Providing Future Income
with Closed-End Funds


We are admonished in the Scriptures to plan ahead and to provide for ourselves and our loved ones.  Growing a retirement nest-egg is a tangible way to live this out in our lives.  We work hard today to set aside for tomorrow so that we will not be a burden to others and to help provide for those we will someday leave behind.  I Timothy 5:8 says, “If any one does not provide for his own, and especially for those of his household, he has denied the faith, and is worse than an unbeliever.”

God gave specific instructions to Joseph on how to prepare Egypt for lean times that were ahead. Let Pharaoh take action to appoint overseers in charge of the land, and let him exact a fifth of the produce of the land of Egypt in the seven years of abundance.  Then let them gather all the food of these good years that are coming, and store up the grain for food in the cities under Pharaoh’s authority, and let them guard it.  And let the food become as a reserve for the land for the seven years of famine which will occur in the land of Egypt, so that the land may not perish during the famine.”  Genesis 41:34-36  Our “grain” is the savings we gather bit by bit and store up for future use.


WHY I ENCOURAGE THE USE
OF CLOSED-END FUNDS

My readership has recently stretched beyond the confines of this website.  Early in 2016, I ventured out and began to write articles for an investing site called SeekingAlpha.com.  This venue allows me to focus specifically on the subject of investing, while garnering great feedback and discussion.  I get to teach and learn at the same time.  The format is a bit more of a blog style and conducive to subjects that may be pertinent at the time, but not so much later on.  Even so, I usually tend to stick to investing topics that are more evergreen in nature – in other words, the content is always applicable, even if read years later.

That little side-venture has led me to realize the importance of sharing what I have personally learned through experience about investing for the future.  This isn’t something we’ve been taught in school or at work or even by our parents.  We have to strike out on our own and educate ourselves as best we can.  When people finally come to the decision to do so, they are hungry for answers and for some direction.

Although I am a proponent of investing in closed-end funds, I will admit that when it comes to investing your hard-earned money, there is no “one size fits all” strategy.  It takes time to learn the ropes, to try, to fail, to understand your own preferences and tolerances and style and limitations.

I have had the opportunity to do that.  Like most other new investors, I began my investing experience as a young adult by putting my savings into a mutual fund.  Unlike most other young investors, however, I embarked on an education in investing and finance on my own.  It began as correspondence courses (this was before the day of the internet) and a LOT of reading.  I have a whole library of books on money management and investment strategies.  Today, I spend many hours a week doing research online.

There is one thing of which I have no doubt:  there are many ways to make money and there are many ways to invest.  Just as individuals are more suited for one particular type of career, they are also more suited for a particular style of investing.  And just as you may be drawn to a specific career field, so also you may be drawn to a specific type of investment.  You may find yourself in a particular career after years of trial and error in your work experience, just as you may find yourself in a particular investment strategy following a similar path.

The thing about being a faithful steward is that you can entrust it all to God.  He will lead you where you need to go.  What may feel like obstacles or bumps in the road are actually for your benefit: they create learning opportunities as well as keep you from getting too full of yourself when things are going really well.

I have had many years to dabble in several different investment strategies.  I discovered that real estate investing is not for me.  Too stressful.  I also discovered that mutual funds and CDs (certificates of deposit) are too boring and slow for my liking.  I enjoy a little more of a hands-on approach and a bit more excitement than that.

Blue-chip stocks, momentum stocks, small-caps, ETFs, covered calls, secured puts – I tried them all.  The one investment type I kept returning to over and over was closed-end funds.  Today, I use CEFs almost exclusively.


WHAT IS A CLOSED-END FUND?

Closed-end funds (CEFs) are a type of mutual fund with a long history.  They hold a basket of securities (either stocks or bonds or both), diversifying risk over a large number of holdings.   The first closed-end fund was created in 1893, more than three decades before the first mutual fund was formed.  Several hundred funds exist today, some of which have been around for more than half a century. 

Traditional mutual funds, the kind most people know about and probably own, are open-end funds.  “Open-End” means it is always open to create new shares whenever there is new money:  in other words, the fund will issue as many shares as investors are willing to buy.  The price you pay per share is the total value of the securities in the fund divided by the total shares outstanding.  This is also known as its net asset value (or NAV).  Open-end funds (what we typically call “mutual funds”) always trade at their NAV.

Closed-end funds operate differently.  While they also hold a basket of securities just like open-end funds, their pricing structure is not the same, making them a whole different kind of mutual fund.  CEFs issue a pre-determined number of shares on the stock market and trade like normal stocks.  This means that in order for you to buy shares, someone else has to sell theirs.  The fund will not create more shares to accommodate new money inflows.  The number of shares available on the open market is set, or “closed”. 

Because of this buying and selling on a stock exchange, the value of closed-end funds fluctuates, sometimes significantly.  These price fluctuations rarely reflect the value of the underlying securities in the fund (its net asset value), but rather, reflect what investors are willing to pay for them.  This difference between the market price per share and its NAV is what makes CEFs valuable to investors.  When a CEF’s market price is lower than its NAV, it is trading at a discount.  When the price is above its NAV, it trades at a premium. 

If your CEF were merchandise in a retail store, you could buy it on sale (at a discount), purchase it at value, or pay more than it is actually worth (at a premium).  It doesn’t seem logical that people would buy merchandise for more than it’s worth, but it happens:  when a product that is in demand is also limited in supply, buyers will bid up the price to a premium.  Such is the nature of closed-end funds.  Purchasing at a discount is where the value lies: you pay less for the fund than it is actually worth.  You can't do that with traditional mutual funds or with stocks.  


WHAT CEF INVESTING HAS TO OFFER

PERPETUAL INCOME

The thing that’s great about closed-end fund investing is that a CEF portfolio is an income machine that keeps churning out dividends no matter what the stock market is doing.  Sure, the underlying positions will shrink during a correction, but the income stream continues, so investors get paid to wait until the markets turn back around.  This also reduces the fear of what the stock market is doing, or going to do, in general.


COMPOUNDED GROWTH

Because CEFs typically distribute high yields, when you reinvest the dividends (or distributions, as they’re more aptly called), you compound your money much faster than through more conventional investments. 

The price charts don’t show this.  As a matter of fact, looking at a typical CEF price chart can look boring, even discouraging.  But these low share prices are what make compounded growth so easy to achieve:  you can pick up more shares for your money.  You would not be able to add nearly as many shares upon reinvestment or averaging-in if the price continually went up.

I have seen this compounded growth play out in my own portfolio and in the funds my teenage daughters own as their first investments.  Compounding is known as the best way to build wealth with the least amount of effort.  CEF investing takes full advantage of this key facet with its high distributions and low share prices.


DIVERSIFICATION

Because a closed-end fund is a mutual fund, it is diversified among many holdings, asset classes, and/or sectors. You are not tied to the success or failure of any one business, as you would be with a stock or a bond.

There are more than 600 closed-end funds available in a wide variety of asset classes and investing styles.  When you hold a portfolio of CEFs, you are even further diversified, without needing a large number of holdings to do it as you would with a stock portfolio.  Closed-end funds make diversification easy to attain.



WHY DOESN’T EVERYONE USE CEFs?

Closed-end funds are one of the most misunderstood investments in the industry.  That lack of understanding has fueled a general fear of them, and created a bad rap.  Even many professional investment advisors will tell you to avoid them because they typically don’t know enough about CEFs themselves.

I made it my mission to understand closed-end funds over the past 8 years because, as an individual investor, they intrigued me.  I spent many years culling what information I could from various sources and experimenting with them in my own portfolio.  I genuinely believe that CEFs’ bad rap is undeserved.

As I’ve said in my writings and musings about investing, I think closed-end funds are a hidden treasure with a “superpower”.  They can offer you all you need for your retirement portfolio.

I even wrote a book about it.  If you’d like to learn more about investing in CEFs for income, you can take a peek at my e-book Perpetual Investing With Closed-End Funds here.


DISCLAIMER:  I am not an investment professional.  I write about investing in order to share what I have learned through my own experience and research.  I believe the Lord led me down this particular path of investing in order to share about it with others and help them in their own quest for providing for their future.


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