Higher interest rates have been a boon for retirees—but the tides are starting to shift. A slowing economy has the Federal Reserve contemplating rate cuts by the end of 2024. And the expectation of lower rates is already sending yields lower: The 10-year Treasury yield has already fallen from its high of nearly 5% last year to under 4% by late August.
The good news is that there are many strategies you can employ to boost your retirement income, ranging from dividend stock allocations to exotic options strategies. The key is finding a plan that matches your income requirements and risk tolerance.
So, without further ado, let’s look at some strategies beyond core bond allocations that you can use to offset these lower yields and boost your retirement income.
#1. Covered Calls
Covered calls are an options strategy that involves selling (writing) call options against a long stock position. In exchange for sacrificing some upside potential, you earn cash premium income above and beyond dividends. Think of it as an added “dividend” on a stock or fund that boosts your overall investment income.
The key to success is choosing the right underlying stock and call options. For instance, you don’t want to write a call option on a stock with earnings around the corner. It’s also crucial to understand how to handle unexpected price movements if you don’t want to sell the stock. (We cover these issues and more in our free e-courses!)
You can also use option screeners, like optionDash, to find opportunities that meet your requirements without having to manually sort through hundreds of tickers.
optionDash makes it easy to find covered call opportunities for your portfolio, matching your income requirements with risk tolerance. Source: optionDash
If you don’t want to take a DIY approach, you can purchase covered call ETFs, which implement the strategy on your behalf. The most popular option is the JPMorgan Equity Premium Income ETF (JEPI), which pays a 6.4% SEC yield in today’s market. However, these funds are less flexible and may involve higher expenses.
#2. Dividend Stocks
Dividend-paying stocks are a more conventional approach to boosting income. While dividend yields have been falling for years, a handful of stocks still offer attractive dividends that they increase over time. And, unlike bonds, stocks typically increase in value over time, making it possible to grow your portfolio and generate income.
Many retirees look toward the Dividend Aristocrats or other high-quality dividend stocks. These companies have consistently increased their dividends over decades, generating stable and consistent income for shareholders. However, you should still be mindful of how stock allocations impact your portfolio’s overall risk.
TrackYourDividends.com makes it easy to screen for dividend opportunities and determine your income levels at a glance. Source: TrackYourDividends.com
Dividend screeners, like TrackYourDividends, can help you identify the right dividend stocks for your portfolio. For example, you can look at quality, value, and trend metrics to decide on companies that fit your risk tolerance levels. Meanwhile, filtering by yield helps ensure that you’re generating enough income to support retirement.
#3. High Yield Bonds
Another way to boost yields is to purchase riskier bonds. High-yield bonds, also known as junk bonds, are those with a BB or lower credit rating. While issuers may not be as stable as a blue-chip company, that doesn’t mean they will imminently default. Many high-yield bonds are just companies with a little too much debt.
Exchange-traded funds, or ETFs, are one of the best ways to invest in these bonds. By holding bonds from hundreds of different issuers, you don’t have to worry about a single default impacting your entire portfolio. For example, the iShares Broad USD High Yield Corporate Bond ETF (USHY) offers a 7.35% SEC yield, holding nearly 2,000 bonds.
When investing in these bonds, you should try to match the bond fund’s duration with your expected holding period. For many retirees, this might mean investing in short-duration high-yield bonds that offer higher yields with a three-year or less duration. That way, you don’t have to worry about changes in interest rates impacting bond prices as much.
#4. REITs and MLPs
Partnerships and trusts are another option for investors seeking greater income. Real estate investment trusts, or REITs, and master limited partnerships, or MLPs, are two of the most popular options. They typically invest in—as the name implies—real estate or energy projects providing a consistent income like oil or gas pipelines.
REITs have historically delivered competitive returns, consisting of steady dividend income and long-term capital appreciation. More importantly, they have a low correlation with other assets, which makes them an excellent way to diversify. However, you should assess each REIT’s indebtedness and other risk characteristics. We also encourage the use of publicly traded REITs. Rarely does the higher yield of a non-traded REIT outweigh the lack of liquidity risk.
On the other hand, MLPs offer unique tax advantages. Unlike a stock dividend, partnership income isn’t taxed when received. Instead, they are considered a reduction in the cost basis of the MLP investment. So, if you hold the MLP long enough and your cost basis reaches zero, distributions are taxed as capital gains in the year of distribution.
Keep in mind, both of these investments could cause issues around tax time. Some may issue a K-1 instead of the normal reports from your broker. If you aren’t familiar with these forms, they may not be worth the added expense and headache when filing taxes.
#5. Exotic Options
Stock options provide endless possibilities for speculation, hedging, and… income generation. While we’ve already discussed covered calls, several other option strategies can generate income in many different market conditions. And you may want to consider these if you’re open to a more hands-on approach.
Some popular strategies include:
- Collars – Collars involve selling a covered call and buying a protective put on a long stock position. If the income from the covered call offsets the cost of the protective put, you generate a small premium income. But unlike covered calls, you have downside protection from the protective put option.
- Spreads – Spreads involve two options at different strike prices, expirations, or both. For instance, a call credit spread involves selling a call option at one strike price and buying another at a higher strike price, creating a net premium income.
- Cash Secured Puts – Cash secured puts involve selling put options on a stock that you’re willing to own. In essence, the yield you generate is the premium income you receive divided by the cash you set aside to purchase the stock if exercised. These are very similar to covered calls and make a nice addition to the more common strategy.
Of course, options are riskier than stocks or bonds because you can easily lose all your investment when used incorrectly. Many retirement accounts also prohibit certain types of options trading, such as so-called naked options. Instead, retirees may want to stick with tried-and-true strategies like covered calls.
The Bottom Line
Interest rates may be on a downward trend over the coming year or two as the Federal Reserve attempts a soft landing for the economy. As a result, retirees may need to start looking beyond core bond allocations to generate enough yield to support them. Fortunately, there are many different options available, including the ones we’ve discussed above.
If you’re interested in generating extra income from your portfolio, take our free e-course covering the Snider Investment Method. We’ll show you how you can use covered calls to generate extra income while maintaining a long stock portfolio. Or, if you’d prefer a hands-off approach, contact us to learn more about our asset management services.