Wednesday, June 10, 2015

Debating the Merits of Closed End Funds

I've struggled a bit with whether closed end funds (CEFs) deserve a place in a dividend portfolio. I had 5% of my portfolio in CEFs at one point last year. I later sold all of my CEF holdings in a quest to increase the quality of my dividend income. I've decided again to add some exposure to CEFs. Here's the biggest reason why:

I've been debating about what assets should count when figuring a safe withdrawal rate for early retirement. I'm a big believer in the 4% Rule. I think it is highly defensible and both reasonable and prudent to plan based upon it. I'm the kind of person who will build in a decent cushion, so whether the most correct SWR is something modestly below 4% isn't so important. Just that it's a quality starting point.

But the next question becomes: which assets should be included as part of the calculation for withdrawal rate? Is it just the taxable portfolio? Do I add home equity? What about retirement accounts? After months of chewing on the issue, I've decided to use taxable investment accounts plus retirement accounts. Basically, any account that invests in stocks, bonds, and mutual funds.

Why did I come to this conclusion? Well, I'm relying on my retirement account to fund the later stages of my retirement. Thus, it should be included. If I exclude it, my safe withdrawal rate is below 4% by a meaningful amount. Currently, the dividend yield of my taxable account is about 3.8%. If I include my retirement accounts at a 0% withdrawal rate, the withdrawal rate of my total accounts is closer to 3.0%. So to get it to 4%, I need to juice the yield!

This is where CEFs come into play. They yield between 8-9%. The income may not be "sustainable" or "high quality", but it's a way to increase a withdrawal rate without selling shares of high quality companies. I'd expect to invest about $10-15k in CEFs over the course of the next few months.

What made me comfortable making this switch is that I used and noticed that using just my expenses and taxable account forecasted value at retirement, the account has a 100% success rate until about age 60. After that, the success rate is more like 75%. The assumed withdrawal rate is close to 5%. If I add in my retirement accounts, the withdrawal rate is just below 4% and has an overall success rate of  95%!

What role do CEFs play in your portfolio? What assets should count towards the 4% Rule? Is it a good idea to use such a high SWR?

1 comment:

  1. Most of traders used to do own KLSE stock analysis and then invest in stocks, and not in open or closed ended funds.