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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% over the 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%.
Yet, many income sources Social Security recipients depend
on have been flat or declining over 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.
The Key to Increasing Income
The key to boosting your monthly income lies in a
security most investors are familiar with:
closed-end funds.
|
|
Social
Security Cost of
Living Adjustments |
|
2005 |
+4.1% |
|
2006 |
+3.3% |
|
2007 |
+2.3% |
|
2008 |
+5.8% |
|
2009 |
0.0% |
|
Right now, over 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.
Good Investing!
Tom Hutchison
Carla Pasternak's Dividend Opportunities
P.S.
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