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Author: brewer12345 Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35367  
Subject: Re: Income Investing: 5.5% goal possible? Date: 6/22/2011 9:42 AM
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Since the 10 year treasury yields a bit shy of 3% and well below your target, you have to accept some risk to generate 5.5%. But since there are few (if any) risk free investments, this is more about taking a measured risk to make a reasonable return.

The first thing to figure out is what your risk tolerance is to get your target return. You would also want to see if your return hurdle is achievable given your return goals.

I manage an account for my father in law that is specifically intended to generate reasonable returns without taking too much risk. I have used a variety of instruments over time, including fixed income, merger arbitrage funds, covered call funds, foreign bonds, REITs, commodities, convertibles and CDs. I have generally been successful, and the drawdown during the recent crash was pretty modest (on the order of 10 to 15%).

Key to this strategy is always looking for the "fat pitch" on instruments that don't have too much volatility. So although I see small cap equities that have excellent return potential (AXL, for example), I will not buy them for his account due to excessive volatility. But when the VIX was north of 40 and I could buy covered call CEFs at a double digit discount to NAV, I bought with both hands.

At the moment, this account is loaded with fixed income CEFs trading at double digit discounts to NAV (BKT, JQC, ACG), vanguard convertibles fund, a dollop of commodities (PCRDX), and a slug of what amount to low volatility hedge funds that can be bought retail (MERFX, ARBFX, LCMAX). I have been letting cash build up as well, which I do from time to time so that I can grab the next fat pitch when it shows up.

Is there risk in this strategy? Sure, especially interest rate risk at the moment. But the risk is a lot lower than an equity or junk heavy portfolio and it is fairly diversified. Plus I meet the middle to high single digit return hurdle. It is not terribly tax efficient, though.

YMMV.
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