How To Create A Worry-Free 9% Income Stream
Pension funds are in the news again... and the news isn't very good. Many plans are underfunded, which means they don't have enough money to pay the benefits they've promised.
Among those many underfunded plans are funds managed by the city of Chicago, which were recently blocked by a court ruling that prevents the fund from reducing benefits. That means the city will need to find other ways to reduce its shortfall.
But Chicago is not alone in its pension problems. Experts estimate pension funds across the country -- both government-run plans and corporate plans run by large companies -- are underfunded by trillions of dollars. That's bad news for the plan participants.
It's safe to assume the experts' original assumptions for these plans were overly optimistic. And in order to keep the promises these funds made to the hardworking men and women who paid into the plan so many years ago, the plan managers have two choices:
1. Find a way to come up with the money (increase the assets in the fund), or
2. Pay out less money to plan participants (cut or reduce benefits).
Really, there's only one choice. Cutting or reducing benefits is an absolute last resort. (And in Chicago, it's not even a possibility.) That means plans are left with finding a way to come up with enough money to continue making payments to participants.
One way plans can increase assets is by shooting for better returns. Since high-quality bonds pay next to nothing in our current low-yield environment (10-year U.S. Treasury notes yield about 1.8%, for example), they're stuck allocating more money to stocks, which carry a significantly higher amount of risk than bonds. While this is a risky strategy, pension plans don't have much choice.
Now here's why I bring all this up: pensions aren't the only ones suffering from this conundrum.
In the current low-interest environment, our choices also seem unappetizing:
1. Move to riskier investments in order to generate an acceptable income stream, or
2. Accept a lower payout.
Neither is a particularly "good" option. But there's a third choice -- one that too few investors even bother to consider.
3. Supplement our income by selling covered calls on high-quality stocks.
If you're not familiar with the term "covered calls," I'm referring to a conservative options strategy that lets investors earn income from stocks they already own.
See, many investors simply hold stocks in their investment accounts and hope that their dividends and capital gains will be enough.
But my readers and I do better by making a deal with other traders who want to pay us cash upfront -- money that goes straight into our brokerage accounts -- for the opportunity to buy shares from us at a higher price.
This lets us collect the cash they pay to make the deal and the money from potentially selling the stock at a profit.
You can use this strategy to generate extra money for day-to-day living costs. It can cover your monthly bills... medical expenses... even provide you with an additional income for the things you otherwise couldn't afford, like taking a nice vacation.
However you choose to use this money, it's one of the most conservative ways to generate extra income from the stocks you already own.
One stock my readers and I have done this with recently is Philip Morris International (NYSE: PM ) . In fact, before this most recent trade, we held it in our Maximum Income portfolio not more than two months ago.
And that's no coincidence. You see, my goal is to establish a long-term core position in PM, which boasts a 4% dividend yield at current prices. Add in another 4.8% annualized income from selling covered calls, and we've set ourselves up with a long-term income stream that consistently pays out 8% to 10% every year.
PM's status as a high-quality dividend stock makes it the perfect vehicle for this strategy. Unlike some of its high-yield brethren -- which pay out big dividends to make up for their high risk -- Philip Morris is able to offer such an impressive dividend payment simply because there's little need for investment in the cigarette business.
For example, Philip Morris is currently rolling out a "heat-not-burn" technology that offers nicotine in a less harmful way to consumers. So far, the company has spent an estimated $2.5 billion developing this new product -- or less than 10% of the reported $26.8 billion it's generated in sales over the past 12 months.
That's a relatively small amount for a new product line, especially when you consider that the cost was spread across multiple years. And the technology represents one of the biggest changes the industry in the past 10 years.
Because it doesn't have to funnel all that money back into the company, Philip Morris dedicates most of its cash flow to rewarding shareholders with dividends and buybacks.
In fact, the company has paid a cash dividend to its shareholders every year since it was spun off from Altria Group (NYSE: MO ) in 2008, and it has an equally long history of raising its payment every four quarters. This adds an extra layer of safety to the dividend's status, as no member of current management will want to be the one responsible for ending that streak.
This dedication to dividends makes PM appealing to income investors seeking high yet safe yields, which should help provide support for prices at current levels. But as I mentioned earlier, we can use our covered call strategy to turn it into a long-term position with the potential to deliver a consistent 8% to 10% income stream year after year.
Now, I won't get into the particulars of our trade in today's essay. Just know that lofty, consistent income streams are possible in this environment -- if you're willing to try something new.
If you'd like to learn more about selling covered calls, I encourage you to check out this special report , which goes into more detail about how this strategy works. And if you sign up for my premium newsletter, Maximum Income, you'll get new trade recommendations every other week, so you'll get plenty of opportunities to generate income by selling covered calls. To learn more, simply follow this link .
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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