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Up 19.7% in 7 months.

That's not bad. Our goal in our most Conservative virtual portfolio was to make $4,000 a month so a person with $500,000 in a retirement account can generate $48,000 a year to live on without touching (and, hopefully, growing) the principal. As we're now up $95,175 on $500,000 in our 7th month (and only about 50% invested), we are comfortably on track as all those little trees we planted begin to take root.

The current positions are actually up $130,845, but we pulled some bad positions that lost us $35,670, which is normal as we begin this process -- you can't pick all winners -- the key is to have the discipline to cut your losses and nurture those winners because, hopefully, those are the ones that will be with you a long, long time and keep producing that income. So, in theory, this type of portfolio gets stronger and stronger each year, and it's amazing how fast it can grow -- especially when we're at a 35% annual pace.

(click to enlarge)We might have done even better, but we picked a terrible time to start this one, initiating a lot of initial positions in August and September, as the S&P topped out at 1,474. The markets began a relentless downturn all the way into QInfinity in November and bottomed out at 1,343 (down 9.5%) around the election, and only last week made it back to where we were. Fortunately, our investing plan includes scaling into positions so we were able to adjust and add along the way -- taking advantage of the dip and giving us a great return -- even though the market is essentially flat to where we entered.

The chart on the right shows the portfolio's performance over time -- down over $13,000 in November before turning around with the markets. All that time we kept planting our trees -- adding an average of 3 positions each month as we will continue to do throughout 2013, as a portfolio like this is always a work in progress and today's review is, in fact, an exercise in identifying which positions we want to cultivate and which ones we are ready to harvest the cash on.

(click to enlarge)The key to our strategy is pretty simple, we look for undervalued stocks that have the long-term potential to either pay us dividends and/or make good candidates to sell options against long-term -- so that we can create our own dividend stream -- something we can do with any common stock.

As you can see from the chart on the left, high-dividend stocks outperform the S&P by a ridiculous margin over time, more than a 2:1 advantage year after year. If you are INVESTING for the long-term, why would you deny yourself that kind of advantage when building your portfolio?

There's another huge advantage we can get when building our portfolios, and that's the discounts we are able to give ourselves by either hedging our entries with option sales or, as we did more often this year -- selling short puts for our initial entries as that strategy either results in A) buying the stock at a steep discount to the current price or B) not buying the stock at all but keeping the put premium. As we didn't trust the market not to have a turndown in 2012 when we began this portfolio -- we mostly sold long puts and took up well-hedged positions so we could ride out what we thought might be a 20% dip in the S&P before the Fed rescued us again.

As we only got 10%, we were happy to do a little more buying into the end of the year -- adding 7 more positions in November and December, including 2 of our 4 positions where we actually bought stocks (GDX and CIM), rather than nervously hedging long-term options.

Note that GDX and CIM are not hedged, both are buy/writes using our "How to Buy Stocks for a 15-20% Discount" strategy. Notice also that, on StJ's brilliant shaded box system for tracking where a trade has been in the past, only 3 of our remaining positions have fallen more than 50% at any point, and one of those is our TZA hedge, which is supposed to fall when the rest of our portfolio is doing well.

The hardest thing to teach in portfolio strategies is patience. When you are investing with 20+ year horizons, it doesn't pay to rush into things your first year trading -- let alone your first few months. This is our 3rd Income Portfolio and our 5th Long-Term Portfolio since we started keeping them in 2006. As each one matures, we have no more need to track them (as they are very easy to maintain once you get the hang of it), and we like to start a fresh one so new Members can catch up on a brand new set of stocks.

This Income Portfolio, since we started off in a climate where we weren't sure we wanted to have a lot of long-term stocks, doesn't have many permanent stock positions but, over the next 6 months, we will begin a transition and, hopefully, we'll be able to get this portfolio to the same level of maturity as our last 4 -- and it will be ready to fly on its own as we set up a brand new Long-Term Portfolio in the Summer.

(click to enlarge)Unfortunately, long-term investing is pretty boring. It's supposed to be boring, as our goal is to generate a long-term income, and you can't do that reliably if your balances are all over the place. Our core strategy is, as always, to BE THE HOUSE, not the gambler and we try, whenever possible, to sell risk to others. Risk is for suckers. Risk is for people who are not in the game for long-term security. Gambling can be fun, but having no money when you retire is not fun at all -- so it's not a game we encourage. Notice, of our 3 most recent positions (full update here), we have 8 out of 11 slots filled with short sales -- clearly, we sell much more premium than we buy, as it should be.

Keeping that in mind, let's take a look at our current positions and make sure we are on track and, if not, do a little course correction to get us there. Now that we have more mature positions, we're also ready to try to draw a regular income (yes, it only took 7 months in a rocky market -- isn't that cool?) and we'll be looking for opportunities to create dividends for ourselves by selling options against our well-entrenched positions.

  • AAPL - 4 2014 $400/500 bull call spreads at $58.05, sold 4 2015 $350 puts for $34.97 for net $23.08, now net $29.98 -- up $2,760 (up 30%). Discipline, discipline DISCIPLINE. How long have we been messing with AAPL before it got cheap enough to go in our conservative portfolio? Now it finally did, and we're up 30% in 5 days (2 days really, as the weekend doesn't count). This is, of course, a fairly small entry in AAPL because we still don't trust it but, if it works out, it will still (at 4 contracts) make $30,768, which is almost our goal for an entire year ($48,000), so why should we risk more with that kind of pay-off potential? Our worst-case is, of course, having to own 400 shares of AAPL at net $373.08 ($149,232), and that would use about $75,000 of our $1M margin, at which point, we'd likely sell the 2017 $300 puts and calls for $100+ and drop our net to well below $300 for 600 shares (if assigned). If we don't want to own $180,000 worth of AAPL at $300 a share -- then why would we buy any when the stock is at $500 but, otherwise -- what a fantastic way to set up a long-term position!
  • ABX - 10 short 2014 $30 puts sold for $4.60 ($4,600) to help pay for 15 2014 $25/40 bull call spreads at $7.41 ($11,115) for net $6,515, now $9,150 -- up 40%. ABX is wildly volatile, but this is really an inflation hedge on gold and gold is pretty low now ($1,650), and we're still up 40% because we sold a lot of premium and picked a good entry spot.

(click to enlarge)Did we like ABX in June, when we started this portfolio? Sure we did, but ABX was at $37 in June, so we didn't buy it. In July, when it dropped to $34, we sold puts and in August, when it fell to $32, we added the spread. This is what fundamental investors do -- we WATCH stocks that we like and we WAIT for them to go on sale and THEN we buy. So, right now, ABX is back to $34, but the VIX is low so not as much fun to sell puts, but the 2015 $30 puts are $4.30 and that's not so terrible, as you are only about 7 months worse off than we were with our July sale. But the key is that the net is the same and it's still a nice net entry on the world's biggest gold miner.

  • (click to enlarge)CIM - 5,000 shares at $2.61, sold 2015 $2.50 puts and calls for .90 for net $1.71, now net $2.15 - up $2,200 (25%). We only bought these on New Year's eve, so kind of crazy money to make in 3 weeks. Keep in mind we max out at $2.50, as this was a fairly conservative entry, so only .35 x 5,000 ($1,750) left to gain. BUT, we really like CIM AND it pays a .36 dividend, so we get another $1,800 a year for NOT selling it and that tips the scales back to keeping it. In fact, we wish it had gone lower so we could have added more at 25% off instead of giving us a quick 25% profit -- which means we played this right, as it's good when you wish you hadn't made the quick money.
  • (click to enlarge)HPQ - 50 short 2015 $15 puts at $5.65, now $3.75 - up 33% ($9,500). Who'd have thought we'd make a profit from HPQ? I did!!! This was one I was really pounding the table on in Vegas, and we rolled into this position from our original loser just after the conference in November. If we do get assigned the stock at net $9.35, that would make the .53 dividend 5.6%, but that's not very likely. We'll probably just keep the cash, with $18,750 left to collect if HPQ can hold $15 for the next two years.
  • MT - 1,000 shares at $16.78, sold 10 2015 $15 calls for $4.50 and 10 2015 $17 puts for $4 for net $8.28/12.64, now net $9.43 - up $1,150 (14%). We only bought this 12 days ago, so not much to tell other than we got a good entry. Of course, there's a skill to that, so I guess that's the lesson here. We follow MT, and when it had "negative" news that we felt was getting an over-reaction, we jumped in on the panic. My comment that day was in response to Yodi asking about an entry on X, but I said I liked MT better at that moment:

X/Yodi - MT had a nice dip today because it is raising capital to cut old debt and restarting a furnace - I don't consider those bad things. It pays a .64 dividend and, for $16.78, you can buy the stock and take advantage of selling the 2015 $17 puts for $4 and the $15 calls for $4.50 for net $8.28/12.64 and that makes the dividend 7.7% while you wait to see if you get called away with an 81% profit. That one is so nice, we should add 10 to the Income Portfolio (small in case we have to DD, and a very nice $6,720 profit if not).

That's all it takes -- patience and paying attention. We KNOW what MT is worth so, when it goes on sale -- we're happy to whip out our checkbook and buy some. The next day, it was off seal already and $1 higher, but we get these opportunities all the time -- this portfolio is full of examples from our last 7 months of trading.

  • TZA - 50 April $15 calls at $2.13 covered with 50 short Jan $22 calls at $1.56 (net $2,850), now net .77 ($3,850) - up $1,000 (35%). We had nice timing going naked on our longs and then covering at the top, so we ended up with very cheap insurance that we never needed but now is the time to spend money and roll so we'll let the $22s expire worthless on Friday, but let's salvage the .63 left on the April $15 calls ($3,150 - down since last update) and roll them to the July $13s for .90 ($1.53) and now we're spending another $4,500 for another 3 months of insurance and we'll look to cover with something next time we have a nice dip (and possibly spend that money to roll the calls to a lower strike) and, if we never have another nice dip, we can already see that our rate of return in a bull market makes $5,000 very cheap insurance indeed.

Keep in mind, that $15/22 bull call spread was good for $35,000 had the RUT fallen 15% instead of rising 15% and we probably would have lost $75,000 instead of making $75,000 and the hedge would have covered half our losses -- like it's supposed to! Remember, we were over-hedged for a while and pulled our losses until we got to the right mix. You have to tinker with your hedges until you get the right balance.

Not a bad-looking set of picks (full set of picks and updated spreadsheets always available under our Virtual Portfolio Tab)! Of course we dump our losers and keep the winners, but most of our mistakes came early on and we've made up for them in spades. This is why we spent most of the Vegas Conference discussing long-term strategies -- this is the way you should be looking to make the bulk of your money -- not messing around with short-term plays. Even in the short two weeks between when I first started recapping these trades until today (21st), we've jumped $37,000 on $250,000 invested (14.8%) -- that's not bad for short-term investing anyway!

Source: Income Portfolio Update - Value Investing In A Low Volatility Environment

Additional disclosure: Positions as indicated, but subject to change (fairly bullish mix of long and short positions -- see previous posts for other trade ideas).