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Published: November 1, 2009
They came every year like clockwork. They were
so usual that most recipients took them for granted. But next
year will mark the first time in decades that Social Security
payments will see no cost of living adjustment (COLA).
You see, the adjustment is tied to increases in the Consumer
Price Index (CPI), which measures inflation. Typically inflation
rises a few percentage points a year, in turn leading to an
annual increase in Social Security benefits. But with the
recession in full force, the CPI has actually decreased about
-1% this past year.
The issue is that the CPI is calculated using a basket of goods
bought by the "average" consumer. Of course, people who receive
Social Security are usually retirees -- and their expenditures
are different than many consumers. For example, medical expenses
and prescription drugs usually make up a large share of a
retiree's budget.
So while the CPI is down, many expenses for seniors continue to
rise. According to a Price Waterhouse study, overall medical
costs have increased +3.5% for the last year. Hospital costs
have increased +6.6%. Even some everyday items like water and
trash collection have risen about +6.0%.
Yet, many income sources Social Security recipients depend on
have been flat or declining during the past year. In addition to
no bump in payments, a one-year CD averaged close to 4% in 2008;
it is paying 1.6% today. Ten-year Treasury notes paid above 5%
in 2007 and pay only 3.5% today.
But you can fight back. We've found a way that you can battle
higher expenses and lower income... and in effect create your
own cost of living adjustment.
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The Key to Increasing Income
The key to boosting your monthly income lies in a security
most investors are familiar with: Closed-end funds.
Right now, more than 650 of these
funds trade on U.S. exchanges. They
invest in every sector of the market
(stocks, bonds, REITs, MLPs, etc.)
and even every niche of every sector
(tax-free bonds, high-yield bonds,
international equity, preferred
stocks, etc.). But what they're best
known for is their income.
Unlike traditional open-ended mutual
funds, closed-end funds don't have
cash going in and out of the fund --
only a set number of shares trade.
If you want to buy in, you purchase
your shares from another investor,
just like a stock.
The structure lends itself to paying
out high income because the funds
don't have to keep money available
for redemptions and can invest all
its assets.
It shouldn't be a surprise then that
it's no problem finding closed-end
funds that pay income. My screening
software shows 290 CEFs currently
yielding over 7%. More than 130 are
yielding 10% or higher. The
overwhelming majority of closed-end
funds pay distributions on a monthly
basis -- 460 of the 654 to be exact.
Adding one of these high-yielding
gems to your portfolio should give
your monthly income a quick boost.
However, the last thing any investor
should do is buy into a fund simply
because it pays an enticing yield.
Just like any other investment, you
need to do your homework. But since
funds are different than a normal
stock, there are a three unique
metrics you should keep an eye on:
Performance During the Downturn
Past performance is a fund's resume.
While nothing is certain, you can
generally increase your chances of
choosing a solid-performing fund by
selecting one that has proven itself
already. In particular, you want to
ask:
- How has the fund performed in good
markets and bad?
- How has the fund performed
relative to its sector?
- Does the fund perform well in the
long term and/or the short term?
If you're most worried about safety,
a good place to start your search is
with funds that were able to hold up
in the last downturn. These may not
offer sky-high gains in a rising
market, but they've proven their
mettle in one of the worst downturns
in recent memory.
Discounts and Premiums
Sometimes closed-end funds trade out
of line with their net asset value,
meaning the share price may be
higher or lower than the per-share
value of the assets held by the
fund.
Some funds may trade out of line
with their net asset value for
years. Therefore, it's important to
look at the discount or premium in
relation to its historical average.
The key is to find funds trading for
less than their average historical
discount or premium.
Avoid Return of Capital
Distributions
Before buying into any fund, you'll
want to know where the dividend
payments are coming from. You can
usually find this by look at the
last year's tax breakdown on the
fund's website.
Many funds have "managed
distribution policies." This is a
fancy way of saying they plan to
make the same payment each month, no
matter how much income the fund
earns from investments.
Usually the fund sets payments at a
sustainable level. But in some
cases, a fund may earn less income
than it pays out -- forcing it to
dip into its assets to maintain the
payment.
These distributions are classified
as return of capital. Such payments
are simply a return of your
principal and erode the value of the
fund. In short, it's usually best to
avoid funds making return of capital
payments.-- Tom Hutchinson
Staff Writer
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