Addressing The Fear Of Leaving Money On The Table

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 |  Includes: AAPL, BCE, MDLZ, MSG, VIAB
by: SA Editor Rocco Pendola

Not a day goes by without a discussion about leaving money on the table. It seems that many investors fear selling a stock or option only to see it move higher more than they fear flat out losing money. If you stop and think about it, this makes little, if any, sense.

As I noted in a Seeking Alpha article from Wednesday, I receive daily correspondence regarding Apple (AAPL) options conundrums. Talk about first world problems:

Yeah, Rocco, I have an AAPL May $525 call that's up 22,472%, I am really afraid to sell because the stock keeps rising. I can't sleep at night and my wife is threatening to leave me. I've been drunk every night this week. Any idea what I should do here?

Of course, that's a dramatized reenactment, based on a true story. But it's not all that far from reality. More than anything, these questions concern me because they suggest gaggles of undisciplined "traders" running around out there. When you have a short-term position that doubles in value (or whatever you set as your profit target when you enter the trade), you sell. It's that simple. Sure, you'll leave money on the table from time to time. Often, lots of it. But, the people who laugh at you never rush to tell you about the time they let it ride and ended up losing it all in a New York minute.

I wonder how many of the folks all worked up about missing another 5% move in AAPL let their other, long-term positions sit dormant in an account with $4.85 dividend checks populating their mailboxes each quarter. You have very little control over whether or not you leave money on the table as a position runs and you contemplate "Where's the top?" In your boring little buy-and-hold portfolio, however, you actually, to a certain extent, control your own destiny with regard to income. Despite this, loads of investors leave money on the table month after month.

I am opening an investment account for my 8-year old. We're not going to buy AAPL because she can't seem to take her hands off of her iPod Touch. She's a smart cookie so we talked about other companies she has heard of and/or can relate to. She already knows about turning a profit and paying a dividend. We reviewed that and then lightly broached the subject of covered calls. She understands the concept of collecting money to give somebody else the right to buy your stock if it moves higher.

If nothing else, I hope this exercise teaches her something we could all use more of - patience. Best case scenario - we're able to accumulate several hundred shares in 3-4 positions by the time she turns 18 (and does one of the following: takes a gig as a barista, travels Europe for a year, attends trade school or packs her bags for MIT).

Let's imagine her portfolio looks like this in 2022, except the key points - price per share and dividend - are stuck on this down day in 2012.

Company (Ticker) Price, Intraday 3/29/2012 Annualized Dividend Per Share, 3/29/2012 Number of shares, 2022
Viacom (VIAB) $52.04 $1.00 200
Bell Canada (BCE) $39.70 $2.19 200
Madison Square Garden (MSG) $33.86 None 200
Kraft Foods (KFT) $37.83 $1.16 200
Click to enlarge

So, if over ten years, we're able to build up those relatively modest lots in VIAB, BCE, MSG and KFT, my daughter will have a pretty sweet nest egg of roughly $32,678 at age 18, based on today's prices. I assume that a mix of regular investments, a few lump-sum purchases and dividend reinvestment will get us to these target levels over the course of a decade.

We came to the decisions on the stocks by brainstorming not only her interests, but if she thinks there's a "future in them." Viacom owns Nickelodeon. Bell Canada owns parts of the Toronto Maple Leafs and Montreal Canadiens. MSG owns the New York Rangers. My daughter likes hockey. And, as a lover of chocolate, she wanted to buy the company that makes Milky Way bars, but they're private so we diversified a bit and went with Kraft. They do some candy, plus mac and cheese isn't half bad.

Three out of the four stocks pay a dividend, all trade options and I would have no issue being long, for the long haul, any of the names.

When she's 18, I hope she realizes what she has there. Not 30 grand to blow, but the ability to retire long before she turns 60.

Using today's data, she would earn $870 in dividend income in year one from the three stocks that pay out. This does not take into account any dividend increases we see between now and then. Of course, dividends could get slashed, but I feel somewhat comfortable that that will not happen with VIAB, BCE or KFT.

Today, you could write VIAB May $50 calls on 200 shares and collect $90. On KFT, you could sell June $39 calls on 200 shares and generate $84. And, on MSG, you could write May $36 calls on 200 shares and take in $60. Do that three times a year per stock and that's another $702 worth of annual income.

Between dividends and covered call income, we're looking at roughly $1,572 of income per year. I love doing it this way because we're being incredibly conservative and only making the assumption that things stay as they are, share price- and dividend-wise, with each stock. So, for all intents and purposes, we're underestimating the power of a plan like this.

That $1,572 comes in 2022, assuming a constant share price and dividend rate. I am willing to bet that both the price per share and dividend per share are higher on all four stocks, where applicable, in a decade. Of course, we could make necessary adjustments along the way on a change in outlook or when shares get called away.

From there, I toss the following figures into a compounding calculator:

  • $32,678 Principal
  • $1,572 in annual income plus $1,500 in additional annual investments for a total of $3,072 per year.
  • 5% annual rate of growth (conservative estimate).

In ten years, that brings the nest egg to $93,800. In 20 years, that's $193,362. And, in 30 years, when she's my age, her nest egg could be worth $355,537.

If we pump up the annual contributions to $4,500 per year because I decide to continue helping out, we're looking at $455,156. Almost half a million bucks before age 40, not counting a job (!), other random holdings and cash grabs along the way. Not too shabby.

Another reason why I prefer these rough calculations - we cannot predict the future. Things could go much worse or much better than we anticipate. In either direction, I have complete confidence that an investor who goes the route of dividend reinvesting and covered call writing, and commits to it over the long-term, will pick more money up off of the floor than the overly-anxious leave on the table.

Disclosure: I am long BCE.