A High-Yield Oasis in a Low-Yield Desert
I spent last weekend at a family reunion with more than fifty relatives in Lewes, Delaware. We’ve been holding this event on a biannual basis for nearly thirty years. By now, everyone knows one another quite well and enjoys catching up.
When we held the first reunion in 1990, my cousins and I were nowhere near retirement age and gave it little thought. But now that we are all in the 55 – 65 age range, retirement is a pressing subject.
Given what I do for a living, I find myself increasingly drawn into conversations regarding how best to generate income in retirement. One night, as several of us were sitting around the fire, I was asked if there was any way to earn 10% annual income without taking too much risk.
There were several bemused smiles as all faces turned in my direction. I don’t know what type of response they were expecting, but I think I surprised them when I said there most certainly is a way to earn 10% income every year without relying on stock market appreciation.
Here is what I told them.
Not Enough Interest
As we all know, bond yields are very low. The 10-year Treasury note currently yields about 2%, which in turn dictates what investment-grade corporate bonds must pay. That means any bond you can find these days with a double-digit yield is most likely on the verge of bankruptcy.
So, bonds are out.
There are solid yields to be had from many common stocks, but even those are only in the mid-single-digit range. I recently wrote about Ford Motor Company (NYSE: F) and its 6% dividend yield. I also like energy giant Chevron (NYSE: CVX), now yielding close to 4%.
That’s nice, but nowhere near the 10% goal I was asked to achieve.
You can obtain yields in the mid-to-high-single-digit range from many pass-through securities including master limited partnerships (MLPs) and real estate investment trusts (REITs). However, those payments are subject to external factors that can result in an unreliable income stream.
If you want consistency in income, we need to look elsewhere.
The 10% Solution
At that point, I’m sure most of my relatives were feeling a bit demoralized. So, that’s when I got to the point: Although you cannot earn 10% in dividend income by owning stocks, there is a reliable way to generate that much income off the stocks you own.
Sound confusing? Let me explain.
Normally, stock market volatility is discussed in a negative context. That’s because when you own stocks, you don’t want them careening all over the place. Instead, you’d prefer a steady rise in value over time.
But when you don’t own stocks, volatility can be quite positive. That’s because it drives up the price of the option premiums that trade based on their value.
Now, I know what many of you are thinking. Options are very risky and have no place in a retirement portfolio.
I respectfully disagree.
I will agree that buying put and call options for speculation is not appropriate for retirees seeking income. But the opposite side of those transactions — selling put and call options — can be quite lucrative and done with limited risk.
Let’s look at a recent example. Eight months ago, we added United Parcel Service (NYSE: UPS) to the Personal Finance Income Portfolio while it was trading near $108. Last week, it jumped up to $114 after the company released solid Q2 results.
That 5% jump in value is nice, but I cannot spend that money unless I sell the stock. UPS pays an annual dividend yield of 3.7%, which I can spend without selling any stock, but that is far short of my 10% objective.
So how do I convert my equity in UPS into a double-digit cash cow?
I can sell a covered call option against my shares of UPS. A few days ago, the call option expiring six months from now at a strike price of $115 could be sold for $6.
If UPS remains above $115 by the expiration date, my shares will be called away from me at that price. If UPS is trading below $115 at expiration, I get to keep my shares.
Either way, the option premium I receive works out to an annual cash flow of 10.3%. Combined with the dividends I receive while I still own UPS, that amounts to an annual yield of roughly 14%.
Join the Crowd
By now, everyone around the fire pit was listening intently. Especially when I pointed out that this strategy is remarkably consistent, regardless of which way the stock market is going.
At this point, someone asked the obvious question: If this strategy works so well, why isn’t everyone doing it?
Actually, a lot of very successful investors are doing it including arguably the greatest investor of all time, Warren Buffett. Some mutual funds do it, and so do many pension fund managers.
They also engage in more sophisticated options strategies capable of generating far higher returns. I don’t have time to explain them here, so I suggest you check out what my colleague Jim Fink has to say about them.
Jim Fink, chief investment strategist of Velocity Trader, Options for Income, and Jim Fink’s Inner Circle, has developed a way to quickly and predictably multiply the gains of regular stocks.
Jim is now making you a promise. If Jim doesn’t deliver 24 triple-digit winning trades over the next 12 months, he’ll fork over $1,950. Each time Jim has made this bold bet, he has delivered!
Jim has put together a new presentation, in which he discusses how to make 163% profits, whether the market is going up…down…or sideways. Want all the details? Click here now.