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Closed-End Bond Funds are Ripe for the Picking

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You really can’t beat getting a dollar for 90 cents. Unless, of course, you manage to find one for 85 cents.

While deals like that really shouldn’t exist in the real world, they’re actually pretty common in the closed-end fund (CEF) space. And today, some of the best bargains are to be found among the safest and most conservative CEFs – those investing in tax free municipal bonds. Right now, you can put together a portfolio of funds offering an immediate 6% tax-free yield plus the opportunity for respectable capital appreciation.

Before I get into that, let’s do a quick review of what exactly CEFs are… and how they work.

CEFs are a type of mutual fund that trades on the NYSE stock exchange, so they look and feel a little like their cousins, exchange-traded funds (ETFs). With a traditional open-ended mutual fund, you invest by sending money directly to the management company, who in turn invests your cash in a portfolio of stocks or bonds. When you want your cash back, the managers sells of a small piece of the portfolio and sends you the money.

But with CEFs and ETFs, you have no direct transaction with the managers. They raise capital like a stock, via an initial public offering, and after that point they trade freely on the NYSE. So you buy from or sell to other investors rather than to the manager.

And here’s where it gets fun. ETFs can never deviate too far from their net asset values (NAV) because large institutional investors have the ability to arbitrage those profits away. For example, if an ETF’s share price were $20 per share but its underlying portfolio of stocks or bonds were worth $25 per share, the large institutional investor could buy a ton of ETF shares for $20, break the ETF apart, and sell the underlying investments for $25, making a risk-free profit of $5 per share.

With CEFs, that creation/redemption mechanism doesn’t exist, so share prices can – and often do – deviate wildly from their underling NAV. And on top of that, CEFs generally have the ability to borrow, and it’s pretty normal for them to be leveraged 20% – 40%. Funds with more conservative portfolios – such as those that hold muni bonds – tend to be leveraged a little heavier than those that hold more volatile securities like stocks.

So, let’s get back to those 90 cent dollars.

The election of Donald Trump has been great for the stock market so far. But it’s been an absolute death sentence for bonds… and particularly tax-free muni bonds. Bond yields were rising before the election, and they’ve shifted into overdrive in the weeks that have followed in the believe that Trump’s policies will stoke inflation and that his proposed tax cuts make the tax savings of muni bonds less attractive.

Well, rising bond yields mean falling bond prices. So, we’ve seen the NAVs of bond CEFs get absolutely clobbered, with many down by around 10%.

But remember, CEF prices often deviate from NAV… and that’s certainly been the case of late. Many bond CEFs have seen their share prices drop by as much as 15%-20%. CEF investors have done what they usually do… massively overreact to market moves. And as a result, they’ve set us up for a fantastic opportunity. If you believe, as I do, that bond yields have gone too far, too fast and that yields are likely to ease in the coming weeks, then we could be looking at an ideal trading setup.

Let’s play with the numbers. Today, you can put together a portfolio of muni bond CEFs yielding about 6% — tax free. If you’re in the 35% tax bracket, that amounts to a tax-equivalent yield of over 9%.

Now, let’s say that bond prices recover half of their losses in the coming months. I think it is likely they recover more than that, but we’ll be conservative. In that case, we’d be looking at something in the ballpark of 5% in underlying portfolio appreciation and probably a good deal more.

And here’s where the 90-cent dollar comes into play. When investors see that bond prices have stabilized, I expect them to pile into CEFs again. After all, where else are they going to find a safe 9% tax-equivalent yield in this market?

When they do, you should see that discount to NAV shrink or even disappear completely. That would add another 5%-10%.

So between the dividends, appreciation of the portfolios and a shrinking of the discount to NAV, I believe total returns in the ballpark of 20% over the next year are likely.

And if I’m wrong?

Well, I console myself by collecting that tax-free dividend check every month.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Life’s Too Short to Fight in a Walmart Parking Lot at 3:00 in the Morning

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I like saving money. A lot.

In fact, I’m a cheapskate and actually take pride in my stinginess.

But you won’t see me fighting the crowds on Black Friday. Not going to happen. Life is far too short to explore the depths of human misery that I see on display the Friday after Thanksgiving every year. Lines forming the night before… elbows flying… fighting over boxes with fellow shoppers… the vulgarity of it all.

No, whatever money I would save isn’t worth the lifetime of bad karma I’d provoke fighting for a space in the mall parking lot.

Still, if you’re in the retail business, Black Friday matters because it gives you an indication of what to expect for the remainder of the holiday shopping season. Nearly a third of all retail sales happen in the month between Thanksgiving and Christmas. So if sales bomb on Black Friday, it can be a bad sign of things to come.

Interestingly, “Black Friday” is something of a changing concept these days. Stores desperate for a finite number of customer dollars have been opening earlier and earlier, and now Thanksgiving Thursday itself is a major shopping day. And of course, internet shopping has also taken some of the sense of urgency out of the whole endeavor.

Nevertheless, you’re going to be blasted with Black Friday news stories over the next several days. Black Friday sales growth has been somewhat sluggish since 2008, but if 2016 to date has been any indication, then I’d expect some surprises this year. With a new president promising to “make America great again,” consumers might – just might – open their wallets a little wider this year.

But I’d be very careful about drawing meaningful conclusions from any reports you read between now and Christmas. Because while Black Friday spending is a big deal for mall retailers, it’s overall effects on the economy are a lot smaller than you might think.

Much of what gets purchased during the holiday shopping season is fairly cheap and disposable. We’re talking about clothes, toys and consumer gadgets that tend to get used for a year or two and then tossed. But what really supercharges the economy are big-ticket items typically purchased on credit.

Think about it. When you buy something on credit, you’re essentially spending tomorrow’s money today. So big-ticket items are like gasoline on the fire.

Well, growth in this segment of the market has been tepid for a long time. Consider the following chart, which tracks orders of consumer durable goods. These are items expected to last three years or more, such as appliances, furniture, large electronics, etc. As you can see, growth was robust and steady throughout the 1990s, eased during the 2000-2002 slowdown, and then rocketed even higher until 2008. Of course, orders absolutely collapsed during the Great Recession that started in 2008. But the most interesting part is what happened after that.

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Durable goods orders enjoyed a nice recovery once the economy came out of deepfreeze. But then in 2012, they flatlined. And they’ve been grinding sideways ever since.

What’s the story here?

Part of it is housing. The housing boom of the 2000s created massive demand for applicances. You have to have something to fill up that massive McMansion, after all. And as home buying has been sluggish since 2008, so has been buying of consumer durables.

But there’s a much bigger factor at work here, and that is demographics. The Baby Boomers are done buying durables. Sure, they might replace a broken refrigerator now and then. But few of them are furnishing a new house. In fact, many are actually downsizing and are giving away furniture they no longer need.

Meanwhile, the Millennials have been slow out of the gate to start families and buy homes of their own. And Millennials that are starting families tend to be more fiscally conservative than prior generations. For all the flack that Millennials take – and hey, a lot of it is deserved – their fiscal conservatism is actually pretty admirable.

The problem, as I wrote a few weeks ago in The Paradox of Thrift, is that what is good for the individual family – discipline and thrift – is bad for the economy as a whole, at least in the short term. So Millennial reluctance to spend like adults is still major headwind for the economy… and a reason that growth has been so lackluster for several years running. And we’re probably a good five years away from that materially changing.

So regardless what Black Friday looks like this year, try to keep a level head. We’re not likely to enjoy pre-2008 levels of growth any time soon.

And as for Black Friday itself… don’t debase yourself by fighting with the unwashed masses for that last bargain-basement blender on the shelf. That’s no way to live your life. Stay at home, eat some pumpkin pie and spend some time with your kids. Or at least relax and watch some football.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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My Housekeeper Has a Nicer Car Than Me

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My housekeeper has a nicer car than me.

Now, granted, 75% of America probably has a nicer car than me. I’m driving a car that, while only four years’ old, looks like it’s going on 20 because my kids have utterly destroyed it. The entire backseat looks like a Jackson Pollack painting of assorted stains and magic marker doodling.

On the flip side, the car is paid for so I refuse to pay a single nickel to get it fixed up until my kids are older. I don’t even like paying to have it cleaned because I know that it will be filthy again by the end of the day.

So I wouldn’t necessarily find it odd that my housekeeper has a nicer car than me… except for the fact that she drives a black Mercedes Benz (the only color a Mercedes Benz should ever be!).

Now, I’ll never fault a person for having good taste in cars. I rather like Mercedes… and I might buy one for myself once my kids are at an age where bodily excretions are no longer likely to soil the upholstery.

But I’ve done the back-of-the-envelope math, and I also know that the monthly payment on that car consumes a huge chunk of her income. It’s phenomenally bad for her personal finances to own a Benz… but it’s great for the dealership that sold it.

And that brings me to one of the more interesting concepts in economics:

The paradox of thrift.

In a nutshell, it’s good for an individual family to be frugal. You have more savings to tide you over when times get tough, and you build wealth for the future. But if everyone gets frugal at the same time, the economy grinds to a halt and there’s less wealth for everyone.

(For the wonks out there, this is an extension of the fallacy of composition, the error of assuming that what is good for the individual must also be good for the group.)

I save a little over a third of my after-tax income. That’s fantastic for me and my family. We’re a lot less likely to get booted out of our house or be denied credit if or when we need it, and I’m able to sleep a lot better at night.

But if everyone did what I did, our economy would probably be back to the Stone Age. Every cable company would be out of business (I cut the cord years ago). And there wouldn’t be a lot of people shopping at the Mercedes dealership either.

The problem is, there are a lot more people like me these days, either by choice or necessity, which is a big reason why the economy has been stalled out in a slow-growth funk for the past decade.

Roughly 10,000 baby boomers enter retirement age with every passing day, and most of them aren’t even remotely close to prepared for it.

According to the Federal Reserve’s latest Survey of Consumer Finances, the median American household, with the head of the household aged 65-74, has a net worth of only $232,000, which would include home equity. (Interestingly, the same survey reported that only 53% of American households save any money at all; the rest apparently live paycheck to paycheck.)

$232,000 isn’t going to get you very far in retirement, as Rodney discussed in the October issue of Boom & Bust (he also offered some solutions to boost your personal savings, and I added an income gem to the model portfolio).

Assuming the standard 4% annual withdrawal, you’d be looking at an annual income of $9,280. The boomers know this, which goes a long way to explaining why their spending isn’t what it used to be.

But their children, the millennials, aren’t exactly big spenders, either. Entering their careers with mountains of student debt, they’re marrying and buying cars and homes much later in life than the generations that came before them.

Again, all of these people are doing the right things on an individual level. It makes sense to pay down debts and to save for retirement. But collectively, this tightfistedness throws a massive wet blanket over the economy… which is why we’ve had years of aggressive monetary policy by the Fed, and political movements to raise the minimum wage and to forgive student loan debt.

Now, I’m not here to bash anyone’s pet political issue. But let’s just say I wouldn’t expect any policy move to have much of an impact on consumer growth. Raising the minimum wage by a couple of bucks or forgiving some portion of student debt isn’t going to compensate for the retirement of 10,000 people per day.

So we need to set realistic expectations.

The economy has grown at about 1.8% per year since 2009. That’s probably about what we should expect for the next several years as well, and that’s assuming we have no major crises (on which point, I wouldn’t hold my breath if I were you ).

So back to that whole “paradox of thrift” thing… I recommend you stay frugal and focus on debt reduction over the next few years.

It’s bad for the rest of us… but it’s a lot better for you.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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You Don’t Want To Beg Your Kids For Money

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I walked to work today. Granted, the weather was nice and it was only about a mile and a half, so it wasn’t any major accomplishment. But for someone whose physical exercise over the past decade has mostly consisted of lifting the TV remote, it was a significant improvement from my routine.

So, you might be wondering what inspired me to forgo the comfort of my car and put on my walking shoes.

It was my wife.

She’s been nagging me for months about taking better care of myself… and getting progressively meaner about it. The final blow that got me off my lazy butt was her comment that she was going to have a great time spending my life insurance money with her new cabana boy husband once I dropped dead and left her a widow.

Ouch.

Well, today I’m going to take a page out my wife’s playbook. I’m going to ruthlessly nag you, though thankfully not about exercise.

Listen to me: You need to max out your 401(k) plan.

Did you get that? You NEED to max out your 401(k) plan!

Social Security may not be around in another 20 years, or if it is, it will likely be available only to low-income seniors. And if you’re like most Americans, you probably don’t have access to a traditional pension plan. Frankly, even if you do, there’s no guarantee that yours will pay what was promised if your company falls on hard times.

So, you’re on your own. If you want anything better than life in a trailer park with ramen noodles for dinner, then you had best get to saving. And the best way to do that is via automatic investment into your 401(k) plan.

I know, I know. Saving is hard, and you have bills to pay today. All of that might be true. But if you don’t start taking your 401(k) plan seriously, you’re not going to have enough money to retire, and you’re going to end up having to move in with your kids in your old age.

That’s a sobering thought. Not quite as sobering as thinking about your newly widowed wife blowing through your life savings with her new cabana boy husband, but sobering nonetheless. I don’t know about you, but I would be humiliated by having to look to my kids for financial support in retirement.

So, let’s talk through this…

You can defer $18,000 of your salary per year into your company 401(k) plan, and that’s not including any company matching. If you’re 50 or older, you can contribute an additional $6,000. That gives you $24,000 in total per year. And again, that doesn’t include any employer matching. Depending on your salary and your employer’s generosity, matching can chip in several thousand more.

Most American workers take home 26 paychecks over the course of the year. So maxing out at $18,000 per year would put you at $643 per paycheck. That might sound like a lot of money, but it’s actually less than you think due to the tax benefits. If you’re in the 28% bracket, it actually equates to about $462 in take-home pay. That’s still not chump change, of course. But with a little discipline, you can squeeze it into your budget.

And if you can’t… well, it’s time to make some changes.

If you rent, consider getting a cheaper apartment or even taking on a roommate. If you own your house, consider firing your lawn crew and your housekeepers. Yes, your home and garden might not look quite as nice if you’re mowing your own grass and sweeping your own floors. But isn’t it better to tolerate a little dust and retire well than to have an immaculate house and be forced to eat cat food in your golden years because your savings ran out?

I’m not saying you have to live like a pauper until you retire. But you should make maxing out your 401(k) plan a very high priority. The longer you wait to take your savings seriously, the more likely you’ll end up going to your own children with hat in hand.

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Trust Your System

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In August of 1971, Ray Dalio – now one of the most respected hedge fund billionaires on Wall Street – was a lowly clerk working on the Street. By coincidence, Dalio was starting his career during one of history’s critical turning points. President Nixon had just taken the dollar off of the gold standard.

Dalio’s gut told him the market would crash the next day. Instead, it rallied. Hard! The Dow finished the day almost 4% higher.

It’s not much of a stretch to compare then to now… Back then – as now – you had central banks meddling in the markets. And back then – as now – you had unexpected results.

Dalio learned a lesson from his experience. He realized that the market has a knack for doing what you least expect it to do… and he reached the conclusion that, rather than trying to guess what happens next, the better course was to simply build a portfolio that would perform well in any environment… no matter what happened. So he launched his All Weather portfolio, and the rest is history.

I’m not necessarily recommending you run out and invest with Dalio. Even if you wanted to, you wouldn’t meet the minimums. You’d need $5 billion in investable assets to get in the door.

But I do recommend that you take a few plays out of his playbook…

First, ask yourself the same question he did: what kinds of strategies can I implement that will work in anymarket, bull or bear?

With stock prices at all-time highs – and with the Fed’s next move anyone’s guess – you need to be confident that your strategy will handle the unexpected.

And as you look for answers, be systematic.

Set your trading rules in advance and follow them – verbatim. If you’ve done proper back-testing, then you should have faith in your system to do its job once a storm hits. If you don’t have faith in your system, then you have no business investing with it.

I incorporate both systematic and fully discretionary trading in my accounts. I think there is an important place for both. But I also never mix the two; they are distinct strategies run separately. If you’re investing using a system, then you need to stick to your system. Sure, you can and should refine it over time. But you don’t ignore its trading rules because it’s convenient or you’re scared. Systems only work when you actually follow them.

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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