Income Investing: Go Ask Alice

Jefferson Airplane has never, ever, been mistaken for a band of financial advisors, but the White Rabbit lyrics can be incredibly instructional to the generation of investors who experienced the classic first hand--- as a description of their own college days' lifestyle. If only they had heeded the dormouse's call to "feed your head." For the sake of your retirement sanity and security, you just have to make income investing an intellectual exercise--- not an emotional one.

The Brainwashing of the American Investor has its own tale of an Alice whose "logic and proportion" had "fallen sloppy dead". Many years ago, when interest rates soared into double digits, elderly Alice was well advised to invest her stash in a portfolio of Ginnie Maes. Smiling broadly, she bragged to her friends about the federally guaranteed 13% interest she was receiving in regular monthly intervals--- much more than she needed to cover her living expenses.

But interest rates continued to move higher, and the decreasing market value of her Ginnie Maes was more than she could tolerate. "If rates continue to go up, I'll have nothing left" she cried to her White Knight financial advisor who suggested patience and understanding. The very same pill that made her income grow larger was also making her market value become smaller. But the income kept rolling in, higher yielding unit trusts were purchased with the excess, and major redemptions were nowhere to be seen. The income kept growing, the market value kept shrinking, and Alice was seeing red from seeing red on her account statements.

So Alice went to her local bank and traded in her absolutely government guaranteed 13 per centers for some laddered, non-negotiable, 8.5% CDs. "No more erosion of my nest egg", she toasted proudly with the hookah smoking bank caterpillar who orchestrated her move to lower income levels. Within a few months, she was liquidating CDs to pay the bills that never seemed to be a problem with those terrible Ginnie Maes.

Don't let such uninformed thinking sabotage your retirement program; don't let the selfish advice of a product sharpshooter send you chasing rabbits when IRE (interest rate expectations) or other temporary market conditions shrink the market value of your income portfolio. Feed your head; feed---your---head. Income pays the bills, and if the income level is both steady and adequate, there is no need to change investments. Market value should be used to determine when to buy more (at lower prices) and when to take profits (at higher ones). It is almost never necessary to take a loss on a high quality (government guaranteed in Alice's case) income security.

More recent experimenters in much more sophisticated potions have addressed the issue with similar results, reaching mind-numbing conclusions such as these: 1) I know that my income has actually grown throughout the debacle in the financial sector but I don't want to buy anymore of these securities until the prices go back above what I paid for them originally. Translation: I'd rather stick with my 4.5% tax-free yield than increase it by adding to my positions at lower prices.

2) Sure, I understand the relationship between IRE and the prices of income CEFs but individual bonds and Treasuries haven't suffered nearly as much. That's where we should have been. Translation: I would be much happier with 3% stability than with an 8% rate of realized spending money. 3) I'm tired of seeing all the negative positions in my portfolio. Let's keep all the income we receive in money market until we're back in positive territory. Translation: I'd rather accept 1.5% or so than reduce my cost basis and compound my yield by adding to my positions at lower prices.

Modern brokerage firm monthly statement "pills" were developed during the dot-com drug era, when Wall Street was trying to emphasize the brilliance of its speculative prescriptions by making us all feel ten feet tall, month after month after month---. But the geniuses on the institutional chessboard produced too many mushroom product varietals causing the red correction queen to lop off many of their sacred heads. The papers that were designed to make our chests burst with pride have turned on us as a haunting reminder of the reality of markets and the cycles that push them in either direction.

It should be easy to navigate a quality income portfolio through whatever circumstances, cycles, and scandals come at you, but a clear head and a clearer understanding of what to expect is required. Most brokerage firm statements make it difficult to monitor asset allocation using any methodology, including the Working Capital Model, and I don't think that it's by chance. Most income investors expect income securities to have stable market values. Constant confusion breeds unhappiness, unhappiness foments change, and the masters of the universe encourage you to fritter around from mushroom to mushroom in perpetual emotional chaos. To who's benefit?

It would be wonderful if an investor's monthly statement would organize his securities based on their class and purpose, but Wall Street doesn't want such distinctions to be made easily. It would be great if the institutions would help investors formulate reasonable expectations about what will happen to the market values of their securities in varying market place conditions, but that's not likely to become a reality any time soon. It would spectacular if the media would produce information and explanation instead of news bites and sensationalism, but you guessed it--- not much chance of that either.

Income investing should be easy. How many hookah-smoking caterpillars have given you the how?