Many people have never seen a down stock market. Turn on the financial news and you hear gloomy predictions about a market correction just around the corner. Interest rates have been rising, but will they continue and for how long remains a mystery. No one can accurately predict the future. What can a client needing to generate income from their investments do?
When the stock market was marching upwards, this wasn’t a problem. If your statement values were higher month after month, you could just tap a little here and there, paying those bills. If the stock market declines, pulling money out accelerates deterioration in your portfolio. What are your options?
1. Covered call writing.
This strategy can be a good fit if the stock market is going sideways or declining. Your client needs to complete paperwork and understand what they are doing. As a good advisor, you should be able to explain the concept. You own several hundred shares of a certain stock. It’s currently trading at $32/share. It’s going sideways, but you still like it. Someone else thinks it is going to go up in price sooner rather than later. There is a procedure where you can sell them an “option” (they are actually called options) to buy 100 shares of that $32 stock at $35/share within the next couple of months. (The date is fixed.) They will pay you a premium, a certain amount of money, for that privilege. If by expiration day, the stock is still trading below $35/share, it’s logical the option will not be executed. You pocket the premium and decide if you want to repeat the process. If at any point the stock traded at or over $35/share and the option was exercised, you need to deliver 100 shares to the buyer, who pays you $35/share. You do not need to hand over those specific shares because you can immediately buy some in the open market for delivery. This is important if the stock you own has a low-cost basis and you do not want to trigger a taxable event.
2. Build a bond ladder.
Generally speaking, the longer a bond runs, the higher the rate of interest you earn. Let’s assume a five-year CD yields about 3.25%. (as of 9/12/22) and one year CD returns 2.50%. Suppose money market funds are returning 1.90%. Instead of a client keeping their money liquid at a variable rate currently at 1.90%, they could split their cash for savings into five buckets, investing each on a different rung of a five-rung ladder. You are earning the blended average and if rates are higher one year from now, the maturing one-year bond becomes your new five-year bond.
3. Buy total return stocks.
This income-oriented client needs to understand investing in the stock market comes with risks. They do some research and buy stocks in companies with earnings growth potential and a history of paying reliable dividends, which they tend to increase over time. Your client has the potential to make money and sell the stock at a profit (if it goes up) yet are also being paid a dividend while they are waiting. As I recall, Warren Buffett is a big fan of buying good stocks and being paid while you wait.
An unsettled stock market or a lower interest rate environment doesn’t mean your income seeking client is out of alternatives. Try and expand their horizons by introducing other strategies.