Co-authored with “Hidden Opportunities.”

In middle school physics, we learned about simple machines, those basic mechanical devices for applying force and getting work done. Think about the wheel and axle, one of the most important inventions in the history of humankind. As simple as it is, we wouldn’t survive without it – automobiles, trains, and nearly all factory equipment wouldn’t exist. We would be moving loads by carrying them or by using sleds or the backs of animals.

Pulleys, wedges, and inclined planes are all examples of simple machines instrumental in our daily lives, simplifying tasks that would otherwise be hard to complete. The engineer in me can’t stop appreciating and talking about simple tools and technologies that make our lives more comfortable. Let us get back on track to discuss simple techniques to brighten your retirement.

Dividends are the simple machines in the financial world, simplifying an otherwise complicated retirement by supplying a regular cash infusion into our accounts. No matter what the market does daily, I know a certain set of dividends will be credited into my account – this feeling is priceless.

They say the first million is the hardest. This is because once a certain level of wealth is attained, the power of compound interest plays a significant role. As investments pay dividends, and when those dividends are reinvested, we accelerate wealth accumulation, making subsequent millions easier (and more automated) to attain.

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.” – Albert Einstein.

Like simple machines powering complex machinery, simple dividends coupled with the power of compounding is the secret to my healthy retirement. So, that is enough physics for today; let’s look at two picks to make some money.

Cash Flow Machine: RVT – Yield 7.5%

The financial markets ended FY 2023 with value stocks being historically cheaper than any other class of securities. The small-cap value category carried an average price / fair value ratio of 0.84%, implying a 16% discounted pricing, while large gap growth stocks traded at a whopping 15% premium. The divergent recovery from the 2022 bear market is clearly seen in the chart below, with investors overpaying for growth names at a time when our economy is grinding into a recession. Source.

According to a study by Goldman Sachs, in 80% of the election years since 1984, the Russell 2000 has outperformed the S&P 500. Source.

In addition to being an election year, in 2024, we expect to see a significant change in the Fed’s interest rate policy, and normalizing rates will trigger a valuation reset, fueling small-cap recovery in 2024.

Royce Value Trust (RVT) is a small-cap closed-end fund, or CEF, managed since its inception in 1986 by the same portfolio manager – Chuck Royce. Although Mr. Royce has taken a step back from lead portfolio manager duties since 2022, the Royce funds continue to benefit from his oversight and experience.

RVT is massively diversified across 486 holdings, a much-needed requirement as small caps tend to be a riskier investment class. The CEF is actively managed, with a 2022 portfolio turnover rate of 60%. This means a holding stays in the portfolio for about 20 months. As such, it doesn’t come as a surprise that a significant portion of RVT’s distributions over the past ten years have been from long-term capital gains.

Industrials and manufacturing companies stand to benefit significantly from government incentives and initiatives to enhance domestic manufacturing capabilities. This segment is the largest holding for RVT, representing ~24% of the CEF’s assets. The next largest sector is financials (~19%), which continues to be deeply discounted following multiple bank failures from 2024 and stands to demonstrate strong recovery with interest rate normalization.

RVT does not utilize leverage in its investment strategy and maintains a variable distribution that is adjusted quarterly based on NAV at the end of the trailing four quarters. This means that the distribution rises and falls with RVT’s NAV, but since the calculation uses an average of the past four quarters, the payment changes are gradual.

RVT’s management fee structure reveals a rare feature among CEFs, indicating a significant incentive for management alignment with shareholder interests:

• Advisor fees can increase or decrease based on the fund’s performance relative to the S&P 600 SmallCap Index benchmark.

• The fund managers will forfeit fees for any month when the fund’s performance over a trailing 36-month period is negative.

At a ~11% discount to NAV, RVT presents an excellent bargain to ride the recovery of the small-cap sector. Small caps are well-positioned for a strong recovery in 2024, and RVT is one of the best income-oriented funds to ride this recovery. Driven by a time-tested active management strategy and a management team that eats its own cooking, this CEF pays 7.5% to wait for the big valuation reset.

Hidden Gem: BTO – Yield 9.1%

It has been ten and a half months since the FDIC shut down Silicon Valley Bank, making it the third-largest bank failure in the United States. Mr. Market feared banking names, and regional banks got the worst of his emotional spree.

Banks almost became the pariah of the stock market, with analysts of varying reputations and backgrounds attempting to predict the next “shoe that will drop.” But the reality is that the Feds