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5% Withdrawal Rate Portfolio
Old 02-23-2015, 04:43 PM   #1
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5% Withdrawal Rate Portfolio

The speaking on the monthly payment of the portfolio got me to thinking about the retirees who might not be real comfortable with standard advice of becoming a do it yourself by reading the Boglehead boards, a few retirement books and determining a withdrawal rate your risk tolerance will allow you to withdraw.

Many retirees enter retirement with little money, these retirees end up being the 70-80 year olds living on Social Security, so I thought 5 percent withdrawal could be possible, here is how I did it:

First the portfolio:
66.6% DNP - Managed Closed End Utility Fund that pays a monthly .065 cents per share distribution I mentioned on the another thread. These are mostly regulated industries with mostly predictable revenue streams that have been capitalized on to provide a steady .065 cents per share for 18 years. Currently trading at a 4 percent premium to assets

16.7% SDOG - S&P 500 ETF dividend dogs, tracks S&P500 very closely with much higher dividend rate. This is for exposure to large cap stocks, trades at NAV.

16.7% RVT - Royce Value Trust - a managed small cap fund that has a managed distribution policy of paying 7 percent of the prior 12 month average net asset values. The fund currently trades at an 11 percent discount.

So as this portfolio is composed with today's asset prices, DNP's monthly dividend at this percentage of the portfolio leads to a 5 percent payout based on the total portfolio value. I implemented this as a real portfolio in one of my IRA's using $36,375.63 to set up a payment of $150.00 per month. I had a small keying error on my purchase of RVT that led to an extra 375.63 investment but I wanted to have an actual portfolio to track going forward to see how this would actually do. I think real numbers are far more interesting as an experiment:

Actual Portfolio Shares:
2,308 DNP = $150.02/mo distribution
150 SDOG ~ $52.50 Quarterly
420 RVT ~ $102.90 Quarterly
Total at current distribution is $51.33 for reinvestment/future increases

The rules I developed to address inflation needs are:

1) Payout will start at $150 per month on March 23rd 2015 and continue for the rest of my life with annual increases each March 23rd of the lessor of the annual change in CPI or 3 percent. Should inflation exceed 3 percent the increase will only exceed 3 percent to the extent prior increases in the payout were less than 3 percent. So that the maximum payout band for the next 10 years per month are, but can be less if inflation is less over that time period:

2015: 150.00
2016: 154.50
2017: 159.14
2018: 163.91
2019: 168.83
2020: 173.89
2021: 179.11
2022: 184.48
2023: 190.02
2024: 195.72

2) Reinvestment of excess funds will be done annually on March 22nd and in a way to best optimize the 66/16/16 balances.

3) Rebalancing by selling/purchasing shares of RVT SDOG and DNP will occur only if value of RVT or SDOG exceeds 25% of portfolio value and shares will be sold to reduce that overvalue back to 16.7 % of portfolio. Shares of DNP once purchased are never sold, no matter the portfolio percentage of DNP. Shares of DNP are for base payout and RVT and SDOG for growth of portfolio to meet inflation.

4) At end of each year 1 months future distributions will be held in cash for cash reserve of distributions. So that March 22 2016 $154.50 will be held in cash before reinvestment of excess. Total cash should be in the area of $605 next year.

5) Payments are only made from distributions and shares are to never be sold to meet distribution, if distributions do not "earn" the monthly payout then the monthly payout will be the amount of distributions. This at present does not appear to be an issue for the next ten years, based on present data.

That is it actually simple to implement, aggressive in it's hopes and done when stocks are at an all time high. Yet I still believe this is very likely to be successful in the long term. An annual review needs to take place for the outlook for the next ten years to see if the plan needs adjustment.

If I knew someone who had limited funds and needed to be able to maximize withdrawals while being able to have the individual withstand market drops by showing with real data the investor is actually buying more distributions at lower costs in a falling market this is the way I would do it. It provides a limit for distributions based on performance without selling shares allows for an initial 5 percent withdrawal and a slowing mechanism if this turns out to be too aggressive, thereby allowing the 5 percent withdrawal.
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Old 02-23-2015, 06:54 PM   #2
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http://online.barrons.com/articles/y...ors-1422482063

66% in DNP? Yikes.

Above article is about valuations and current risks in this area, from Barrons a couple of weeks ago.

Longer term, who knows what could negatively affect utility shares.

I'd be unable to sleep at night with so much in one industry, although it is one that has been less risky. YMMV.


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Old 02-23-2015, 07:29 PM   #3
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I'd probably spread it out a bit more than 66% in one CEF, but I don't think DNP is particularly risky.

New Addition To My Dividend Compounding Portfolio: Duff & Phelps Income Fund - DNP Select Income Fund (NYSENP) | Seeking Alpha
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Old 02-23-2015, 08:03 PM   #4
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And RVT: If it "has a managed distribution policy of paying 7 percent of the prior 12 month average net asset values", then it may not be technically correct to say that our portfolio won't be selling shares. To stick to that 7% distribution come what may--there could very well need to be some selling. Yes, it trades at a nice discount, but has an ER close to 0.7%. I'd look to keep more of every dollar I've got working for me.

If I had looked at every place I could cut and still absolutely needed a 5% WR (with inflation adjustments), I'd probably be forced to go with a high % of equities and would probably tilt toward value stocks (which also tend toward higher dividends). But I'd recognize I was rolling the dice and increasing the chance of crashing in order to get that 5%. And I'd keep an eye on Otar's "red zone" as I got older and watch interest rates for a chance to buy an inflation-protected SPIA when/if the time was right.
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Old 02-23-2015, 08:25 PM   #5
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Another thing is that if your portfolio suvival period drops to 25 years, and then 20 years, you can draw more anyway as long as you have a reasonably diversified portfolio.
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Old 02-23-2015, 08:28 PM   #6
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And RVT: If it "has a managed distribution policy of paying 7 percent of the prior 12 month average net asset values", then it may not be technically correct to say that our portfolio won't be selling shares. To stick to that 7% distribution come what may--there could very well need to be some selling.

If I had looked at every place I could cut and still absolutely needed a 5% WR (with inflation adjustments), I'd probably be forced to go with a high % of equities and would probably tilt toward value stocks (which also tend toward higher dividends). But I'd recognize I was rolling the dice and increasing the chance of crashing in order to get that 5%. And I'd keep an eye on Otar's "red zone" as I got older and watch interest rates for a chance to buy an inflation-protected SPIA when/if the time was right.
The portfolio is not selling shares RVT is a managed fund and they sell shares all the time as part of their management. They are just committed to returning 7 percent of the portfolio per year, therefore the selling decisions are theirs and not the portfolio owner.'s decision to make and they just arrive quarterly in the distributions. And while RVT trades at a discount when they distribute 1.00 per share 10 cents of that distribution wasn't even reflected in the stock market price due to the discount more than offsetting the 9.8 cents of expense on the portfolio, making the investment actually expense free. As long as RVT continues to trade at a discount those distributions are hugely favorable to uncovering value on your purchase and advances in the market.

The advantage of the system I outlined here is no research is needed on whether or not the 5 percent withdrawal will work, it lets you know when you are in trouble easily. You just have the cash monthly come to your account and review your status each year.

This is not a strategy I would advocate for most people on this forum, as the level of sophistication is so much higher of the forum participants, however often there are people who are short of retirement funds or scared of the stock market and only want steady income and so I designed what I thought was a good answer, to arrive at a relatively stable level with an upward growth bias that is about 90% overall in stocks, which is the only way to get a 5 % withdrawal to work over the long term with interest rates what they are today.

For people that are just in fear of the market the distributions from the funds being consistently able to meet the monthly transfer will I think enable people to see this would work for them and have some market risk when otherwise they would refuse to get into the stock market invest some money in the stock market.

After I designed it appealed to me intellectually and I feel if I outline how I do this my wife will be able to continue this strategy, unlike my common stock selections which she would never be able to implement. So if I were to die before her and have a demonstrated path of success, she would hopefully not just sell all my stock into bonds and live on that. I also know quite a few other people who sold in 2009 and never got back into the market. Following a real investment over the long term that is actually made is far more convincing than theoretical portfolios or alluding to tweaks made to a portfolio.
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Old 02-23-2015, 09:42 PM   #7
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Observation:
- Distributions from the plan do not keep up with inflation, unless inflation is less than 3%.

Opinions:
This plan is not as simple as it might need to be (ref if--> then rules for distributions, need for a re-look every year with a view toward the outlook for the next 10 years, etc. Not good for a couch potato--clearly they would not know what sectors will do well for the next 10 years. People who study securities every day don't really know.)
If the plan is designed for an investor without the interest or background to make detailed investment decisions, then there is a problem in that the underlying principles are opaque to that investor (i.e. the Dogs of the Dow strategy, how DNP operates, where the distributions from RVT are coming from, etc). The recipient of these funds is just asked to rely on the black box, and will undoubtedly be subject to a sales pitch from someone else with a better "black box" (with lots of back-tested data to prove it).

Here's "simple" (IMO): Put all the money in either
a) a single target-date fund chosen to match their circumstances
b) Wellington + MM fund (or one of the very short term bond funds which will come on the market soon to complement MM funds)
c) Wellington + MM fund
d) Vanguard Balanced Index Fund + MM fund.
e) One of the well-known "Lazy portfolios" (though this will require rebalancing--maybe not a good thing/temptation for our disinterested retiree. On the plus-side: some have a blog or book that may be useful in givign the recipient an intellectual underpinning for what he is doing, to help him stay on the right path despite entreaties from FAs, helpful friends, etc)

On one day each year, take 5% of the existing fund balance and put that in a MM account to be autoforwarded to the checking account at a rate of 1/12th every month. The recipient will never run out of money, they will pay much lower ERs, and they don't need to worry about their "lifeline" CEF being liquidated or merged into something else, or that new government policies or other unforeseeable factors will make utilities a bad bet. If the recipient wants to know if their portfolio is "keeping up" with inflation, they can just check the CPI figures to see if their monthly check grew by the right amount. If they are losing ground--they need to cut back somewhere. Much better to find out early rather than to continue taking a set amount adjusted for inflation until the money is entirely gone.

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The portfolio is not selling shares RVT is a managed fund and they sell shares all the time as part of their management. They are just committed to returning 7 percent of the portfolio per year, therefore the selling decisions are theirs and not the portfolio owner.'s decision to make and they just arrive quarterly in the distributions.
I was just pointing out that the below info was possibly misleading, as shares will be sold (even if the recipient isn't seeing it)
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5) Payments are only made from distributions and shares are to never be sold to meet distribution, if distributions do not "earn" the monthly payout then the monthly payout will be the amount of distributions.
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Originally Posted by Running_Man View Post
Following a real investment over the long term that is actually made is far more convincing than theoretical portfolios or alluding to tweaks made to a portfolio.
I can see how that might be appealing, but I think it is highly subjective. I'm (personally) not much swayed by the actual results an investor got over the last 10 years as a guide to future expected returns, and if I saw a plan that involves narrow sector funds etc I'd question whether the same sectors are likely to perform as well forever.

But I can see the attraction of your plan, and my opinion shouldn't carry any special weight. It's obvious that you've spent some time on this.
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Old 02-24-2015, 01:17 PM   #8
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@Samclem,
I see your point and what I will do will include c & d versus what actually occurs with the chosen method I have chosen. However what % of stocks/MM would you recommend for this comparison and is there annual rebalancing? Or is this all fund and only the 5% transfer annually occurs?

RM
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Old 02-24-2015, 03:09 PM   #9
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70% of DNP appears to be in the water, gas, and electric. They have really road the interest rate tailwind for several years. Many of these are running near astronomical 18 PE's, low growth, and 3% plus yields. Who knows the future, but that would concern me. Of course I am being hypocritical as I won't touch a utility common, but I keep loading up on utility preferreds. I love the near 6.5% I am getting and willing to accept price movement to get the yield. In fact if they drop I will buy more too!


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Old 02-24-2015, 05:06 PM   #10
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For what it is worth, I mistyped previously and choice "b" should have had Wellesley and choice "c" should have been Wellington. The main difference between the two is the allocation to stocks and bonds: 60s/40b for Wellington (VWELX), 40s/60b for Wellesley.


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@Samclem,
I see your point and what I will do will include c & d versus what actually occurs with the chosen method I have chosen. However what % of stocks/MM would you recommend for this comparison and is there annual rebalancing? Or is this all fund and only the 5% transfer annually occurs?

RM
Given the situation you have described (where the investor needs every dollar working for him in order to fund retirement spending), it would probably be best to minimize the amount of cash (MM) and just have every dollar in stocks and bonds. So, for purposes of comparison (and for simplicity), I would just hold zero in MM except for a small sweep MM account to hold the annual disbursement from the main account which is then sent to the checking account in 12 equal monthly installments. That eliminates the need for rebalancing, etc. More importantly, it makes it easy to go back and see how the options would have done in the past (just be sure to use data that includes the dividends that were paid). One source of annual total return values for many MFs is Yahoo finance (for VWENX as an example, see VWELX Performance Overview | Vanguard Wellington Income Fund Stock - Yahoo! Finance ). I think you'll find that waiting for actual results goign forward in real time will take a very long window before anything is evident--and then you've still just got one set of data. Looking retrospectively you can get a feel for the possible ramifications of various asset allocations much more quickly, and do many 25-30 year windows (as FIRECalc does). There's nothing wrong with this approach, as long as you don't torture the data to optimize an asset allocation/withdrawal scheme, etc that would only work in a very rare set of circumstances that is unlikely to be repeated. The future won't be just like the past--but we are all counting on the main factors staying roughly similar.

Obviously, in the real world there are lots of possible variations. At the end of the year, some investors take any excess above inflation (after their annual withdrawals) and put it into a very stable short-term bond fund, CD, or a bank savings account until an acceptable buffer is built up (say 2-4 years spending) to help them meet expenses if their portfolio takes a big dive. This may help them stay on course from a psychological perspective, but it has been shown to take a big toll in terms of performance of the portfolio if taken to extremes. It's better to leave the money at work and to have a means to dampen the volatility of withdrawals.

Bob Clyatt's book "Work Less, Live More" also presents a withdrawal smoothing approach (the "95% rule") that can help dampen the annual variance in withdrawals (more here, as well as in other threads). It can be easily modeled via a checkoff box in FIRECalc. In the case we are discussing, I think many people would find this more attractive than carrying a lot of cash (dead weight).
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Old 02-24-2015, 06:13 PM   #11
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For what it is worth, I mistyped previously and choice "b" should have had Wellesley and choice "c" should have been Wellington. The main difference between the two is the allocation to stocks and bonds: 60s/40b for Wellington (VWELX), 40s/60b for Wellesley.

Given the situation you have described (where the investor needs every dollar working for him in order to fund retirement spending), it would probably be best to minimize the amount of cash (MM) and just have every dollar in stocks and bonds. So, for purposes of comparison (and for simplicity), I would just hold zero in MM except for a small sweep MM account to hold the annual disbursement from the main account which is then sent to the checking account in 12 equal monthly installments. That eliminates the need for rebalancing, etc. More importantly, it makes it easy to go back and see how the options would have done in the past (just be sure to use data that includes the dividends that were paid). One source of annual total return values for many MFs is Yahoo finance (for VWENX as an example, see VWELX Performance Overview | Vanguard Wellington Income Fund Stock - Yahoo! Finance ). I think you'll find that waiting for actual results goign forward in real time will take a very long window before anything is evident--and then you've still just got one set of data. Looking retrospectively you can get a feel for the possible ramifications of various asset allocations much more quickly, and do many 25-30 year windows (as FIRECalc does). There's nothing wrong with this approach, as long as you don't torture the data to optimize an asset allocation/withdrawal scheme, etc that would only work in a very rare set of circumstances that is unlikely to be repeated. The future won't be just like the past--but we are all counting on the main factors staying roughly similar.

Obviously, in the real world there are lots of possible variations. At the end of the year, some investors take any excess above inflation (after their annual withdrawals) and put it into a very stable short-term bond fund, CD, or a bank savings account until an acceptable buffer is built up (say 2-4 years spending) to help them meet expenses if their portfolio takes a big dive. This may help them stay on course from a psychological perspective, but it has been shown to take a big toll in terms of performance of the portfolio if taken to extremes. It's better to leave the money at work and to have a means to dampen the volatility of withdrawals.

Bob Clyatt's book "Work Less, Live More" also presents a withdrawal smoothing approach (the "95% rule") that can help dampen the annual variance in withdrawals (more here, as well as in other threads). It can be easily modeled via a checkoff box in FIRECalc. In the case we are discussing, I think many people would find this more attractive than carrying a lot of cash (dead weight).
In your examples, would you have dividends and capital gains distributions paid to the MM throughout the year or would you have them reinvested?
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Old 02-24-2015, 06:29 PM   #12
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In your examples, would you have dividends and capital gains distributions paid to the MM throughout the year or would you have them reinvested?
I'd reinvest them.
In the "old days" (that is, until a couple of years ago when brokerages/MF companies had to start tracking cost basis), I and a lot of folks got in the habit of having all divs and CG distributions go into a MM account, then using that money during the rebalancing to invest in assets that needed to be plussed-up. This made recordkeeping easier. Now that someone else is tracking the cost basis for me, I just let the small additions buy more shares, it's very easy to sell the lots as needed when you rebalance, and with MM rates at zero, it makes sense to have this money at work.

The portfolios/allocation/distribution approach I recommended has the primary virtue of extreme simplicity. It's not exactly what I'm doing. There are much more well-documented schemes out there, many of them very simple as well.
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Old 02-28-2015, 09:51 AM   #13
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IMHO a 5% AWR from the proposed portfolio is simply a yield-chasing disaster waiting to happen. I wish the OP luck with his CEF port. He'll need lots of it.
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AA = 60/35/5. Expected CAGR = 5.7%. GSD (5y) = 7.8%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.5%. Net Port Yield = 1.7%. Term = 36 yr. FI Duration = 4.9 yr. Portfolio survival probability = 86%.
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Old 02-28-2015, 02:43 PM   #14
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Why is it a yield chasing disaster waiting to happen? Why does he need luck with the cef portfolio?

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Old 02-28-2015, 04:03 PM   #15
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Why is it a yield chasing disaster waiting to happen? Why does he need luck with the cef portfolio?

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I'd like to know that too.
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Old 02-28-2015, 04:21 PM   #16
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I have a way to get a 6.6% withdrawal rate for a retiring 65 year old male......an SPIA......of course inflation might be an issue.
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Old 02-28-2015, 04:59 PM   #17
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According to firecalc.com our 60/40 port with a TER = 0.9% can support an 3.6% AWR with COLA for 38 years with a 85% success rate.


If we want a 100% success rate for a term of 38 years we need an AWR </= 3.1%.


If anyone thinks that the OP's CEF portfolio will have a greater expected CAGR a/o less volatility vs our indexed 60/40 port I'd like an explanation of why.


BTW, the gross nominal expected CAGR of our port = 6.6%.


Our portfolio expenses: TER = 0.9%; inflation = 2.0%; equity withdrawal volatility factor = 1.2%. net AWR = 2.8%. Total portfolio expenses = 6.9%.
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AA = 60/35/5. Expected CAGR = 5.7%. GSD (5y) = 7.8%. USD inflation (10 y) = 1.8%. AWR = 3.0%. TER = 0.5%. Net Port Yield = 1.7%. Term = 36 yr. FI Duration = 4.9 yr. Portfolio survival probability = 86%.
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Old 02-28-2015, 05:29 PM   #18
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Firecalc is probably not optimized for closed end funds. There are other elements about CEF's such as alpha generated from buying at a discount and the fact that you have distributions well above 5%, which should support a 5% withdrawal rate, heck it really isn't even a withdrawal rate as much as it is taking 5% in income and reinvesting 2-3% on top of that.

Not sure where the yield chasing comment came from, but these aren't particularly high yields for CEF's.

Also, you are comparing a 60/40 portfolio projection vs a real life 100% equities portfolio. See any fundamental problems with that?

Not sure of the beta with the 60/40 portfolio, but CEF's are pretty boring and slow moving assets typically. I have several that have betas in the .5 range. Not sure of the 60/40 portfolio volatility, but the CAGR for CEF's should be far and away higher.
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Old 02-28-2015, 05:47 PM   #19
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If I wanted to build a "set it and forget it" portfolio for someone who was not very interested in investing (as stipulated in the OP), and it was supposed to be pretty much self-sustaining, I would not pick a CEF--too much management risk, and the investor I've built it for will never notice that until it has been driven into the ground by an idiot. And if the magic CEF was invested in a narrow sector of the market dependent on the continuance of the existing regulatory environment, that would be another cause for worry that the thing might not work for 30-40 years. And if my passive investor did notice (and sell it for a huge loss), what would he/she then invest in? They'd be prey for the sharks.

There are a lot of CEFs that sell at a discount to their NAV for good reason.
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Old 02-28-2015, 05:57 PM   #20
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How is there management risk with a CEF? There are lots and lots of CEF's that use all sorts of strategies to invest in lots of different industries. They are all bad investments? I stated that I wouldn't go 66% in one fund, probably 5% max, but I don't think the entire universe of CEF's are off limits to people who want to make money.

If someone wants to be a passive, set it and forget it investor, they are likely destined for failure at any rate. People understand and focus on their money and make money or they don't and deservedly serve as painful examples of what not to do.

There are a lot of CEFs that sell at a discount to their NAV for good reason.

Such as? Lots and lots of super smart folks have studied it and consider it a mystery of modern finance that shouldn't exist, but I'm curious to hear your explanation.
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