A steady investment portfolio can mean a steady stream of income in retirement.
Controlling volatility by looking at the capital structure of assets within a portfolio can help keep income steady in different economic climates, according to Louis P. Stanasolovich, a certified financial planner and founder, CEO and president of Legend Financial Advisors, Pittsburgh.
In the March edition of Risk Controlled Investing, Stanasolovich looks at ways to monitor portfolios such as looking at the capital structure of corporations.
Corporate entities with “shaky capital structures” may not recover from a recession so “it is important to be at the top of the corporate capital structure” in order to survive any company bankruptcies. One of the best ways to accomplish that is to own only senior-secured bank loans.
These investments are often secured by collateral, such as plant or equipment, and are given priority over other classes of loans, preferred stocks and common stocks, he says in the newsletter. He notes that “Historically, default rates on these types of loans are only approximately two-thirds that of junk bonds because of the tight borrowing standards set by banks.”
But even so, he continues, “we don’t believe the credit crisis is over” and believe that these types of loans and the mutual funds that own them will continue to have problems. Consequently, “we believe the more prudent approach would be to cut losses and utilize high grade securities such as treasuries and government agency bonds as well as money market funds for the fixed income portion of portfolios.”
In Risk Controlled Investing, Stanasolovich also discusses taking distributions and depositing them into a discount brokerage account’s money market fund for distribution if desired, rather than the traditional wisdom of simply reinvesting dividends. The funds can then be used to distribute cash if desired or to rebalance the portfolio. “This, coupled with the low transaction costs of most trading platforms, prevents or at least minimizes the need for generating additional taxable gains because the advisor would not have to sell off appreciated funds to rebalance and/or generate cash flow for the client.”
The traditional reasons for reinvesting, such as avoiding commissions on reinvesting proceeds from distribution, are from a different time when investors bought funds with loads or from a single mutual fund family, he reasons.
But today, Stanasolovich continues, people have their investments in a number of funds and use discount brokerage firms.
The one instance when it pays to reinvest dividends and capital gains is when “a mutual fund has had a hard close.”
“When a mutual fund has a hard close, no new shares of the fund may be purchased, even by existing shareholders. In this case the only way to gain additional shares of the mutual fund is to have the distributions reinvested in the fund,” according to Stanasolovich.