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Return of Capital Question
Old 10-05-2019, 10:58 AM   #1
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Return of Capital Question

Slow day at the marko household and I stumbled upon T Rowe Price's "Retirement Income Fund" (TRLAX). It claims to pay a fairly steady 5% annual 'income' on a monthly basis.

Digging a bit deeper, I found that 75% of that 5% is return of capital. While I understand the concept of supplementing dividend gains with capital to make the 5%, I'm at a loss as to why anyone would find this attractive.

75% of my own money isn't 'income', it's my own money already! I could do the same with any stock or fund by drawing back the difference of whatever dividends I receive and be in the same place.

Meanwhile, I'm potentially drawing down on my principal; and the fund's NAV hasn't budged in the two years it's been in existence. With principal draw downs, might it only pay 5% of the remaining balance?

Per usual, I'm sure I must be missing something.

Insights?
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Old 10-05-2019, 11:13 AM   #2
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Not that it would be my choice, but that fund is easier than maintaining an AA that provides a steady stream of cash.

I suspect more than a few people think they are "earning" a 5% return, which sounds high in the present environment. It's similar to the supposed 8% annual return by delaying the start of Social Security benefits. The reality is much less than 8% because delaying SS simply spreads your monthly benefits over a shorter period of time.
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Old 10-05-2019, 11:35 AM   #3
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.... 75% of my own money isn't 'income', it's my own money already! I could do the same with any stock or fund by drawing back the difference of whatever dividends I receive and be in the same place. ....
Uh oh T, they're on to us.
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Old 10-05-2019, 01:11 PM   #4
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Assuming it is not destructive to NAV or share price or otherwise causing some long term impairment to the fund, some investors find it attractive since it can result in a "tax free income". That is real money to spend that is not subject to IRS taxation while the investment cost basis is shrinking resulting in a future capital gain that gets taxed more favorably. An interesting write up here:
https://seekingalpha.com/article/429...return-capital
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Old 10-05-2019, 02:17 PM   #5
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Assuming it is not destructive to NAV or share price or otherwise causing some long term impairment to the fund, some investors find it attractive since it can result in a "tax free income". That is real money to spend that is not subject to IRS taxation while the investment cost basis is shrinking resulting in a future capital gain that gets taxed more favorably. An interesting write up here:
https://seekingalpha.com/article/429...return-capital
Thanks. So if I read the article correctly, return of capital is not necessarily 'my' money but could be the general, organic growth (unrealized capital appreciation) of the fund--not counting dividends and interest.

This particular fund's NAV holding steady implies that they are not eating away at principal but are maintaining a steady balance despite 1) paying out 5% to the holder and 2) returning 75% of that 5% via the organic gains.

So even if it is sending me 75% of that 5% via ROC, 'my' money could very well be staying intact yet I get to spend those returns tax free as if it were my own money while lowering my basis.

Do I have it right?
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Old 10-05-2019, 07:53 PM   #6
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I do not know about TRLAX, but I think you have it about right.

I have avoided most CEF investments as they (their holdings and internal operations) are more difficult to understand relative to say a large cap stock or index fund. And especially because many use ROC which seemed to be silly on the surface and require more work from the small investor to track cost basis (more painful for purchases before 2009(?) or whenever the law was changed requiring brokerages to track basis over time).

But after understanding ROC for CEFs a little better I might have wished I had invested more heavily in a few of them in the past. With the hope of receiving "free money" ;-) in my golden years.
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Old 10-06-2019, 07:30 AM   #7
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OTOH, I have a high yield bond fund that averages around 6% for the past 20 years. Not tax free but that extra 1% sort of covers that ( vs 5% tax free) and its al lot simpler it seems.
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Old 10-06-2019, 09:12 AM   #8
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I hold enough of "ETV" to give me $1000 per month of mostly ROC. ROC each month reduces my share basis, but NAV is fairly stable. This CEF holds a basket of large caps and sells options against them. The option premium is returned each month as mostly ROC. It has been paying .1108 monthly since 2013.

I'll pay LT cap gains once I sell or when my basis is finally reduced to $0. I pick up additional shares when market volatility gives me a buying opportunity. Nice cash flow and does not impact my MAGI for ACA.

When buying closed end funds, it's important to read the fine print in the prospectus. Understand how and when the distribution types and rates are determined. A CEF that unexpectedly cuts it's distribution can result in a huge price drop. Been there, done that.
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