Stocks, Bonds, and CEFs

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Problem: I need to generate enough monthly income to pay for my health insurance.

I’ve been reading a lot about the pros and cons of stocks and bonds that pay dividends. Normally a bond fund would be a good place to generate monthly income. But with the recent stock market volatility, money has been moving into US bonds. This has driven up prices and with interest rates dropping, it may not be the best time to move into bonds. The other option is dividend producing stocks. There are stocks funds that provide a monthly dividend, but they tend to be real estate investment trusts (REIT). One drawback is that much of REIT income is taxed as ordinary income, which carries a higher tax rate than dividends from stocks. I then started looking at closed end funds (CEF). Closed end funds are different than mutual funds. With a mutual fund shares, you buy from the fund itself. CEF share values are based on their underlying assets as well as on investor demand, so CEF shares commonly trade at a premium or discount to their net asset value (NAV). It is better to buy into a CEF when the price is below the NAV. Unfortunately, right now most bond CEFs are higher than their NAV. Many equity CEFs are trading at a discount to their NAV, but I found that most equity CEFs pay a large percentage of their dividend from selling the asset. For example, if you get 8 cents per share each month, 1 cent may come from investment income and the other 7 cents will come from return of capital. This means they sell some of the asset to make the payout. This payout is not the same as a yield that you get from bonds. It sounds more like an annuity, where you get a regular payout regardless of the performance of the underlying asset. I’m not sure what effect asset erosion will do over time. To make it even more complicated, many CEFs use options to leverage their trading strategy. It may be just what I need to generate more monthly income. Or, another way to lower my net worth. I’ll keep you posted.

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