1. HOW CAN CMA PROVIDE AN INCOME PORTFOLIO AT 8% WHEN CDS, MONEY MARKETS AND US GOVERNMENT BONDS ONLY PAY 0-3%?
Each of the securities in the Portfolio are selected to provide a "long term" fixed income stream. CDs and money funds are typically short term maturities, and rates keep getting reset lower whenever interest rates fall like they are now doing at banks. The securities we use have much higher cash flow yields because the common stocks are distributing their income as dividends, and it is higher in percentage terms than CDs pay. The bonds and preferred stocks used are originally issued at committed fixed coupon and dividend rates of from 6 to approximately 10%, so an average current yield from these of approximately 8% is just normal for these securities. The issuers are prominent companies: CBS, JC Penney, Disney, Ford, Goodyear, Sprint and many others. (Current yield of 8% income representation means that when the portfolio is purchased for a client account, the custodian states the anticipated "Estimated Annual Income" to be received from the investment holdings, as calculated from the past 12 month of income collections recorded from each security's income payment history. The "percent value of income yield" is determined by dividing the Estimated Annual Income by the Current Market Value of the portfolio holdings).
2. WILL THIS PORTFOLIO ACCOUNT FLUCTUATE IN VALUE, LIKE THE STOCK MARKET DOES?
This portfolio account has up to 30% of its assets in common stocks, and each have high dividend yields. These stocks are usually sought out and held by long term income investors. This is unlike growth stocks that fluctuate a lot more from investors, traders and mutual funds moving in and out of growth stocks based on the latest rumor, news release or earnings report. The high yield common stocks that we use typically have predictable business income streams, from stable predictable businesses like utilities, energy companies, major banks and commercial real estate companies. So, only a little less than one-third of portfolio assets are in common stocks, hence low stock market fluctuation risk across the entire portfolio.
3. I AM A LONG TERM INVESTOR, RETIRED, AND NEED HIGH INCOME BEYOND A 1-2% RETURN NOW ON CDS, WILL YOUR RATES GO DOWN?
Rates would only go down if the 30% of assets held in the common stocks have their dividends cut by the issuer companies. But, the mantra of corporate America is to raise dividends over long periods of time, not reduce them, even if interest rates fall on say CDs. In fact, when interest rates are low, like they are now, many companies that use some debt in their financial structure get the benefit of lower borrowing costs, which grows profits and can cause the dividend on their common stock to be hiked. Regarding the remaining 70% of assets in the portfolio, these are bonds and preferreds that have fixed contracted dividends and coupon interest rates fixed for the entire life of the securities 10, 20, 30 years or more. So, if short term CD rates go down, preferred share and bond interest rates stay pegged at their fixed rates.
4. IS THIS PORTFOLIO ACCOUNT LIKE A BOND MUTUAL FUND?
This account is not a bond fund. Each client has his/her own individual securities account, a "separate account" with 50 or more securities (common stocks, preferreds and bonds) as holdings in the account. GreatBanc Trust Company and the SEI Trust Company maintain each account on their books. They collect all the income receipts on the securities and credit them to the account. This income accumulates in the money market fund within the account, and is then either distributed out to the client at their request, or reinvested periodically into more high income securities. Unlike a "bond mutual fund", the Trust Company Custodian states an "Estimated Annual Income" amount that the portfolio should earn over a one-year time period. This Estimate is compiled from the dividend and interest payment history on the securities in the account for the past 12 months.
5. WHAT HAPPENS IF I JUST WANT TO LIQUIDATE OR MOVE THE ACCOUNT?
If one wishes to liquidate an account, it is pretty simple. CMA will sell all the holdings on the NYSE or other public exchange at competitive pricing and all the proceeds can then be remitted to the client as a check from the trust company or wire transferred. It takes 3 business days to do this. Also, all the securities are "portable" meaning that they can be held in any other type of securities account at a brokerage or trust company. Securities are moved all the time in the industry at the request on the account holder. It is called an "in-kind" securities transfer.
6. WHAT ARE THE INCOME TAX ISSUES ON YOUR PORTFOLIO ACCOUNT?
All of the dividends earned on “qualifying common stocks” are taxed at about half the typical federal income tax rate that applies to "interest income" today. The income from non-qualifying commons, preferreds and bonds are taxed as ordinary passive income...similar to CD interest. If the person using this portfolio is not interested in spending the interest income each year, it would be desirable to place this portfolio within a tax-deferred IRA, ROTH IRA or Qualified Plan account, and not have it taxed annually, even though the interest and dividend income is left in the account to be re-invested.
7. CAN THIS BE USED FOR GROWTH INVESTING, SIMILAR TO STOCKS FOR THE LONG TERM?
We recall that over the years, statistics say that common stocks historically generate an average of about 10% annual returns compounded. Well, if this portfolio can predictably generate a 8% Iin Estimated Annual Income and one leaves the income in the account for reinvestment, then "yes" this can be a growth investment strategy as the re-investment of income is buying more and more income securities.
8. I AM AN EXISTING CLIENT OF CMA, HOW WOULD YOU ADVISE ME USING THIS PORTFOLIO?
A lot of times our clients like to be a part of the "asset allocation" process, that means how much of their account funds are put into growth stocks, income real estate securities, conservative fixed income, or near-cash money market. This portfolio gives them a good choice, an alternative, to invest either a small, moderate or large portion of their assets with us in a relatively stable high income portfolio account. The other client assets can then be focused on a different strategy desired by the client like: short term trading, growth, balanced or capital preservation. Also, this new portfolio has a low fee cost compared to other more actively managed account strategies...so investment cost is reduced, which can increase net return, after-fee return.
9. WHAT ARE PREFERRED AND REIT STOCKS, I KNOW WHAT BONDS AND COMMON STOCKS ARE?
Hundreds of companies today are issuing preferred shares that are senior debt obligations to the company’s common shares and these have "fixed contracted" dividends. The dividend will not be hiked or lowered for the full term of the security. Debt rating agencies count these as equity capital of the company, rather than bond debt. Preferreds will not appreciate above their par values of typically $25 per unit or share, so one does not get share price growth. In exchange for giving up the potential of share price growth, the investor gets a senior quality security, a fixed distribution rate, cumulative rights to dividends and most importantly a dividend yield that is substantially above most common stock dividend yields.
REIT shares are fractional ownership shares of large pubic owned/traded companies, whereby the corporate income from real estate rents and leases flows corporate tax-free to the REIT shareholders. These companies own income real estate in various sectors of the economy such as: office, commercial, industrial, distribution, multifamily apartment complexes, hotels. A REIT's real estate portfolio is usually spread across the entire US, and individual REITs own real estate of a couple of billion to $20 billion or more. They are large scale professionally managed businesses.
10. I SEE THERE ARE ABOUT 50 HOLDINGS, HOW IS ALL THE INCOME EARNED
The custodian of each account is collecting, on behalf of each client's account, all the dividends and interest payments that are paid out by securities issuers, and it is credited to each account. Dividends on common stocks and REITs are usually paid quarterly, some pay monthly distributions to shareholders. On corporate bonds the interest payments are paid by the bond issuer semi-annually to the custodian, and are then credited to the account. As an example, if a portfolio owned 100 shares of a preferred having an 8% dividend, then $.50 per share or $50 total is paid out and collected by the account every quarter.
11. WHAT DOES DIVERSIFICATION DO TO MAKE THIS PORTFOLIO LESS RISKY, THAN OTHER INCOME INVESTMENTS?
Diversification is the most important strategy of the portfolio to manage risk. In practice, if a securities portfolio can hold investments across many companies and many industry settings, one avoids full impact risk of having all of one's eggs in one basket. Today, as an example, housing is in a recession or worse, yet via diversification away from housing in this portfolio, it does not have housing investment risk. In our economy, various industries are either better or worse than others on growth and earnings. Using diversification spreads the financial risk across the whole economy. This would appear to be a better approach than a CD or holding an income investment in just one company or one bank.
|
