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Building a New Retirement Portfolio

This column originally appeared Jan. 31 on RealMoney . We're running it today as a bonus for readers. To subscribe to RealMoney click here.

My mother recently retired after a 43-year career in the computer software industry, and she asked me to create her retirement portfolio.

With her retirement, she wanted to make 8%-10% annually, which is more than any money manager could get given current interest rates.

Additionally, she wanted liquidity (the ability to take money out), which is something a hedge fund couldn't give her since they typically have one-year lockups.

She also wanted transparency, the ability to look at her portfolio on a daily or (God forbid) hourly basis.

And finally, she wanted low volatility, which is very difficult to get when aiming for returns higher than the 4%-5% returns of T-Bills.

First, I do not believe it's possible to make 8%-10% with no volatility. There will be down periods as well as periods that make more than 8%-10%. But I do believe it's possible to put together a portfolio with the following characteristics:
  • "Do no evil": My main concern was to make sure no pick was at too much risk of losing money. This is more important than making money.
  • Yield: Since income is important to my mom, most of the picks have to spin out a good amount of cash.
  • Diversification: I focused on the following areas in pursuit of diversification:
    1. Number of picks: There's various academic research on what constitutes a diversified portfolio. I've seen reports suggesting anywhere between 15 and 125 picks. I settled on about 20 picks that I liked for her.
    2. Beta: Meaning diversify in correlation to the U.S. markets. If the domestic market goes up you won't go up as much, but if it goes down you won't go down as much.
    3. Fund family: My intent was to put her into several closed-end funds, but I didn't want her to be exposed too much to any one fund family.
    4. Type of yield: In other words, balancing municipal bonds, preferred stocks, U.S. Treasuries, corporate bonds (focusing on high to medium quality, the lower the quality the higher the yield), global, bank loans, inflation indexed, duration (the average length of a loan), etc. Every type of bond has different characteristics, and while they are all largely correlated to interest rates, a high-yielding corporate bond will not necessarily go up or down the way a municipal bond might if interest rates keep going up -- which they are unlikely to do after 13 straight increases.
    5. Track record: In particular, I wanted to make sure the funds had good track records in the 2000-02 period.
    6. Discount to net asset value: All of the closed-end funds I picked trade on the New York Stock Exchange. Many of them trade at prices that are lower than their net asset value. In other words, if they hold $15 a share of assets, they might trade at $14. If you buy at $14 and the next day the fund decides to liquidate, then you get $15 of assets. It's been shown in various academic studies that funds trading at a heavier-than-normal discount to their net asset value tend to appreciate more than their peers (and, of course, give a higher dividend).

My goal was to find closed-end funds with all of the above characteristics that were also trading at larger-than-usual discounts to their net asset value. Additionally, if hedge fund activists like Opportunity Partners, Karpus or Western were also in the fund, then that gave me comfort because I could assume they had done their homework on the holdings of that fund and were comfortable with it. Furthermore, they might try to open up the fund, in which case there would be a chance for quick capital appreciation.
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