Monday, March 16, 2015

Federal Reserve effects on income investors

I can hear investor hand wringing from here.   They are a nervous wreck over how the Federal Reserve Bank’s actions may affect interest rates and subsequently stock prices


Every day the market moves in relation to what it thinks “The Fed.” Is going to do.  The Fed., of course, is the Federal Reserve Bank.  Janet Yellen, its president, will be speaking this week about how the Federal Reserve Bank will manage its assets and the effect that will have on interest rates.  Very smart and very rich investors are very nervous that the higher interest rates will negatively affect stock prices.

Even Alfred Ferol called me to discuss how we should position his portfolio.   Should you sell your winners?  Should you sell everything?  Is there anything you should buy?  

Here is my take.   Market timing is a fool’s errand.   For every report you read about stock prices going down in an environment of increasing interest rates, you can find a report that shows just the opposite.  This dichotomy of opinion is not new to investors.    What you need to do first is decide if you are really an income investor.

If you are an income investor, you only care about your interest, dividend, and covered call income. 

Interest Income

Interest comes from those bonds you bought at a discount to par.   The price of these bonds will go down if interest rates go up.   But the par value of the bonds stays the same and provided that you hold to maturity and the underlying company is solid, you interest income is probably safe. 

Hopefully, even if your bond maturities are laddered, your max duration is between 5 and 7 years.  If interest rates truly are in a period of consistent increases, you will be able to get more income from the next bond you buy in 5 or 7 years.

Dividend Machines

Some of your dividend stock prices may suffer.   Particularly those stocks that are dependent on European business.   During periods where US interest rates go up, the US dollar increases against the Euro making these multinational stocks go down.  A weak Euro means revenues, when measured by the US dollar, are less than when the Euro is strong.    But, a well selected multinational stock like Kimberly Clark, or Coca Cola, or Johnson and Johnson will still pay your dividend.  Moreover, it is highly likely they will continue to increase your dividend.

Many of these multinational companies were on quite a road up as far as stock price goes making their dividend yields look anemic (less than 3%.)   I usually try to sell calls on these stocks to get more yield and if my stock is taken away, I move the cash into a higher yielding stock.  But some stocks like JNJ do not have very good calls.   So when the price goes down, I either ignore it or I add to my position.

Covered Calls

Covered calls are the most variable of the three income streams I use.   You cannot count on selling calls on every stock every ninety days or so.   You have to work your portfolio constantly.   One of the good things about uncertainly is it leads to volatility.   Volatility is a covered call seller’s friend.   You only need one call buyer that thinks a stock is undervalued and has potential to go up to fill your cash coffers with covered call premiums.

In summary, be not a market timer.   I stick with my three primary sources of income, interest from discount bonds, dividends from Dividend Machines, and covered calls on Dividend stocks and then I go out to dinner.

Good Income Investing.