by those who are least emotional, most decisive, naturally calm, patient, generally conservative (not politically), and self actualized.

Investing is a long-term, personal, goal orientated, non-competitive, hands on, decision-making process that does not require advanced degrees or a rocket scientist IQ. In fact, being too smart can be a problem if you have a tendency to over analyze things. 

The first step is to calmly establish guidelines for selecting securities, and for disposing of them. 

For example, limit equity selections to Investment Grade Value Stocks: NYSE, dividend paying, profitable, and widely held companies.

Don’t buy any stock unless it is down at least 20% from its 52-week high, and limit individual equity holdings to less than 5% of the total portfolio. Take a reasonable profit (using 10% as a target) as frequently as possible. With a 40% income allocation (the average in MCIM portfolios), 40% of all profits and dividends would be allocated to income purpose securities, assuring long term income growth. 

For fixed income, focus on investment grade securities, with above average but not “highest in class” yields. With variable income securities, avoid purchase near 52-week highs, and keep individual holdings well below 5%. Individual Preferreds, Bonds, and pretty much all other should be acquired using income CEFs, and these positions should also be kept below 5%.

Take a reasonable profit (more than a years’ income for starters) as soon as possible. With a 60% equity allocation, 60% of profits and interest would be allocated to stocks, thus assuring that the equity bucket is not ignored. 

Monitoring Investment Performance the Wall Street way is inappropriate and problematic for goal-orientated investors. It purposely focuses on short-term dislocations and uncontrollable cyclical changes, producing constant disappointment and encouraging inappropriate transactional responses to natural and harmless events.

Coupled with a media that thrives on sensationalizing anything outrageously positive or negative (Google and Enron, Peter Lynch and Martha Stewart, for example), it becomes difficult to stay the course with any plan, as environmental conditions change. First greed, then fear, new products replacing old, and always the promise of something better when, in fact, the boring and old fashioned basics still get the job done.

Remember, your unhappiness is Wall Street’s most coveted asset. Don’t humor them, and protect yourself from their Elm Street products. Base your performance evaluation efforts on goal achievement… yours, not theirs.

Here’s how, based on the three basic objectives we’ve been talking about: Growth of Base Income, Profit Production from Trading, and Overall Growth in Working Capital. 

Base Income includes dividends and interest produced by your securities, without the realized capital gains that just may be the larger number much of the time. Your long-range comfort demands regularly increasing income, and by using your portfolio working capital as the benchmark, it’s easy to determine the destination of accumulating "smart cash".

With a portion of every income dollar reallocated to income production, you are assured of increasing the total annually. If market value is used for this analysis, you could be pouring too much money into a wrong, albeit falling, bucket to the detriment of your long-range objectives.

Profit Production is the happy face of the market value volatility that is a natural attribute of all securities. To realize a profit, you must be able to sell the securities that most investment strategists (and accountants) want you to marry up with.

Successful investors learn to sell the ones they love, and the more frequently (yes, short term), the better. This is called trading, and it is not a four-letter word. When you can get yourself to the point where you think of the securities you own as high quality inventory on the shelves of your personal portfolio boutique, you have arrived.

You won’t see Wal-Mart holding out for higher prices than their standard markup, and neither should you. Reduce the markup on slower movers, and sell damaged goods you’ve held too long at a loss if you have to, and, in the thick of it all, try to anticipate what your standard, Wall Street account statement is going to show you: a portfolio of equity securities that have not yet achieved their profit goals and are probably in negative Market Value territory.

 As any good retailer would, you’ve sold the winners and replaced them with new inventory, compounding the earning power. Similarly, you’ll see  trading opportunities within your diversified group of income purpose CEFs, knowing that lower price/higher yield opportunities are likely as interest rates eventually move back to normal levels. 

If you see large green amounts on your statements, you are not managing your portfolio productively. 

Working Capital Growth (total portfolio cost basis) just happens, and at a rate that will be somewhere between the average return on the income securities in the portfolio and the total realized gain on the equity portion of the portfolio. It will actually be higher with larger equity allocations because frequent trading produces a higher rate of return than the more secure positions in the Income allocation.

BUT, and this is too big a but to ignore as you approach retirement age, trading profits are not guaranteed and the risk of loss (although minimized with a sensible selection process) is greater with equities and Index ETFs than it is with income CEFs. This is why the asset allocation moves from a greater to a lesser equity/ETF percentage as you approach retirement. 

So is there really such a thing as an income portfolio that needs to be managed? Or are we really just dealing with an investment portfolio that needs its asset allocation tweaked occasionally as we approach the time in life when it has to provide the yacht… and the gas money to run it?

By using cost basis (Working Capital) as the number that needs growing, by accepting trading as an acceptable, even conservative, approach to portfolio management, and by focusing on growing income instead of ego, this whole retirement investing thing becomes significantly less scary.

So now you can focus on changing the tax code, reducing health care costs, saving Social Security, and spoiling the grandchildren.

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