One Way To Fight Back Against Low Interest Rates…
I saw an amazing story in the Wall Street Journal recently. It says a lot about the “new normal” we’re in — and the challenge individual investors face.
The California Public Employees’ Retirement System will borrow money to boost its returns. This is a $400 billion fund that provides pensions for millions of California’s government employees and teachers.
The system is underfunded — by a lot. And the managers need to generate higher returns. Their answer is “more assets and better assets” according to the system’s chief investment officer. So they will borrow up to $80 billion in funds to help meet their objectives.
Leverage is one way to increase returns, assuming everything goes well. Calpers will also increase its allocation to illiquid private equity funds. These are the “better assets” from which the managers expect higher returns.
Why This Matters For Individual Investors
As individuals, we might not be able to turn to private equity funds. They often have large minimum investments are only available to institutions. But a recent report from Bain & Company, a leading firm in the field, tells us we might not be missing much.
Private equity still outperforms public equities. The asset class produces steadier, more reliable returns in all major regions, over several time horizons. However, returns of private and public equities have started to converge in the US.
A simple comparison with the S&P 500 Index indicates that, over a 10-year horizon, US buyouts did not produce much of a premium over the public market. One could argue this is not an apples-to-apples comparison.
Source: Bain & Company
But here’s the thing… As individuals, we face the same problems Calpers faces. Interest rates are dropping, and investors cannot rely on bonds for income like they did in the past. The chart below shows that an investor with $100,000 in retirement funds could have achieved income of $500 a month from corporate bonds as recently as 2010.
Source: Federal Reserve
That chart shows the amount of annual income a $100,000 investment in high-grade corporate bonds generated at rates available at that time. The value has been falling since its October 1981 peak of $15,400 to a recent low of $2,500.
I’m not sure that Calpers’ strategy of borrowing and locking money up for 10 years in private equity funds is the best solution to the problem. But I do agree that new solutions are needed.
That’s why I believe that covered calls can be a part of a winning income strategy.
Covered Calls 101
This strategy can boost income from the equity allocation of a retirement account and potentially offset some of the loss of income caused by low interest rates.
Now, I know what you might be thinking… Probably something along the lines of: “Aren’t options risky?” or “I don’t know the first thing about trading options.” But covered calls are quite possibly the safest way to trade options. Savvy traders and investors alike have been using it to juice their income for decades.
Here’s how it works… A call option gives the buyer the right — but not the obligation — to buy a stock from the call seller if it’s trading above a specified price before a specified date.
When you sell a call option, you accept the potential obligation to sell a particular stock at a specified price at a set time in the future. When you sell a call, you generate instant income in the form of a premium. I like to think of this as a “bonus dividend” because it helps investors re-frame the way they think about this strategy.
Now, I only recommend selling “covered” calls. A covered call requires you to sell call options on a stock you just bought or already own. Not only is this strategy safer, the beauty is that it allows income investors to earn more from their holdings than what they simply would with dividends alone.
How You Can Get Started
Over at my Maximum Income premium service, we make trades like this all the time.
For example, a few months ago I recommended a trade on Conagra Brands, Inc. (NYSE: CAG).
CAG is a packaged-food producer with many well-known brands you see on grocery store shelves every day. The stock had been in a downtrend since 2016. But one analyst told Barron’s that the recent lockdown should lead to new customers for ConAgra.
Of course, this was bullish news for CAG. Upside surprises in revenue and earnings could boost the stock. But even if it didn’t, the stock was priced at a very reasonable 15 times expected earnings and offered value at the current price. This made the stock appealing as a more conservative income holding, but we had the opportunity to enhance our income with a simple covered call trade.
With our trade, you could earn an extra earning 2.2% in 30 days. If we can repeat a similar trade every 30 days, we’d earn a 28% return on our capital in 12 months.
Action To Take
While you may not execute a trade like this every month, it gives you a good idea of the potential this strategy has for investors. It can turn a small yield of about 2% and magnify it into much, much more.
The point is, while most investors sit and wait for their dividends to roll in, we don’t. Over at Maximum Income, we’re not content to settle for the low interest rates the market offers. We’re in this game for income, and we play to win.
We’ve been making trades like this for years — and my readers have been earning hundreds (even thousands) in regular income, like clockwork. That’s the power of my strategy.