A Better Investment for Passive Income (Part 1)

I met with my personal banker a few months ago; a nice, intelligent chap who is driven and hardworking. To cut the story short, our meeting ended shortly after he introduced a couple of investment options and I asked which of them offer returns in excess of 8% per annum.

For comparison, your standard savings account pays between 0.05% to 0.4% per annum. That's $40 every year for for every $10,000 you leave in your bank account. What if I say I know a way to make 37x of 0.4%? I bet I have your attention now.

I discovered Closed End Funds (CEF) more than a decade ago and they formed the larger chunk of my investment portfolio up until recently. Investopedia explains what a CEF is but in short, it is a mutual fund that offers higher dividends (monthly/ quarterly payouts) with little-to-no capital gains (appreciation of share price).

Below are two CEF currently in my portfolio. Charts are added only for aesthetic value :)

Cornerstone Strategic Value Fund (CLM), pays a monthly dividend of US$0.23 (before tax) at a price of US$14.90 a share. This gives you a return of 18.5% per annum.

Oxford Lane Capital Corporation (OXLC), pays US$0.60 quarterly  (before tax) at a price of US$11.02 per share for a return of 21.8% return per annum

As you can see from above, CEF are great investment tool for generating stable passive income with significantly lower risk than investing in equities. 

Who should invest in CEF?

If you are currently employed and does not have the "freedom" to track the stock market. CEF is a great way to park your money aside and let it bloom on its own. 

If you have large amount of savings sitting idle in your bank or wads of cash rolled up in your Milo tin can. Definitely!

If you are wondering if there are better options than buying endowment plans or topping up your CPF OA/ Special account for that paltry 4% (well, it's capital protected). Maybe. It depends on your risk appetite.

Who should not invest in CEF?

What you lose with CEF is opportunity cost. Thus, CEF is not for you if you are a savvy investor who can make more through other investments. 

Here are some tips💡for investing in CEF

• CEF depreciates in capital more often than they appreciate. As such, the common strategy is to average down your holdings on a regular basis to keep it inline with the current share price.
• Some funds pay monthly dividends versus quarterly dividends. Monthly dividends are smaller and hence, capital depreciation during ex-dividend is usually unnoticeable.
• When choosing CEF, take note of it's net present value (NPV) and its reputation for paying out dividends predictably. CEFConnect is a great site for finding those information. In addition, you can read up the fund at Yahoo! Finance and download the historical performance the fund.
• Invest in the CEF before the ex-dividend date to receive a payout but the lowest price to get in is usually on the ex-dividend date itself.
• The upside to investing in CEF is stability but you will need to pay a 30% tax to the US government as dividends are classified as income.
• Low risk does not equate to no risk. Investing differs from gambling when you make informed decision based on facts and historical data.

Advanced CEF investing

There a couple of investors I know personally who moves between funds to maximised their capital returns. Doing this requires impeccable timing, precision and an uncanny familiarity with the  dividend calendar. Most of them pick 2-3 CEF and cycle through them monthly; selling on the ex-dividend date and making in excess of 40% returns on capital annually.

I am not smart enough for that. 

Once again, I have intentionally kept this post short. Feel free to drop comments, ask me any questions you might have on this topic or if there are topics you would like me to write about.

Have a great week ahead!