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Finding Income in a Closed-End Fund

Finding Income in a Closed-End Fund
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In our low-interest rate environment, many retirees are desperate for income-creating investments. Income is typically thought of as interest, dividends, or capital gains. If you think income of 5-10% sounds good, you might want to look into the world of closed-end funds.

(Please note: This is not a recommendation; it is information for your consideration. I do not know what works for your portfolio or comfort level.)

Closed-end funds (CEFs) are similar to mutual funds or exchange-traded funds (ETFs) in that they represent a portfolio of stocks, bonds, or other investment vehicles. They are typically managed for income generation. Unlike mutual funds or ETFs, you buy closed-end funds on the stock market for their market price, which could be more or less than the value of the fund’s portfolio. Their market price is said to trade at a premium or a discount to the value of the fund’s holdings.

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The market-priced CEF means the fund’s price will fluctuate with supply and demand, which means your account value with CEFs will fluctuate. However, if your objective is income and CEFs meet your income needs, does your account value really matter?

Suppose you own an investment home that you rent out. You use the rental income to supplement your retirement income needs. The market value of the home could rise or fall, but since the objective is income, the home’s market value is not an issue. That’s how to view a CEF: An investment’s market value only matters if you plan to sell the investment.

Can you deal with volatile market prices? Are you going to hold the CEF because there is no need to sell? (I held onto these funds during the 2008 market drop — and while I had to shallow hard a few times, they just kept paying.)

If you consider CEFs for your income needs, you’ll want to understand these fund management actions: managed distributions, return of capital, and leverage.

Managed distributions ensure you receive relatively stable income over the year. Return of capital is one way a fund manager can provide income and manage the fund’s tax situation. Leverage is when the fund borrows money to boost its holdings and potential payouts. Leveraged funds have increased volatility.

If you’re interested in CEFs, do your own research or consult your financial adviser.

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About the Author

Lt. Col. Shane Ostrom, USAF (Ret), CFP®

Lt. Col. Shane Ostrom, USAF (Ret), CFP® retired from the Air Force in 2000 and joined the MOAA team in 2006. His responsibilities include researching and answering member inquiries regarding military benefits, health care, survivor issues, and financial concerns.