Restructuring portfolios with income in mind
by Steve SelengutMr. Selengut is a private investor and a contributing editor to Advisor Magazine. He is the author of the book ‘The Brainwashing of the American Investor: The book that Wall Street does not want you to read.’ He can be reached at email@example.com.
Over the past six months, I’ve had at least a dozen conversations with consulting clients and CEF group members concerning the bind they are in trying to restructure their portfolios toward income production.
Most own high quality securities, maybe not perfectly diversified and clearly DRIP developed, but with as much as 50% of the market value in long term capital gain status. “How do I move to larger income production without incurring an enormous tax burden?” is their question.
My first experience with this phenomena occurred in the ’80s, when a new client arrived with his share of a generation skipping trust dominated by an 80% EXXON exposure! He had decided to change professions, build a new home, get a fancy car, etc., and every dollar spent produced tax liabilities requiring additional sales… just imagine the downward working capital spiral!
At the moment, we have perhaps the lowest LTCG rates ever, making the procedure proposed below particularly attractive. A 20% tax on gains offset by up to 10% in distribution income (or 6% tax free) softens the blow considerably, plus the compounding effect if there are years before retirement.
Upward Markets Bring Upward CEF Prices
This is true right now in all scenarios, even with minimal capital gains in the picture… never a better time to switch than when (CEF) prices are at their lows. The very same forces that move the markets upward in the future will, experience has taught us, bring CEF prices right along with them.
In each conversation, even with individuals in their forties and fifties, a diversified portfolio of high quality Closed End Funds was recognized as the path to their income target… particularly at current market levels.
Obviously, the longer the time to retirement, the smaller percent of the capital gains need to be realized each year to get the job done. But, in a correcting market, securities that will ultimately be sold for conversion to income production can also be sold for offsetting losses. Each year, you should aim to reduce the long term capital gain positions by about 25%… more if retirement is imminent.
So the next question, one that you are likely to be thinking, is this:
What can I do in my normal, day-to-day, portfolio management that will bring me to retirement without owing anything to Uncle from my personal portfolios?
Let No Reasonable Profit Go Unrealized
Well that’s pretty easy too. Let no reasonable profit go unrealized, ever, no matter what your broker or favorite guru is preaching or predicting. So long as there are plenty of qualified securities to reinvest in, any profit is “reasonable”. With CEFs producing between 6% and 12%, mostly monthly, about 15% quarterly, very few pay as much as 1% per month. So…
When you have a qualified selection universe of 45 Tax Free, 125 Taxable, and 100 Equity CEFs with an average yield around 9% (September 16th, 2022), any profit between 1% and 3% becomes reasonable, one or two issues a day per portfolio. Inch the target up during rallies, but always take 5% or more if you can get it. There will still be plenty to buy.
This approach will accelerate your income and working capital growth significantly. AND (a very big and), all of your capital gains taxes will be paid out every year, giving you full ownership of your investment portfolio come retirement… and there is no such thing as bad profit. One more thing.
As fear takes over from greed during corrections, most investors are slow to add capital to their portfolios… call it investor nature. So change your perspective and consider anything above breakeven as an opportunity to infuse new capital into your portfolio for reducing cost basis/increasing yield in the old holdings and establishing potentially quick turnarounds in some new ones.