Don’t Settle For Low Interest Rates… We’re Not
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 current 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.
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.
My Latest “Bonus Dividend” Trade
Over at my Maximum Income premium service, we make trades like this all the time. In fact, I just recently recommended adding CyrusOne Inc. (NASDAQ: CONE) to the portfolio. It is a great candidate for this strategy.
CyrusOne provides data centers for about 1,000 customers around the world. Data centers are complex structures that require redundant power and connection sources along with backup computer capabilities. Revenue for the past 12 months topped $1 billion and has been growing steadily at an average of more than 20% a year.
CONE is a real estate investment trust (REIT), or a company that owns, operates, or finances income-generating real estate. To qualify as a REIT, the company is required by the IRS to pay a minimum of 90% of taxable income as dividends very year.
In a recent update, management noted that COVID is having little impact on the business. The company has adequate access to capital to complete expansion plans, and customers continue paying their bills. Interestingly, management’s bottom line forecasts were unchanged, and the company’s backlog grew to $90 million, a sign that growth should continue.
The dividend of $2 a year is safe, as funds from operations (FFO) more than covers the payout. Liquidity is not a concern since no debt repayment is due until 2023.
All the good news explains how the stock rebounded from this year’s selloff and is now near all-time highs.
The dividend yield of about 2.7% is safe and can be enhanced with a covered call. That makes the stock appealing as a Maximum Income trade.
Action To Take
While I can’t offer the exact details of the trade today, you could do a few things with this pick…
You could simply buy the stock and leave it at that. But with our strategy of using covered calls, you could earn an extra 1.9% in 36 days. That might not sound like much now, but if we keep selling similar covered calls on the stock while we own it, we’d have an additional 19% return on our capital in 12 months. That’s just from selling the covered calls. We also get to keep the normal dividends the company pays out each quarter.
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 “bonus dividend” strategy.