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Posted by Michael on July 26, 2008, 10:15 am
My fixed income account is comprised of between 25% and 30% financial
issues (preferreds, bonds, a few funds). After taking a sizable hit, I
asked my advisor if we weren't overweight in that sector. He said that
with an income producing account a good portion of that account will
invariably consist of financials. Is this correct? Thanks in advance.
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Posted by dapperdobbs on July 26, 2008, 8:15 pm
> My fixed income account is comprised of between 25% and 30% financial
> issues (preferreds, bonds, a few funds). After taking a sizable hit, I
> asked my advisor if we weren't overweight in that sector. He said that
> with an income producing account a good portion of that account will
> invariably consist of financials. Is this correct? Thanks in advance.
Sounds like it depends on what definition you are using for
"financials". I think generally, "financials" refers to a very diverse
number of companies whose principal business consists of lending
money, whether for construction, equipment, or consumer loans. A bond
is not, as far as I understand, a "financial", but could be classed
that way if issued by a company whose business is, for example,
banking.
Traditionally, a fixed income portfolio would contain interest-bearing
intruments (such as bonds), or high yield preferred stocks - such as
you have. The idea is that bonds will not default, so the principal is
safe. Preferred stocks may be "cumulative preferred" - their dividend
is (given a priority) subordinate to interest, but senior to the
common stock, and if suspended, continues to accrue (cumulate) and
will be paid out when the dividend is restored. There is some
additional stability in preferred stock, due at least in part to the
higher dividend payout. But the principal in bonds and preferreds is
also subject to loss of purchasing power due to inflation. Thus when T-
Bills fall below the rate of inflation, they actually pay "negative
interest". Other classes traditionally found in income portfolios are
utilities, municipal bonds, and perhaps some CD's.
With interest rates at their current low levels, many dividends paid
by non-financial companies are higher than most interest rates. An
important factor not to be overlooked is that many companies have
steady earnings increases from year to year, and a history of
increasing their dividends. A screening program can give you high
dividend payouts, but there are all the factors of the company to be
very carefully considered before buying shares of the stock. Your time
frame is an important factor to consider - the longer it is, the more
time you have for dividend increases, and the less you have to worry
about overall market vagaries up and down. But you always have to look
very carefully at the underlying business of the company.
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Posted by Michael on July 28, 2008, 4:00 pm
Dapperdobbs, my sincere appreciation for one of the most complete and
concise answers I have ever received on this subject.
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Posted by anoop on July 28, 2008, 7:56 pm
> With interest rates at their current low levels, many dividends paid
> by non-financial companies are higher than most interest rates. An
> important factor not to be overlooked is that many companies have
> steady earnings increases from year to year, and a history of
> increasing their dividends.
Keep in mind that the high dividend % currently being reported
may be misleading. Many stocks have fallen in anticipation of
reduced earnings making the past dividends look overly attractive.
Anoop
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Posted by on August 12, 2008, 7:06 pm
> My fixed income account is comprised of between 25% and 30% financial
> issues (preferreds, bonds, a few funds). After taking a sizable hit, I
> asked my advisor if we weren't overweight in that sector. He said that
> with an income producing account a good portion of that account will
> invariably consist of financials. Is this correct?
First, to be very clear about what we mean by "financial issues" here,
most likely your account's decline was due to bank-issued preferred
stocks and/or bonds.
Second, I assume by "fixed income" you mean income that will not
adjust with inflation and so is pretty much the same dollar amount
year after year. If so, I would expect a "fixed income" account to
hold high grade corporate bonds; government bonds; and preferred
stocks. When it comes to preferred stocks, one can peruse
quantumonline.com to see what is typical. Use its screener (under
"income table"), and filter by company type. Banks and financials are
about 300 of 1200 preferreds. So I would say your advisor is being
accurate.
I am studying what has happened with banks this past year or so and
propose another question: Should we as investors expect managers of
our fixed income accounts to take more care? I think overall this
would be asking a little much. First, I propose the mission of a fixed
incom account's manager is to preserve income first and be less
concerned with the principal's fluctuations. Second, it seems to me
the decline in banking securities happened rather quickly; people,
even those in the business of investing, got caught off-guard. Third,
what would the manager buy in place of the sold bank securities?
Fourth, if the bank preferreds etc. started as pretty high grade,
chances are they have downgraded but not all the way to junk, meaning
your income should remain safe. Fifth, I would wager it's been over a
decade since bank preferreds and bonds have seen such a massive
downturn. Fact is that many banks' credit obligations were not
obvious.
To me, the only argument that might counter this is that banks are
inherently risky. Banks' common stock P/Es historically are well below
the P/E of the S&P. This is evidence of the risk. Should a fixed
income account manager therefore have fewer bank preferreds and bank
bonds? I would say no, because high grade preferred and bonds have
more safety built into them, as dapperdobbs describes.
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to keep the conversations on-topic for financial planning. Other posting
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