“In my view, for most people, the best thing to do is own the S&P 500 index fund,” said billionaire investor Warren Buffett at the 2020 Berkshire Hathaway Annual Meeting. “People will try to sell you other things because there’s more money in it for them if they do.” While it’s notoriously difficult to outperform the S&P 500 index over the long run, the advice may be a little too cynical when it comes to building a risk-appropriate portfolio and deciding whether to hire a covered call advisor.
After all, the S&P 500 index produces a paltry 1.47% yield and has a 15% standard deviation over the past 30 years. And, of course, you only realize the S&P 500’s strong returns if you have the stomach to stay in the market! In this article, we’ll look at why you might want to consider covered calls for your portfolio and how an advisor can help you leverage them without taking on unnecessary risk.
Why Use Covered Calls?
Many retirement-aged investors turn to dividend stocks and bonds to generate monthly income. While bond interest rates have become more attractive, they don’t offer the same upside potential as stocks. At the same time, dividend stocks don’t offer quite as much yield as bonds, meaning they often fall short of meeting income requirements for retirement.
Covered calls are a great way to boost the income from a stock portfolio and reduce the risk at the same time. By selling a call option against a long stock position, you receive income from the option’s premium while retaining some of the stock’s upside and dividend potential. And by writing covered calls each month, you can earn a recurring income.
In addition to generating income, covered calls can help hedge against downside risk. When you sell a call option and receive income, the income can help offset a decline in the underlying stock price – effectively creating a buffer. As a result, you may use covered calls in top-heavy markets to “take money off of the table” and reduce your overall risk.
Finally, some investors use covered calls as an income-generating machine. A great example is the Option Wheel strategy, which involves selling a put option until you end up buying a stock and then selling a covered call against the stock until you end up selling it. While it’s not a strategy for long-term investors, it is a great income generation strategy.
How Advisors Can Help
More than half of investors have self-directed brokerage accounts, while about a quarter of investors engage financial advisors. Fortunately, investing in passively managed, low-cost index funds has never been easier. And since advisors typically charge a flat rate or percentage-based fee, there’s an opportunity to reduce costs and build more wealth.
But, while advisors don’t typically beat the market, they can prevent you from making costly mistakes. Fran Kinniry, head of the Vanguard Investment Advisory Research Center, found that a good advisor can increase your after-tax investment returns by about 3% by avoiding costly mistakes like selling when the market is down and missing out on a rebound.
Advisors are also essential when investing in sophisticated assets. While stocks and bonds are straightforward(-ish), covered calls present some unique challenges. For example, it’s difficult to tell if a covered call opportunity is over- or under-valued – much less make other decisions without understanding relatively obscure stock option concepts like time decay and deltas.
DIY investors may also struggle with questions like:
- What stocks are best for covered calls?
- What strike price and expiration should you use?
- How do you properly diversify your covered call portfolio?
- What do you do if your stock appreciates in price?
- What do you do if your stock drops in price?
- How many contracts should you sell against the stock?
Covered call advisors can help you answer these questions. With in-depth options knowledge, they can help you navigate the complexities of the options market to control risk and enhance income. They can also help you integrate covered calls into a broader portfolio, helping you balance income objectives with long-term growth and other factors.
Most covered call advisors are simply financial advisors who specialize in covered calls, which means they can also help with other financial planning activities. For instance, they can help you determine how much to expect from Social Security and other income sources and then explore ways to fill in the gaps using covered calls or other strategies.
Finding the Right Advisor
Hiring a financial advisor involves placing a lot of trust in one individual or business, making it an extremely difficult decision and process. After all, you’re trusting them with thousands or millions of dollars and future quality of life. The good news is that there are some ground rules that you can use to simplify the process and maximize the odds of hiring a great advisor.
Some essential tips include:
- Find a Fiduciary – Broker-dealers must follow suitability standards (e.g., this product is likely going to benefit the client) whereas financial advisors have a fiduciary duty to their clients (e.g., this is the best and lowest cost product for the client).
- Look for Credentials – Financial advisors must pass a securities exam to practice, but these exams merely ensure they’re familiar with the law. The best advisors go above and beyond by seeking credentials like Certified Financial Planner (CFP) or Chartered Financial Analyst (CFA).
- Follow the Money – Financial advisors can be compensated in several ways, including fee-only (e.g., you pay them hourly for advice) or fee-based (e.g., they receive a cut of fees from the products they recommend). Generally, fee-only advisors produce the most unbiased advice since they only benefit from helping you.
- Prioritize Communication – Financial advisors are responsible for translating complex topics into easy-to-understand terms. If you don’t understand what’s happening, it might be time to look for an advisor capable of better communication.
Finding an advisor specializing in covered calls can be even more challenging since it’s a relatively unique skill set. Rather than trusting an advisor’s skill sets, you should ask pointed questions about their strategy and approach to covered calls to understand how they will build and manage your portfolio.
The Bottom Line
Financial advisors can help you develop a plan for retirement savings and income generation. While they probably won’t help you “beat the market,” they can help you avoid costly mistakes and navigate complex financial products to achieve your objectives. And, if you’re considering covered calls, they can provide a helpful hand to avoid common pitfalls.
Snider Advisors can help you develop a financial plan to meet your requirements with the help of covered calls. Like a typical advisor, we can help with everything from Social Security planning to tax guidance to withdrawal optimization. But unlike other advisors, we harness the power of covered calls to help your portfolio do more to reach your goals.
Schedule a free consultation today to learn more!