It's never too late to start planning your financial future. A year ago, I wrote about a
retirement portfolio I was setting up for my mother, who had recently retired after a 43-year career in the computer software industry. The main question I had to ask myself was what sort of portfolio would be ideal for someone like her. My mom wanted a return of about 8%-10% annually, which is more than a traditional money manager could get. Additionally, she wanted liquidity (the ability to take money out), which rules out all hedge funds. And she also wanted transparency, the ability to look at her portfolio on a daily or (Heaven forbid) hourly basis. And finally, she wanted low volatility. On Stockpickr, I set up two retirement portfolios for my mom. Last year's portfolio achieved everything it set out to do -- and then some. Including dividends, the portfolio returned 10.6%, and 20 of the 21 stocks in the portfolio were up for the year (also including dividends). About one-third of the dividends were tax-free, so the taxable equivalent return was about 12%. I still believe many of the stocks are fine to hold long term, and for the most part I wouldn't change anything about the portfolio. Note that a taxable equivalent return of 12% was 2%-4% more than my initial and expected goal. This is not necessarily a good thing. When a strategy is too successful, it tends to swing back in the other direction. While I expect to get a return of 8%-10% from this approach over time, I also expect some underperformance to occur as a result of the recent success of this strategy.
That said, if I were starting from scratch, what follows is the retirement portfolio I would pick today. First off, here are the criteria I would use, which are the same as last year:
- "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: 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).
| Nuveen Investments' Discount to Net Asset Value |
For many closed-end funds, it's the same story. Hedge funds have entered this strategy and it has become more difficult to find huge bargains. However, I do have some, one of which is Putnam Premier Income Trust ( PPT), which is at a 9% discount to net asset value. It pays a 5.45% dividend rate. Both Karpus and activist fund Chapman Capital are shareholders, which makes me think that at some point the activists are going to press Putnam to open up the fund in order to close the discount to net asset value. Karpus is known to invest in closed-end funds trading at a significant discount. You can take a look at the top Karpus holdings on Stockpickr. Chapman has been very active lately, pushing for change at a variety of companies. Check out Chapman's top holdings. The Seligman Select Municipal Fund ( SEL) is trading at a 10% discount to net asset value and gives out a tax-free dividend of 4.44%. The discount has narrowed slightly off of its lows, but not very much:
| Seligman Select's Discount to Net Asset Value |
In late December Seligman reduced its dividend, primarily because of the inverted yield curve. However, that will right itself if either long-term rates go up or the Federal Reserve cuts current interest rates. There is little risk of default in Seligman's underlying holdings, unless ones such as the New York City Municipal Water Finance Authority and others of similar ilk suddenly run into unspeakable difficulties. The Insured Municipal Income Fund ( PIF) trades at an 11.65% discount to net asset value and has a 4.49% tax-free yield. There is extremely little risk of default here as well, since the underlying loans are insured. Like Seligman, one of Insured Municipal's top holdings is the New York City Municipal Water Finance Authority. Unless the water turns dirty, this fund should come away smelling like roses. The Black Rock Corporate High Yield Fund ( CYE) has an 8% discount to net asset value and an 8.28% dividend. The discount to net asset value has definitely narrowed for Black Rock:
| Black Rock's Discount to Net Asset Value |
But the fund has ticked downward lately. The thing I like about this corporate bond fund is that it has not reduced its dividend. With the yield curve inverting for a substantial length of time, almost all of the corporate bond funds I searched through had lowered their dividend at some point. But this one held on. I'm willing to bet that the discount to net asset value for Black Rock goes down to 4% and you'd get an 8% dividend and some capital gains on the shares. The Western Asset High Income Opportunity Fund ( HIO) has an 8% dividend and an 8% discount to net asset value. Interestingly, this one has actually increased its dividend over the past 12 months. Then there's the Alliance World Dollar Government Fund ( AWG). This is an interesting arbitrage opportunity. On April 13, shareholders of Alliance will receive shares equal to the net asset value of the stock dividend by the number of shares. In other words, the discount to net asset value, which is currently 10%, will close. Many opportunities can now be found in the real estate closed-end funds. The Neuberger Berman Real Estate Securities Income Fund ( NRO) is mentioned on TheStreet.com Ratings Team's list of top discounted closed-end funds. The RMR Real Estate Fund ( RMR) is another interesting one in this sector. Its discount to net asset value has widened recently due to the real estate fallout:
|RMR Funds' Discount to Net Asset Value |
Yet the fund owns many health care REITs and office REITs, which are not affected as much by the housing bust. It pays a 7% dividend and is at a 13% discount to net asset value. RMR has not lowered its dividend since going public in December 2003. The Cohen & Steers Select Utility Fund ( UTF) owns slow-moving utilities yet is at a 15% discount to its net asset value and pays a 5% dividend was recently increased. The discount has actually narrowed recently, but I believe this one can potentially have a zero percent discount to net asset value or even trade at a premium to net asset value:
|Cohen & Steers' Discount to Net Asset Value |
Although I am a huge fan of the Royce family of funds, it's probably time to get out of ones like Royce Focus Trust ( FUND) and Royce Value Trust ( RVT). These funds trade at premiums to net asset value, and if the market slips they can have a double shock as their underlying assets go down and their premium to net asset value shrinks. In other words, they would have the opposite effect of the other funds in the retirement portfolio. However, for equity exposure I'm starting to like Adams Express ( ADX), which trades at a 14% discount to net asset value and owns mostly large-cap stocks. In addition, Adams owns a closed-end fund that trades at a significant discount to net asset value, giving it a "double discount" to net asset value around 20%. If the equity markets head upward, this stock could have 20% to 40%-plus returns as the discount to net asset value closes. If the equity markets decline, the stock has a significant cushion in its discount. These are the types of situations I like the best. To see the rest of the retirement portfolio, please check out the "Mom 2" portfolio on Stockpickr. The portfolio tracking function has been enabled, so you can track it as well -- but that will not include dividend returns. For other resources that were useful in constructing this portfolio, check out the following: The list of top 10 discounted closed-end funds. This portfolio is updated every two weeks. To receive an email when it is updated, bookmark it by rating it with four stars. The list of TheStreet.com Ratings' top discounted closed-end funds. These are the highest-rated closed-end funds as determined by TheStreet.com Ratings Team. The list of creative ETFs. These exchange-traded funds offer interesting diversification into equities based on research into buybacks, insider buying, etc.