There are few things that have a stronger hold on investors’ imagination than gold. When inflation and market volatility spike, many folks simply can’t resist the yellow metal’s call.
But the truth is, for us dividend investors, gold is a raw deal. That’s mainly because, of course, it pays no dividend! Heck, if you buy physical gold, it actually comes with a cost for storage and safekeeping.
Worse, gold doesn’t even work as a hedge against inflation and volatility—at least it sure hasn’t this time!
This shows the dangers of buying based on outdated investor “sacred cows” like the one that says gold is a safe haven. Oftentimes they’re as far as they can possibly be from the truth!
So what should we buy to protect us from inflation and heightened volatility instead?
A “Dividends-Only” Strategy Is Proven to Work in Tough Times
For that, I prefer to come back to a time-tested (and more or less ignored) strategy that actually works when tough times hit: buying investments that pay high, steady dividends that can see us through and, in the case of today’s crisis, help offset inflation. That way we can avoid having to sell when the market is in a panic.
So how do we get that cash flow and buy a basket of oversold assets at the same time?
Members of my CEF Insider service know this well: we’ve been collecting dividends on our closed-end funds (CEFs) all through the last two tumultuous years, getting the income we need to get us through with little need to sell stocks to augment our dividend stream. (As I write this, our CEF Insider portfolio offers yields from 7% to upwards of 10%, and 16 of our 23 holdings pay dividends monthly.)
CEFs are a bit like ETFs in that they invest in a variety of assets, from stocks to bonds, preferred stocks and real estate investment trusts (REITs). Plus, CEFs trade at big discounts to their portfolio value (or “NAV”), meaning when the market turns, investors will be positioned to benefit twice: once from the appreciation of the funds’ assets and again when their market prices rise to meet their NAVs.
There are a lot of CEFs that are screaming buys now, thanks to an average 4.7% discount to NAV across the space. Below we’ll highlight three that offer diversification, attractive discounts and high dividends that can help you avoid having to sell before the market fully recovers.
CEF Pick No. 1: Instant Diversification + a Healthy 5.7% Dividend
We’ll start with the Source Capital Income Fund (SOR), which has a 5.7% yield that is currently rock solid thanks to the whopping 154% return its underlying portfolio has delivered over the last decade.
The fund gives us access to its diversified portfolio of domestic stocks, including insurer American International Group (AIG), Comcast (CSCA) and semiconductor maker Broadcom (AVGO). It then mixes in some attractive foreign firms to give us a nice global/US balance, including mining giant Glencore plc (GELN), holding company Groupe Bruxelles Lambert (GBLB) and beverage maker JDE Peets NV (JDE).
With a 6.8% discount to NAV, we’re getting a nice double discount here, one through the fund and another thanks to the market pullback.
CEF Pick No. 2: Small-Cap Focus Powers This FUND
Next up is the 6.1%-discounted Sprott Focus Trust (FUND), an oversold small-cap-focused CEF yielding 9%. Since this fund has earned a 140% total NAV return over the last decade, it can easily sustain those payouts, especially at its currently oversold level.
FUND’s holdings include Cal-Maine Foods (CALM) and investment manager Federated Hermes (FHI), both of which have outperformed the market this year, thanks to their focus on consumer staples and interest-generating investments, respectively.
The CEF focuses on a mix of smaller firms like these and bigger names like Warren Buffett’s Berkshire Hathaway (BRK.B), which is also a top-10 holding. This year, it’s been a winning strategy, with FUND posting a 3% total return, versus a 13% drop for the S&P 500.
CEF Pick No. 3: An “All-American” 7.7% Dividend With Plenty of Cash to Invest
We can stabilize our portfolio further with General American Investors (GAM), a fund I like for a “stealth” 7.7% yield in addition to its 15.8% discount, one of the biggest on the market now.
Let me explain that “stealth” yield: while GAM only pays one “normal” dividend per year, in February, it also pays a huge special dividend in December that is at a minimum 6% and is invariably a bit higher (my estimates peg it at 7.7% this year).
This is particularly powerful in years like this one, where GAM has the time to sell assets when it wants to, unlike some other funds that are forced to sell to sustain their high payouts.
But what about fundamentals? On that level, GAM is strong. With a 12% annualized return, GAM has shown reliable big profits for a decade without taking on risks associated with investments like crypto and gold.
GAM’s portfolio is full of household names, such as Microsoft (MSFT), Alphabet (GOOG), Republic Services (RSG), Apple (AAPL) and Amazon (AMZN). What’s more impressive is that GAM has built up a war chest of cash (about 8.8% of the portfolio as of the end of April) in preparation for the inflation pullback. Now that stocks look like they’re starting to stabilize, that high cash level has left GAM nicely positioned to buy a lot of assets on the cheap to boost profits above its historically impressive 11.9% annual return.
Put all three of these together and you’ve got reliable large-cap stocks, oversold small-caps in an oversold small-cap fund, and a diversified mix of foreign and domestic stocks to get you a hedge against more volatility. You’ll also get a solid 7.5% average income stream that is the true inflation hedge: while investors panic in the short term about where markets and economies are going, these funds will keep delivering their payouts day and night.
Michael Foster is the Lead Research Analyst for Contrarian Outlook. For more great income ideas, click here for our latest report “Indestructible Income: 5 Bargain Funds with Safe 8.4% Dividends.”
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