For investors seeking income and moderate growth in their 50’s, a thoughtful combination of #dividend stocks and covered call #stockoptions can potentially meet both needs. This strategy targets investors in their 50’s seeking the right balance of income and growth as they approach retirement. By this stage of life, building wealth becomes a priority while moderating risk exposure. Dividend stocks and covered calls can potentially achieve both for investors who have likely maxed out contributions to retirement accounts and need to generate rising income from their taxable portfolio.
This dividend and covered call strategy is a do-it-yourself (DIY) approach, better suited for self-directed investors who enjoy researching and selecting their own stocks. As Benjamin Franklin famously said, “If you want something done right, do it yourself.” Paying a financial advisor an annual fee of 1-2% can erode long-term returns, especially if the advisor underperforms the overall market. For DIY investors willing to learn and take on moderate risk, creating your own dividend portfolio and selling covered calls can potentially lead to solid returns. But be prepared to invest the time and effort to research quality dividend payers and understand options strategies. Joining a group such as the American Association of Individual Investors (AAII) is a great start for learning.
Stock Screening
Solid dividend paying stocks can provide a foundation for reliable income and capital appreciation over time. I focus on stocks with these four criteria:
- P/E ratios below 10
- share prices under $20
- dividends payouts greater than 5% with a history of consistent dividend increases, and
- positive 5-year equity returns
Using these parameters in your stock screeners on popular platforms like Robinhood or Yahoo! Finance can help identify quality companies with shareholder-friendly management. The dividends provide current income while the share prices appreciate.
Warning Signals
However, investors should exercise caution with stocks that pay excessively high dividends above 8%. Extreme #highyield can be a red flag for an unsustainable payout. Companies may be stretching to pay dividends that exceed their earnings. This is may not sustainable long-term. Here are some reasons that dividend payouts may be so large:
- Stocks that have tumbled in price recently – a perfect example was Lumen Technologies (symbol LUMN) which sported a 10% dividend at $10 share price in 2022 before dropping to $1.72 today and stopping its dividend.
- Stock share prices that are artificially inflated by high dividends – Hindenburg Research purported that Icahn Enterprises (symbol IEP) was doing this (see the article for more information).
- The company has a variable dividend based upon income with extraordinary current income – CVR Partner, LP (symbol UAN) had a huge dividend for a year of huge profits, with 40% dividend yields before lower income brought the current dividend rate down to 21% yield today (still pretty awesome if you ask me).
When evaluating dividend stocks, examine the dividend payout ratio compared to earnings. Very high payout ratios above 80-90% indicate the dividend could be cut if earnings decline. Also, research cash flow, debt levels, and industry trends. Sometimes high yields compensate for riskier underlying business fundamentals. While enticing, reaching for extremely high yields can backfire if the dividend is slashed due to financial strains. Moderately high, safe yields in the 4-6% range provide income without as much risk – I personally like 8 to 12%, but I don’t mind the extra risk.
Going Against Advice
While common advice like broad diversification, avoiding trading, and using mutual funds may work for some, I prefer a more concentrated, hands-on approach.
I invest in 10-20 stocks across industries I understand, allowing me to closely track operations and news. While diversification has merits, I believe knowing your companies in depth can aid smart investment decisions. I also sell covered calls on my holdings several times per month to generate income, providing a trading fix without churning the core portfolio (frequent trading degrades returns).
Finally, I steer clear of mutual funds with expense ratios (usually between 0.25% and 1%) that erode returns over time and studies show most active funds underperform index funds after fees. For DIY investors willing to research quality stocks and learn strategic options trading, this dividend and covered call strategy aims to deliver better risk-adjusted returns compared to passive mutual fund investing.
Covered Calls
Adding covered call options to this dividend portfolio can further boost income. Covered calls involve selling the right for someone to buy your stock shares at a set price by a future expiration date. If the share price stays below that price, you keep the option payment as income. If the stock rises above the strike price, the shares are called away at the agreed price.
See my article “Primer on Exchange Listed Options” for more information on stock options.
Examples
Here are examples to underscore this:
EXAMPLE #1 – If you own 100 shares of XYZ stock at $50, you could sell a monthly covered call option with a strike price of $55 for a premium of $1 per share, or $100 total. If XYZ stays below $55/share, you keep the $100 premium. If XYZ rises above $55/share, your shares are called away at $55 each.
EXAMPLE #2 – If ABC stock declines from $30 to $25, the covered call premium provides income to partially offset the stock loss. The call strike price limits upside but generates income.
EXAMPLE #3 – Let’s say you own 200 shares of stock DEF currently trading at $45 per share, for a total position value of $9,000. You sell 2 covered call option contracts with a strike price of $50 expiring in one month for a premium of $1 per share, or $200 total (each contract covers 100 shares). If DEF rises to $55 per share by option expiration, your shares will get called away at the $50 strike price. You lose the upside above $50 but gain the $200 premium plus $50 per share compared to your $45 cost basis. Your total profit would be the $200 premium plus 200 shares * ($50 strike – $45 cost basis) = $200 + $1,000 = $1,200. So, although you missed some upside above $50 per share, the covered call boosts your overall gain through the collected premium and selling the shares at an advantageous price.
For investors in their 50’s (like me), covered calls add income and downside protection. The options income can mitigate potential stock declines. If the stock rises strongly, the shares are sold at the advantageous strike price. This balances growth with consistent income for an age appropriate, moderate risk approach.
Some dividend stocks may not have enough options volume for writing covered calls. In that case, the dividends can still provide income while awaiting share price appreciation.
Summary
For investors seeking income and moderate growth, a thoughtful combination of dividend stocks and covered call stock options can be an effective strategy for meeting both needs.
- Screen for solid dividend paying stocks with P/E ratios below 10, share prices under $20, dividend payouts above 6% with a history of increases, and 5-year positive returns.
- The dividends provide income while shares appreciate.
- Exercise caution with extremely high yields above 8% which may signal unsustainable payouts.
- Adding covered calls boosts income through option premiums and downside protection. For a balanced approach, covered calls provide income if shares stagnate or are called away at profitable prices if shares rise.
With proper research and discipline, dividend stocks and covered calls can produce a stable income stream while allowing for portfolio growth over the long-term.
About Robert Rhodes
Follow on LinkedInRobert C. Rhodes is an experienced sales and business development professional with a background in finance, operations, and #strategicplanning. His proven track record of success in driving sales, leading teams, and managing customer relationships is visible as a former CEO of publicly traded companies with a history of successful #fundraising, #mergersandacquisitions, and revenue growth. He is skilled in managing financial and operational challenges in high-tech and #cybersecurity industries.
- Industries – Edtech, Oil & Gas, Heavy Industry, and Technology
- Specializes in public company M&A and disclosure
- LinkedIn profile
- Listed on Business Talent Group as available for projects through DSV Consulting
DISCLOSURE – I made frequent usage of Claude from Anthropic to write this.
Here is a link to the original article on LinkedIn, as well as the post: