What’s the difference between being rich and being wealthy? Rich people have assets that don’t necessarily produce income, for example, a house with $1 million in equity.
Wealthy people accumulate assets that produce income, for example, a home that rents for $4,000 per month. It takes much more financial sophistication to be wealthy.
I am a hardcore lover of income. Income makes me happy every single day. As a retiree, I must always focus on increasing my monthly income.
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Two strategies I use to increase my monthly cash flow are selling covered calls and investing in income via closed-end funds. But which strategy is right for you?
Selling covered calls for passive income. I have written extensively about covered calls recently because as interest rates decrease, finding high-yielding products will become more challenging.
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Someone selling covered calls can dictate how much money they want to generate. There is some risk with selling covered calls; however, you can mostly prevent bad things by making smart plays from the beginning.
You will need a nice pot of money to sell covered calls effectively. The reason is that you must own 100 shares of a company to sell one covered call. Therefore, getting into the covered call game will take some effort and capital.
Happy Financial Independence Day 3
Investing in closed-end funds for passive income. On the other side of the spectrum is investing in closed-end funds. Closed-end funds are (mostly) leveraged exchange-traded funds with a set share amount.
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Having a set amount of shares means the funds don’t grow or contract with inflows or outflows of capital. Instead, they have a net asset value (NAV) that you can use to gauge its performance or interest from investors.
The main reasons to invest in closed-end funds versus ETFs are 1) outstanding fund managers, 2) long histories of success, and 3) to receive a high level of income.
I typically invest in closed-end funds that pay over 10% in dividends—sometimes over 15%. Surely, it must be risky to invest in CEFs that pay this much in dividends. Well, it’s time to dive into this highly volatile debate.
What is the Sequence of Return Risk?
The risk of income. I can receive a 4.25% interest on my Discover high-yield savings account. Based on the rule of 72, it would take me 16.9 years to double my money at this yield.
At a 10% yield, it would take me 7.2 years; at 15%, it would take 4.8 years. You can see where I am going with this analysis. We cannot simply sit still and wait for the banks to make us rich. We need to use a combination of safety (HYSA), security (CEFs), and risk (Covered calls) to become wealthy.
So, is it risky to purchase closed-end funds? Meh, I don’t think so if you come in with the right approach. Is it risky to sell covered calls? Meh, as long as you are patient.
The risk of selling covered calls is that your cost basis goes upside down. This means that you spent $10,000 on shares, but they are now worth $8,000 (for example). You must be patient and let your shares rebound.
The risk of investing in closed-end funds is that the share price will drop. However, you will be okay if you are in it for the income.
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CEFs use leverage to juice their returns. However, leverage is a double-edged sword: it increases your returns during good times and poisons your returns during bad times. I typically balance out my CEF investing with index funds (but that’s a story for another day).
Let’s talk about income. Now for the fun part—generating income. Let’s take a $50,000 income portfolio versus a $50,000 covered calls portfolio.
With $50,000, I can purchase 2,580 shares of my favorite closed-end fund, PIMCO Dynamic Fund (PDI). Each share pays a monthly dividend of $0.2205, for a grand total of $569/month. I don’t have to do anything except receive and enjoy my dividends every month.
With $50,000, I can purchase 4901 shares of my favorite covered call stock, Rivian (RIVN). I don’t recommend spending all of your money on one stock, but bear with me. I can sell 49 covered calls (with a 30-day expiration date) and earn $3,773.
Now, you can see the difference quite clearly. I am generating almost seven times the income by selling covered calls. However, my approach to covered calls is reckless.
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It would be better to keep half of my covered calls portfolio in cash, which still gives me a whopping $1,886; this is an annual yield of 45%.
Let’s talk about time. Why would anyone want to purchase closed-end funds versus selling covered calls? It’s an issue of how you value your time.
Selling covered calls doesn’t take a massive amount of time; however, it is much more nuanced than investing in closed-end funds.
Let’s say you own 1,000 shares of Rivan with a cost basis of $11. The current stock price is $13, and you sell covered calls at the strike price of $14.
Rivian’s stock price shoots up to $15, and you wake up on a Monday with $14,000 in your account—someone exercised your shares. You made a profit of $4,000 plus the commission.
But the true question is whether you should purchase shares at $15 to start the cycle again. I would not jump right back in at these elevated prices. This is where the nuance of selling covered calls will test most people.
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You can balance out this approach by selling cash-secured puts, but again, this requires some skill and time.
On the other hand, I can kick back and collect my closed-end funds. It feels so good to receive $568 on the first of the month for doing absolutely nothing.
My wife and I have a $50,000 income investing portfolio that pays us over $600 per month. As much as I love selling covered calls, I prefer my quiet, closed-end fund strategy.
Together, we stand. Of course, using covered calls and closed-end funds together can give us amazing results. Let’s see how I would allocate a $50,000 portfolio.
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I would invest $10,000 in a dividend ETF like the Schwab US Dividend ETF (SCHD), which would give me some growth and dividends.
I would invest $30,000 in PDI, which would pay me $340 per month. Finally, I would allocate $10,000 to a covered call strategy.
I could safely earn $462 by selling RIVN covered calls against my $10,000 portfolio. So, I would earn $800 monthly from closed-end funds and covered calls, PLUS some growth and dividends from SCHD.
Conclusion. The moral of the story is that the more you know, the more your income will grow. I would love to sit on the sidelines and collect dividends from PDI.
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However, using a small $10,000 covered call strategy almost doubled my monthly income. This is the true value of selling covered calls.
Selling covered calls works best in conjunction with other income strategies. You should only allocate a $50,000 covered call portfolio if you have a $400,000 overall portfolio (for example).
I like closed-end funds because I can depend on highly skilled professionals to run them and pay me dividends. Your covered calls strategy depends 100% on you, so it’s good to limit the resources you dedicate to it.
The more money you allocate to covered calls, the more time you dedicate to your program. Closed-end funds are the exact opposite.
The more income you allocate to closed-end funds, the more time and money you have to enjoy your life. Again, there is nothing like receiving $600 per month for doing absolutely nothing. Good Luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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