Some Smart Ways To Grow Your Retirement Nest Egg

A disturbing amount of people haven’t saved enough for retirement. That begs the question: How does one build the investment portfolio to see you until the end of your life? For answers, we turned to Steve Sears, president and COO at Options Solutions in Chicago.

Larry Light: What’s your take on the retirement crisis in America?

Steve Sears: The older one gets, the less time to recover from the march of time. The war in Ukraine, within that context, is thus arguably more nettlesome to investors who are retired or nearing retirement. As markets have weakened following Russia’s attack, millions of people, here and abroad, are forced to wonder what may happen to them if the war triggers a prolonged stock market decline, or even checkmates the Federal Reserve’s plans to raise interest rates to offset inflation.

These are nuanced issues, but this is a simple fact. Each day, 10,000 people in America turn 65. Many, if not most, are ill prepared for retirement. They have not been able to save enough money. Even those who have saved money must worry about out-living their money.

Consequently, people need new ways to think about old problems. Bonds are unlikely to provide meaningful income. Stocks, which remain close to all-time highs despite the painful pullback since January, continue to be widely owned by just about everyone in America from Reddit traders to people deep in retirement.

Hence, it may make sense for some investors to think about ways to enhance yields, and perhaps simultaneously reduce risk. Many sophisticated investors have long used a simple options trading strategy—the covered call—to do just that. Also, there are ways to use options that enables investors to stay invested in the market with less risk by defining bullish and bearish ranges.

Light: But are options suitable for my retirees or people planning their retirement?

Sears: The perception of options as risky is largely animated by how people perceive options, rather than how options are generally actually used by conservative investors. Sure, many people understand speculating, and options are used for speculation, usually by the least sophisticated investors.

But many more investors use options in very conservative ways to help solve basic investment goals like generating income, reducing risk, buying below the market and even selling above. If any of those four basic investment goals are appealing—and how can they not be?—you owe it to yourself to learn about the covered-call strategy.

Light: What’s so special about covered calls?

Sears: If you like stocks, many investors tend to love options. The judicious use of puts and calls enables investors to curate their stock portfolios, oftentimes harnessing the very forces that push stock prices higher and lower.

There are many complicated institutional strategies for accomplishing the latter, but a bedrock strategy is the covered call, which entails selling call options on stocks that an investor already owns. By doing so, an investor gets paid for agreeing to sell their stock at a higher price within a specified time.

Light: Sounds logical. What’s the rub?

Sears: If you own a stock trading at say $50, you could sell a call option that gives you the right, but not the obligation, to sell your stock at $60 in two months. In return, you get paid XXX by the options market. Should the stock be below the $60 strike price at expiration, you keep the options premium. Should the stock be above the strike price at expiration, you could sell the stock at an effective price of $6XXX—strike price plus premium—or adjust the position in the options market to avoid selling the stock.

Light: OK, but what about managing risk and protecting my portfolio. What about the risk?

Sears: The risk to the strategy is that the stock races higher and moves far above the strike price. When that happens—and it does from time to time—investors must buy back the call at a higher price, or sell the stock, or some of the stock to cover the price of buying back the call.

This may seem like a real hardship, but our experience has repeatedly proven that such situations enhance investor discipline. The sale of a stock that is sold because of a call option repurchase or assignment often means that an investor is selling at, or around, high prices. After all, stock prices do not always rise. That’s a lesson that many people are now learning.

Without doubt, the covered call strategy requires more time and effort than passively owning stocks, but the strategy can help investors take better control of their journey through the financial markets.

At Options Solutions, we think of the covered call strategy as a way for investors to be paid by the options market just for being a long-term investor.

Light: This makes a lot of sense, but isn’t it risky to be heavily invested in stocks, especially as one nears or is in retirement? What strategy, or strategies, do you recommend to reduce risk?

Sears: Warren Buffett has noted that 100% is his favorite equity allocation. In his annual shareholder letter, he just reminded investors of that very fact. Anyone who does that has to own a great basket of stocks, and they must understand how to watch and manage the basket. It may sound hard, but anyone can do it with some help and education.

Not everyone is a stock-picking genius like Buffett, but anyone who wants to invest in stocks with defined risk parameters can consider what we call a “buffered-protect strategy.” We believe this is a cost-effective way to reduce portfolio risk and stay invested.

Stock and other investments are affected by events that are often difficult to predict. Growing uncertainty from rising rates, inflation, and Fed tapering is fueling additional uncertainty. The customizable buffered protection strategy offers a cost-effective approach that seeks to reduce equity risk and offers limited upside at little to no up-front cost.

Light: This isn’t exactly the classic asset allocation of 60% stocks and 40% bonds.

Sears: Wall Street is built on a 60/40 allocation, but that portfolio allocation arguably has much more to do with the business models of brokerage firms than with what makes sense for investors. Debates aside, many people have not saved enough for retirement.

They need income. They are walking a delicate tightrope, hoping that something does not happen to push stocks lower at precisely the time that they need money. Meanwhile, rates are rising, and arguably fewer people understand how to navigate the bond market than the stock market. Still, we think there is a way that deserves consideration that can keep people invested, and potentially increase income.