Last week I had a private e-exchange with a man of many bucks (recently inherited) but few words:

Cryptic Cyberspaceman: “Which is better, a stock that appreciates at the rate of 4% a year and pays no dividends, or one that has a 10% yield but no appreciation?”

The stock that yields 10%, if it will do so forever, is better than the one that will grow 4% forever. If nothing else, you can take your 6% after-tax from the dividend (if you’re in the 40% federal-state-local bracket) and reinvest it. So each year, the value of your holding grows by 6% instead of 4%. Why do you ask?

Cryptic Cyberspaceman: “ZF (the Zweig Fund) pays about 10% and seems rock steady. It’s traded like a stock but acts like a cross between a mutual fund and a money-market. Do you know it? Own any of it?”

The Zweig Fund is fine. I don’t own any of it, but once did. It’s a “closed-end” mutual fund that, like many others, is traded on the New York Stock Exchange, just like GM.

It’s a perfectly good choice, but don’t mistake it for a true money-market fund. Yes, it’s stated goal is to distribute 10% a year (2.5% a quarter) and, yes, Marty Zweig (whom you may have seen on Wall Street Week) is a smart veteran, better than most at limiting risk. But in an extended bear market, I doubt you’d see those 10% pay-outs uninterrupted. Or if they were uninterrupted, you might well be getting your own capital back — i.e., the fund would be liquidating assets, at depressed prices, to keep paying the distribution. That’s not a return on your money, it’s a return of your money.

Just be sure you’re buying this or any other closed-end fund at par or a discount to net asset value.

Cryptic Cyberspaceman: “Hunh?”

With a regular “open ended” mutual fund, you buy shares direct from the fund manager, who takes your money and puts it to work with everyone else’s; and you redeem your shares from the fund manager. (Yes, some brokers can now do this for you, as a considerable convenience. But behind the scenes, that’s still how it works.) The funds are “open-ended” in the sense that they ordinarily keep selling shares to anyone who wants to buy. There’s no limit to how many investors, and how much cash, they may attract.

Closed-end funds, by contrast (also sometimes called “publicly traded funds”), gather a set pool of money in a public offering, and that’s it. The pool may grow as the fund’s holdings appreciate, but the only way to get into the fund is to buy shares from someone who wants to get out. I.e.: call your broker.

If a lot of people want to get in and not too many are keen on getting out, the price goes up — sometimes to a premium far above the value of the underlying assets of the fund. More typically, they sell at a discount, especially in a bear market. (So there you have a double whammy: the underlying value of the fund has dropped with the bear market, and the discount has widened, to boot.)

You’ll find a list of closed-ends and the premium or discount at which each most recently sold every Monday in The Wall Street Journal under the heading “Closed-End Funds.” (There’s probably a free place to get this on the Internet as well, but I haven’t found it — please chime in and I’ll post it next time I do an update.)

Closed-ends selling at, say, a 10% discount let you control (and reap the benefits from) $1 worth of stock for 90 cents.

The only problem is that, unlike owning that $1 worth of stock directly, there’s a management fee deducted from the fund each year. So a 10% discount may be wholly appropriate. Then again, if the manager is good enough, the value he adds may justify the fee, or (as hoped) more than justify the fee.

Some closed-ends are perceived to have such lousy managers, and/or high expense ratios, the discounts can widen to 30% or 40% in a bear market. Marty Zweig, on the other hand, is generally perceived to be worth what he costs. The Zweig Fund usually trades just a little below — or above — the underlying value of its securities (“net asset value” or “NAV”).

Which is a lot of background to a simple cryptic question. My short answer would be: ZF is fine, especially for someone in a low tax bracket. But ordinarily I prefer to buy closed-ends in the midst of a bear market, when their assets are cheap and their discounts are wide.

Of course, since we will never again have a bear market — or inflation, panics, or worries of just about any kind, other than what to wear — I guess this is all a little academic.

Oh, and one other thing: Never buy a closed-end fund on the initial public offering, no matter how eager your broker may be to sell it to you. You will pay a built in underwriting commission that does you no good whatever. Just wait a few weeks or months: ordinarily, closed-ends fall to a discount.

Monday: Does Your Computer Have a Sense of Humor?


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