Supermarket Investing

When I walk into my local supermarket, magnificent smells of freshly cut flowers and a sea of fruits and vegetables welcome me. Further on, I encounter the aroma of baked bread, cookies, and cakes. My senses are overloaded, and I have yet to start shopping.

A supermarket layout is science-based, but pomp and circumstance also play a significant role in our shopping experience. It’s full of vibrant colors, smells, and sounds designed to keep us moving as we fill our shopping carts. The items we need are located in the back; the things we want are near the front. End caps display new or seasonal products designed to catch our attention. Between the front door and the milk section, we encounter presenters offering us free food and drink samples while introducing us to a new recipe or cooking trend. If we make it through the aisles unscathed, we must pass one final test – the checkout stand. While checking out, we stare at soft drinks, chips, candies, and tabloids, all impulse buys. I always shop with a list, and I never enter a grocery store while hungry to avoid the subtle traps.

Investing is similar to grocery shopping – a lot is going on, so a plan is recommended. Investing without one is like entering a grocery store without a list; if you’re not careful, you can get into trouble. A financial plan keeps you focused on your goals and helps you avoid distractions that may derail your future. It can also limit impulse purchases of investments that don’t belong in your financial basket.

We need staples to survive, like fruits, vegetables, meats, eggs, milk, etc. We don’t need peanut M&M’s, but they’re fun to eat on occasion. A portfolio designed to last generations needs a strong core of globally diversified high-quality stocks and bonds. An appropriate allocation for your core holdings is 85% to 95% of your total balance. Invest the remainder of your account in high-flyers, seasonal trades, or alternative investments if you want to give your portfolio a boost.  

The center aisles are a mix of, well, mixes, packaged foods, and canned foods; ingredients developed to enhance your meals. Portfolios require supporting investments as well. Small-cap stocks paired with large-cap companies mixed with a few bonds is a recipe for success.

My wife can make the rounds in our grocery store with her eyes closed, which is good and bad. She is an efficient shopper, but it’s possible to become complacent and ignore new items or products – investors who are pococurante risk missing new ideas or opportunities. If you let your portfolio get stale, you may fall behind your stated goals. I recommend reviewing your holdings and your plan two to three times per year to stay up to date with new trends. Avoid putting them on auto-pilot.

Should you avoid end cap displays or check out items? No. These sections of a supermarket can introduce you to bargains, new products, or reflex purchases. They can also bring some fun to your shopping experience. Investing in seasonal trades, speculative stocks, or alternative investments may bring you joy if they work. Limiting your purchases to 3% to 5% of your portfolio value will avoid pain or destruction if you’re wrong.

When I was fifteen, I worked in a small grocery store with some friends. I earned $2 per hour and learned much about stocking shelves, bagging groceries, and watering produce. I was continually moving from one aisle to the next. It was our job to ensure the store looked good at all hours. It was a good primer for my chosen career.

As you build your shopping investment list, include a basket of large, small, and international companies. Add a mix of bonds, real estate holdings, and alternative investments. Rebalance your accounts annually and review your plan often. Think generationally, but pay attention to short term opportunities. A balanced portfolio based on your financial goals will treat you well over time.

Happy shopping!

Anyone who believes the competitive spirit in America is dead has never been in a supermarket when the cashier opens another checkout line. ~ Ann Landers

January 25, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

Bubbles

On December 5, 1996, former Federal Reserve Chairman Alan Greenspan delivered his famous “irrational exuberance” speech. He was referencing the speculation surrounding the valuation of dot.com stocks. The market eventually corrected, and the bubble did pop, but it took three years to do so. Twenty-five years later, the S&P 500 index is up 417%. If you purchased the index on the day of his speech, your average annual return has been 7%, and a $10,000 investment is worth almost $52,000!

Today, some experts are declaring we’re currently in a bubble, and the market could crash. One high profile investor said we are in a bubble with “very seldom seen levels of euphoria.” He added: “never been a great bull market that ended in this kind of bubble that did not decline by at least 50%.”[1] On CNBC this morning, another investor said: “It feels a lot like 1999 to me.”[2]

The market will eventually correct, as it has done for centuries. The S&P 500 had three major corrections this century: 2000 to 2003, 2008, and 2020. Yet, we are currently trading at all-time highs.

During the first decade of the century, US stocks generated a negative return, but international stocks, small-cap holdings, and fixed income investments produced positive returns. This year, emerging market stocks are up 8.6%, outpacing the S&P 500 by 6%. During the past six months, small-cap stocks have trounced the S&P 500 by 20%!

Diversification is the essential component to creating generational wealth. A balanced portfolio allows you to capture returns from global markets while reducing your overall risk. Your US stock exposure may fall between 20% to 40% in a diversified account, so a majority of your portfolio is elsewhere.

Rather than worrying about bubbles, focus on your goals, save your money, follow your plan, and enjoy your life.

Life is too short, too precious, too painful to waste on worldly bubbles that burst. ~ John Piper

January 21, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

Data Sources: YCharts


[1] https://www.cnbc.com/2021/01/21/jeremy-grantham-says-market-is-in-a-bubble-amid-investor-euphoria.html, by Weizhen Tan, January 21, 2021

[2] https://www.cnbc.com/2021/01/21/barry-sternlicht-stock-market-frenzy-feels-like-1999-dot-com-bubble.html, by Kevin Stankiewicz, January 21, 2021

Are You A Thousandaire?

Can you retire without a million dollars in savings? Will you be forced to work forever? Is there a light at the end of the tunnel? Despite what some financial experts suggest, it’s still possible to retire with less and live life on your terms.

Let’s say you retired thirty years ago with assets of $335,000 ($500,000 today) and an annual income of $50,000. At $50,000, your Social Security benefit would have been about $1,230 per month or $14,760 per year.

Investing your $335,000 nest egg in a portfolio of funds, with an asset allocation of 60% stocks, 40% bonds, produced an annual income of $17,139. Combining the Social Security benefit with your investment income generated a total of $31,899 during your first year of retirement, or 64% of your employment income.

Today, thirty years later, what is the value of your portfolio, and how much income is it generating? At the end of last year, your account balance was $949,072, and the annual income from your investment portfolio was $43,736. Your Social Security payout was $22,104. So, your combined income last year was $65,840, an increase of 106% from your retirement income from thirty years ago.

Last year, your investment account was worth $949,072, and it generated an average annual return of 9.46% per year, tripling your original investment despite withdrawing money every year. The total income you received from your portfolio for the past three decades has been $958,122, almost three-times your initial investment![1]

To summarize, you invested $335,000 and received $958,122 in payouts, and your account balance is now worth $949,072 -staggering numbers.

Here is the portfolio:

  • Vanguard Total Bond Market = 40%
  • Vanguard 500 Index = 30%
  • American Funds Europacific = 15%
  • Fidelity Emerging Markets = 5%
  • Fidelity Real Estate Investment Portfolio = 5%
  • Vanguard Small Cap Index = 5%

If you can’t imagine saving more than a million dollars, fear not, because you can still retire. To help you in your journey, here are a few ideas to improve your golden years.

  1. Watch your expenses. You can control your spending. If you can lower your costs, you need fewer assets to retire. Before you’re ready to retire, allocate time to review your spending habits and budget. Where is your money going? How is it being spent? Are there items you can eliminate or reduce? A few hours of review may yield substantial savings.
  2. Invest for growth. A common reaction from retirees is to invest more conservatively once they stop working; this is a mistake. To maintain your lifestyle in your later years, you must own stocks. Stocks will grow over time and keep you ahead of inflation.
  3. Invade your principal. It’s okay if you invade your principal to meet your living needs. If you need a few extra dollars, don’t worry about dipping into your accounts to withdraw more funds. If your accounts are growing, you may accrue a slush fund for emergencies and opportunities.
  4. Rebalance your accounts. Annually rebalancing your accounts reduces your risk and maintains your asset allocation. January is an ideal time to rebalance them since most mutual funds pay dividends and capital gains in December.  Most investment firms can rebalance your accounts automatically.
  5. Give to others. You might not feel like a Rockefeller, Vanderbilt, or Carnegie, but giving a few dollars to those less fortunate will go along way. Unfortunately, there always people in need, so your donations will help others.
  6. Enjoy your retirement. It’s not what you earn; it’s what you keep. You can live within your means during your retirement. It’s your choice. Once you get a handle on your spending and income, you can plan for a joyful and enjoyable retirement.

Happy Retirement!

You only live once, but if you do it right, once is enough. ~ Mae West

January 20, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

Data Sources: YCharts and Morningstar


[1] Morningstar Hypothetical Tool. January 1, 1991 to December 31, 2020.

Brady v. Brees

Tom Brady and Drew Brees are meeting in the NFC divisional playoff game today. Tom Brady is 43; Drew Brees is 42 – the oldest match up for quarterbacks in a playoff game. Messrs. Brady and Brees will be first-ballot Hall of Famers when their careers end. Mr. Brees is the NFL leader in passing yards with 80,358. Mr. Brady is second with 79,204. Mr. Brady is the all-time leader for touchdowns with 581, Mr. Brees is second with 571. Mr. Brady ranks eleventh for games played at 301, and Mr. Brees ranks sixteenth. Mr. Brees and the New Orleans Saints won Super Bowl 45, and he was named the games MVP. Mr. Brady is the all-time leader in Super Bowl wins with six, and he was named the Super Bowl MVP four times.

A quarterback aged 40 or more is rare, and these two are defying the odds. Despite their success, they have faced criticism and doubts. The San Diego Chargers traded Mr. Brees in 2005 after successful shoulder surgery. I bet the Charges wished they had kept him on the roster. He continually faces criticism about his height and arm strength. Phil Simms said, “Listen, his arm strength was never great.”

Tom Brady was the 199th pick, drafted in the 6th round, a snub he has not forgotten. In 2016, Max Kellerman “decided to declare that Brady’s career was about to be over sooner rather than later.”[1] He also called him “a bum.” After four years, Mr. Kellerman admits he was wrong about Tom Brady’s late-term playing career.

I’ve never met Tom Brady or Drew Brees, but I suppose they ignore the criticisms, and they probably aren’t aware of most things said about their potential “demise.” Rather than listen to the experts, they work out regularly, practice often, eat well, and repeatedly perfect their craft – they follow their plan and focus on what they can control.

The average NFL career lasts 3.3 years.[2] Mr. Brady is playing in his twenty-first season, Mr. Brees is in his twentieth. To survive and excel in the NFL for two decades requires perseverance, dedication, and tenacity – traits these two NFL greats have in abundance.  

As an investor, you may face criticism and doubt about your investing style or portfolio. TV personalities, experts, analysts, relatives, neighbors, friends, or social media trolls may give you pause to think about your financial future. You may hear others say: “How come you own that company?” or “Why don’t you own this company?” or “The stock market is going to crash, you should sell your stocks!” Tune out the noise and chatter.

To create generational wealth, focus on those things you can control and ignore the rest. Here is a shortlist of things you can manage.

  1. Savings. How much money do you save per month or year? The amount you save will have the most significant impact on your future wealth. Contribute the max to your 401(k) and IRA. Automate your savings. If you save $10,000 per year for thirty years, you could have more than $1.5 million in assets when you’re ready to retire.
  2. Expenses. You have complete control over your spending. The less you spend, the more you save. January is an excellent time to review your spending habits. If you spend some time pouring over your bank and credit card statements, you may find a few expenses to reduce or eliminate.
  3. Investments. You can purchase any investment in the world – stocks, bonds, real estate, gold, Bitcoin, art, jewelry, etc. However, if you want to retire in style, it’s best to own investments that grow, like stocks. The 100-year average for stocks has been 10%. If you keep most of your money in cash, it will lose value every year because of inflation and taxes.
  4. Diversification. Diversify your assets across stocks, bonds, and cash and rebalance your portfolio annually. Diversification is considered a free lunch on Wall Street.
  5. Plan. Your financial plan is unique to your situation. To succeed as an investor, buy investments you’re comfortable owning and follow your plan; it is your financial playbook, guiding you to long-term success.

Investing is not a sporting event, but it does require a game plan with long-term strategic thinking to succeed.

If you’re wondering, Brees holds an edge over Brady in games won – 5 to 2.

“Don’t ever underestimate the heart of a champion.” ~ Rudy Tomvanovich

January 16, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.


[1] https://www.sportscasting.com/max-kellerman-finally-admits-he-was-wrong-about-tom-brady-becoming-a-bum/

[2] https://www.espn.com/blog/nflnation/post/_/id/207780/current-and-former-nfl-players-in-the-drivers-seat-after-completing-mba-program

Bye, Bye and Buy Bonds?

Interest rates are trading near historical lows, but they’re rising. Since July, the yield on the 30-Year US Treasury has soared 42%. Last March, it dropped to a low of .99%. Now it’s yielding 1.88%, an increase of 90%. Rising rates from all-time lows is not a rousing endorsement to buy bonds.

Despite the low rates, bonds belong in a diversified portfolio. Bonds are safe and consistent, and they offer stability not found in other investments like stocks, gold, or Bitcoin. Also, bonds are negatively correlated to stocks, so when stocks fall, bonds rise. During the market correction last March, interest rates dropped 36% as investors purchased US government bonds. As rates fell, the iShares 20+ Treasury Bond ETF rose 15%, while the S&P 500 dropped 12%.

Bonds are a source of funds. When stocks fall, bonds rise. You can use your bonds to buy stocks – buy low and sell high.

Another reason to buy bonds is to match the maturity with your purchase. If you’re buying a new home in two years, then buy bonds with the same maturity – two years.

My career launched more than thirty years ago in Pasadena, California, as a stock-broker hired by Dean Witter. I was young, with no connections, so my primary tool for prospecting was the telephone. I cold-called morning, noon, and night looking for new clients. One of the investments I used for calling was the 30-Year US Treasury bond. At the time, they were paying more than 8%, guaranteed. My pitch was simple: “Hello, Mrs. Jones, this is Bill Parrott from Dean Witter in Pasadena. We are currently offering a guaranteed investment paying more than 8%. Would you like to hear more about it?” I couldn’t give them away because most people thought interest rates were going to rise.  Well, they were wrong, and interest rates dropped more than 87% over the next three decades. If they bought the bonds, they could have enjoyed thirty years of 8% guaranteed income, and their bond would be worth $143 today, a gain of 43%.

Since interest rates are rising, bond prices are falling. The price of a 30-year bond will fall 22.4% if interest rates rise 1%, so my recommendation is to keep your maturities short – less than five years.

Bye, bye, and buy bonds!

January 12, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

Data Sources: YCharts

A Correction Is Coming!

The NASDAQ is up 388% for the past ten years, so it’s due for a correction, a pullback of epic proportions. When will it happen? I’m not sure, but it is coming. Get ready.

Before you decide to sell your stocks and buy gold or Bitcoin, let’s review the last decade. A $100,000 investment in the NASDAQ is now worth $488,000, a 388% increase. The index averaged 16.9% per year for the past ten years – a remarkable number. A few components include Apple, Tesla, NVIDIA, PayPal, and Netflix, so I’m not surprised the index performed so well.

However, the NASDAQ rise was not straight-up, but a jagged increase peppered with peaks and valleys. Let’s look at a few of the dramatic declines from the past ten years.

  • 2011. The index fell 17% from April to September.
  • 2012. The index fell 8.7% from March to May.
  • 2013 was a mild year, but the index did fall more than 4% in April and August.
  • 2014. The index fell 6.7% in May, 8% in October.
  • 2015. The index fell 9.6% from July to September.
  • 2016. In February, the index fell 9%.
  • 2017 was tranquil, with one minor dip of 3.7% in July.
  • 2018. The index fell 18% from August to December.
  • 2019. The index dropped 8% in May.
  • 2020. The index dropped more than 30%.

So, my prediction of a significant correction is meaningless because the market always fluctuates – rising and falling, like the tide. Do not fear a pullback; instead, use it as an opportunity to buy quality stocks at reduced prices.

If you attempted to time the market for the past ten years while living in fear of a correction, you missed out on astronomical returns.

Stay invested, my friends.

January 11, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

Data Sources: YCharts and Macrotrends

FOMO

Tesla, Plug Power, Fiverr, Stitch Fix, Sunrun, Zillow, Chewy, Pinterest, and Peleton – the list goes on. Many stocks soared last year, rising more than 100%. Do you feel like you’re on the outside looking in as others get rich buying stocks highlighted by a few storybook names?

It would take hundreds of thousands of dollars to buy every company traded on the market. If you could, it would give you access to high-flyers – at all times. Yet, there is a way to buy the market with one fund. The Vanguard Total Stock Market Index Fund gives you access to nearly every publicly traded company.

The Vanguard Total Stock Market Index Fund owns micro -, small -, mid-, and large-cap stocks. A few of the top 25 holdings include Apple, Amazon, Tesla, NVIDIA, Home Depot, and Netflix, each of these companies turned in stellar performances last year. The fund itself earned 21% last year and 31% in 2019. The 15-year average annual return has been 9.88%, and since 1992 it has produced an average annual return of 10.29%, outperforming the S&P 500. A $10,000 investment from 1992 is now worth $166,250.[1]

If you’re worried about missing out on the party, consider a total stock market index fund.

January 7, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.


[1] YCharts. Vanguard Total Stock Market Index Fund (VTSAX), 4/27/1992 to 1/5/2021.

What will the market do?

A popular question this time of year is: What will the market do? I don’t know. I can guess, of course, but it’s just a guess. But, more importantly, what market are you referencing? Stocks? Bonds? Gold? Bitcoin? YCharts identifies twenty-one major indices and tracks several thousand more from ninety different providers. Morningstar follows more than 85,000 global markets.

Last year, market returns varied significantly. The NASDAQ was up 45%, while the energy index fell 33% – a spread of 78%! Small-cap stocks rose 11.9%, real estate dropped 10.9%. Long-term bonds rose 12.4%, junk bonds fell 1%. And the ever-popular 60/40 index rose 6% after being declared dead and obsolete last year.

Some investors are concerned about the valuations of the market. I assume they’re worried about our US market, but I’m not entirely sure. The United States has three primary indices – NASDAQ, S&P 500, and Dow Jones. It’s possible to have exposure to a dozen different indices in a diversified portfolio where the US allocation accounts for about 25%. Does it make sense to liquidate an entire portfolio because of one overvalued market? It does not.

Rather than worry about the market, concentrate on your personal goals, save your money, think long-term, and buy the dip.

January 5, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

Are You Rigid?

The Oak and the Reeds is an Aesop Fable about flexibility. The mighty oak stands proud against the wind while the reeds bow low. They bow, but they do not break. The mighty oak stands rigid; it is stubborn and fights the storm. During a northern hurricane, the mighty oak was uprooted and fell among the reeds. The reeds were flexible; the mighty oak was not.  Bruce Lee knew this philosophy well when he said, “Notice that the stiffest tree is most easily cracked, while the bamboo or willow survives by bending with the wind.”

Investors can learn much from this Aesop Fable. Investing is not binary or rigid. It is not black or white. To be a successful investor, you must be flexible, willing to bow down to the market. If you’re not sure about your investing strategy, the market is an expensive place to figure it out. Many investment programs are rules-driven – low PE, small-cap, momentum, etc. But, if you’re not willing to break the rules in the short term, it may cost you in the long run. For example, if you focus solely on low PE stocks, you missed Amazon’s epic run. Amazon’s average PE is 234. Its low PE over the past 17 years was 93, and the high was 3,735. During Amazon’s elevated PE phase, the stock soared 7,310%. A $10,000 investment in 2004 is worth $741,000 today.

Be flexible.

January 5, 2021

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

How to Generate Income with Options

In a low-income, zero-interest rate world incorporating an option writing strategy may give your account a boost.  Writing options on stocks you own or want to own is an excellent way to increase your income without altering your asset allocation strategy or investment plan. If you own individual stocks, this could be a strategy for you. 

There are several ways to generate income from trading options, but I will only focus on two popular strategies – covered call and put writing.

Covered Call Writing

A covered call or buy-write allows you to generate income on stocks you own if you’re willing to sell your shares at a specified price. For example, let’s say you own 1,000 shares of Apple (AAPL), currently trading for $123.25 per share, and you would like to sell them at $130. As a result, you sell the January $130 call for $2.00. Because you own 1,000 shares, you sell ten contracts (one contract = one hundred shares of stock). The $2.00 is the option premium you’ll receive, so ten contracts will generate $2,000 income (10 × 2.00 × 100) before fees. The $2,000 will credit your account on the day of your trade.

If Apple stays below $130 on the third Friday in January (expiration), you’ll keep your shares. You can then sell another call option on Apple, expiring in February, March, or April, and repeat the process. If it trades above $130 at expiration, you’re obligated to sell your shares at $130, regardless of how high it trades above the strike price. If Apple closes at $200 on expiration, you’re still obligated to sell the stock at $130 and forgo the $70 profit.

As a warning, never sell a call option without owning the underlying stock position because your risk is unlimited.

Put Writing

Put writing involves selling a put option on a stock you want to own, comparable to placing a limit order on a stock you wish to purchase at a lower price – except you get paid to wait.  For example, if you want to buy Apple at $110, currently selling for $123.25, you can enter a limit order and wait for it to trade to your price, or you can sell a put and get paid.

When you sell a put, you’re obligated to purchase the stock if it trades at or below the strike price at expiration. If you sell an Apple January $110 put, you’ll receive a credit of $1.13 per contract. If you sell ten contracts, the credit will be $1,130 (10 × $1.13 × 100), before fees. If Apple trades at or below $110 per share, you’re obligated to purchase 1,000 shares at $110 regardless of how far it trades below the strike price. If Apple stays above $110, your option will expire worthless, and you’ll profit on your trade, and then you can sell another put option expiring in February, March, or April.

A put-writing strategy is best suited for investors with a high tolerance for risk. It’s also recommended you only sell puts based on the amount of cash in your account. This strategy is known as a cash-covered put. For example, if your cash balance is $25,000, you can sell ten put contracts on a $25 stock (10 contracts = 1,000 shares; 1,000 shares x $25 = $25,000).

I trade options to generate a few extra dollars each month; it’s my side hustle. I mostly sell puts on stocks that fall sharply, which increases volatility and boosts the amount of premium I receive. When stocks fall, fear rises. An ideal trade for me is to sell a put option on a stock that is dropping 20% or more with a delta of less than 20 (If an option has a delta of 20, it means there’s a 20% chance the stock price will touch my strike price). My time frame for selling a put on a stock that’s getting crushed is three to four weeks because an option is a wasting asset, so if the stock recovers, the option will expire worthless, which is my goal.

A stock rarely drops 20% or more two or three days in a row, in my experience. If a company misses its earnings or revenue targets, investors sell the stock and drive it down to unrealistic levels. When this happens, I try to sell my put option when the market opens and fear is spiking. When investors realize the company is not going out of business, the selling will stop, and my option trade becomes profitable.

Of course, not every option trade is profitable, so I’m quick to cut my losses if I’m wrong. I want to live to see another day.

Options involve risk, but they’re an excellent way to generate a few extra nickels.

Happy Trading!

Terms[1]

Contract: One option contract = 100 shares of stock.

Expiration: The day the option contract expires.   Options expire on the third Friday of every month.  Several stocks also have options expiring weekly.

Call Option – Buyer: An option giving the buyer the right to purchase a stock at a specified price.

Put Option – Buyer: An option giving the buyer the right to sell a stock at a specified price.

Call Option – Seller: An obligation to sell stock at a specified price.

Put Option – Seller: An obligation to buy a stock at a specified price.

Premium: The amount you must pay to purchase an option or the amount you will receive when you sell an option.

Strike Price:  The exercise price where you can buy a call or sell a put.

At-the-money: The stock price is equal to the strike price of the call or the put.

Out-of-the-money: A call option where the strike price is above the stock price. A put option where the strike price is below the stock price.

In-the-money:  A call option where the strike price of the call is below the stock price. A put option where the strike price is above the stock price.

Delta: The amount by which an option premium moves divided by the dollar-for-dollar movement in the underlying asset.

Volatility:  The measure of the fluctuation in the price movement in a security over a period of time.

December 14, 2020

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.


[1] The Bible of Option Strategies – The Definitive Guide for Practical trading Strategies by Guy Cohen