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Home » Business And Finance Articles » The 10 Rules For Successful Taxfree Income Investing

The 10 Rules for Successful Tax-Free Income Investing

Do you sometimes question the performance of your investment portfolio? If you are like most investors you have your income producing assets thrown in together with your equity portfolio. You look at the total mix of dividend paying stocks, bonds, mutual funds and equities, and you're confused as to why they're not producing enough income or growing your portfolio value sufficiently.

I have found that part of the reason is the nearly universal propensity of investors to ignore the long-term implications of their income investment decisions while they focus on short-term effects.

Because fixed income investing simply isn't regarded as being as exciting as other stock market investing, it has often been relegated to the "ho-hum" category by writers and not as much ink has been devoted to its ins and outs as has been expended on other types of investing. I think that's a disservice to those interested in this type of investment.

Investing for income, be it taxable or tax-free, -- and, for the record, my preference for generating tax-free income for clients is the use of CEETBFs (Closed End Exchange Traded Bond Funds) as described in my free e-book "How to earn 5% - 6.5% tax-free income." -- has some common denominators, which I have broken down into 10 rules. These will help you make better decisions and, at the same time, view income oriented investments with the correct mindset, so that you don't constantly try to second guess yourself.

1. It's important to consider the performance of the Fixed Income portion of a portfolio separately from the equity portion. Why? Because the objectives are entirely different.

Equity investments are for growth, while the primary purpose of owning fixed income securities is to generate a secure cash flow-either for spending or reinvesting until it is needed. For most people, the long-term goal of an Investment program is to generate enough income to live on, without having to touch the principal.

To most effectively analyze and manage your investments, keep your equity account separate from your income generating account.

2. All fixed income securities are "interest rate sensitive." Because of this their market price will always "vary inversely" with the anticipated direction of interest rates. Interest rates on the rise, prices will fall. Interest rates thought to be headed south, investment prices will move higher.

This applies to all Bond, Preferred Stock, & REIT prices. Accept it and live with it! The variables for the movement in price are the quality rating of the issuer, the length of time until Maturity, or the Call Date.

Do remember that price changes in Fixed Income Securities are not an indicator of, and have little impact on, the ability of the issuer to pay interest. So instead of beating yourself up when interest rates start to rise, take advantage of higher yields.

3. Because of what they are, Fixed Income Securities are generally held for the long term. The factor to consider is the amount of income being received. There is no benefit in trying to predict the future direction of interest rates, and I strongly suggest you avoid that-along with constant monitoring of changes in portfolio value.

Remember, fixed income investing works in a way like your day-to-day personal finances. You pay your expenses from your income, not from your net worth.

4. Buy only fixed income instruments where the costs are transparent. In other words, many new issues sold by brokers can carry hidden costs. While commissions have to be disclosed mark-ups don't.

There are often extremely large mark ups-3% or more is not uncommon-on new issues. Buyer beware.

5. Seek out instruments with the longest duration and only those that are Investment Grade. If you're conservative, you can find many closed end funds that are insured and use no leverage, though they offer a slightly lower yield.

6. All Interest Rate Sensitive Securities follow the same rules! This means the value of everyone's bonds will be going in the same direction as yours at any given time. Don't submit to temptation. Emotions, fear, or other non-objective motives are not good reasons to switch from one Fixed Income fund to another.

Focus on diversification and avoid investments with yields that seem too good to be true. In that aspect, Fixed Income investing and Equity investing share a couple common guidelines: (1) if it seems too good to be true, it probably is, and, (2) no matter how good the hype, you can't make a silk purse out of a sow's ear.

7. Income production is the primary reason to purchase Fixed Income Securities. Once you truly understand that you will realize that the only thing you need to pay attention to on your monthly statement is the "Income Received" number. I suggest you ignore the others.

8. To become a successful Income investor, you must also understand the following points and agree with them:

* Higher interest rates are a boon to the Fixed Income Investor; they put more money in your pocket.

* Lower interest rates also offer benefit for the Fixed Income Investor; they give you the chance to add Capital Gains to the total spending money your investments generate.

* Changes in the market value of Investment Grade Fixed Income Securities should have absolutely no meaning to you 95% of the time.

9. Open Ended Income Mutual Funds will not serve your objectives. It is no secret that the fixed income variety almost never go up. As interest rates cascaded downward over the last several years, Open Ended Income Mutual Funds did not show the same degree of gains enjoyed by individual securities-while Closed End Funds did respond to these factors.

10. There are a number of reasons why it's to your benefit to primarily use Closed End Exchange Traded Funds: Low acquisition costs, complete liquidity, professional fund management and monthly predictable cash flow. Additionally, you're offered the opportunity to buy more when prices fall and to realize capital gains when interest rates are on the downturn.

Why haven't you heard about these funds from your financial professional before? Especially now when many are yielding around 6% tax-free? For the simple reason that there is no money to be made for the financial professional recommending them. While these funds may increase your monthly income, they won't do a thing for the commission hungry salesman.

If you manage your portfolio, hopefully these 10 points will assist you in more profitable investing. If you're unsure about putting an income portfolio together by yourself, find a professional who works with these types of funds and is aware of the principles I have described, and let him or her assist you in creating the income you need to enjoy a dignified retirement.

© Ulli G. Niemann

And here is another random article you might be interested in...

Credit Card Debt Management

Credit cards that are used in moderation could be helpful in managing your finances. This means that splurging through the use of credit cards is almost financial suicide.

Here are few tips to manage the way you use your credit card to prevent you from acquiring debts that could lead to your financial death (excuse the pun).

1) Planning. Before purchasing any product using your credit card, make sure to provide yourself with a plan on how you will be able to pay for your credit card bills. Prioritize your needs before your wants. Purchasing grand items that you don't really need might give you that temporary high that impulsive buyers are addicted to. But that temporary high would eventually turn to long-term down feeling due to your piled up debts.

2) Limit. For you to be able to manage your debts and payments, never go overboard when it comes to your credit limit. If it's possible, it will help a lot if you just use about two-thirds of your limit.

3) Statement of account. Keep a record of all your credit card transactions for future reference. In order to prevent inaccuracies of bills and fraud, always remember to check the list of your purchase for the month. If your list and the statement of account do not match, report this to your bank.

4) Piled up debt remedies. There are a number of steps you have to do in order to escape these financial problems.

* Determine the amount you need to pay and provide yourself with a plan that would fix your finances without pressure.

* Consider paying the minimum amount to be paid. Then, ask for debt consolidation options that would make it a lot easier for you to pay your debts. If you don't know how to solve your financial problems, there are financial advisers that could help you with your credit card management. They might offer you financial assistance through bank loans that would allow you more time to pay aside from the debt consolidation method. But of course, remember to research on the agency before getting involved with them. Don't just go saying amen to whatever they offer since there is a possibility that they could cause the situation to aggravate.

Self-control is the best way to prevent getting debts that you won't be able to pay immediately. But if you're already in the pits, considering the abovementioned suggestions won't hurt.