This past weekend, I wrote a broad article on how to structure an IRA portfolio. Now I'm going to focus for a bit on individual stocks, and particularly on how to use them. When choosing stocks for an IRA, you want stable companies that have room for further growth. Not only should they pay a good dividend, but they should have a good track record of increasing their dividends over time.
The first stock I'd like to discuss as an IRA candidate is Verizon Communications (VZ). From the 20-year period between 1992 and 2012, Verizon's share price has climbed from $24.31 to $42.94, which is over a 3% annualized gain in share price. This will more than keep up with inflation, which is a major concern about retirement portfolios as retirees live longer and longer. If you retire at 65, it is more likely than ever to live into your 90s, and you can be certain that US dollars will not have the same purchasing power 20-30 years later.
The combination of share price gains with adequate yield is the goal of most retirement portfolios, so let's examine Verizon's track record in this area.
This is a plot of Verizon's quarterly dividend over the past 20 years:
The dividend was increased throughout the entire period, with the exception of a five-year period around the bursting of the tech bubble in the early 2000s. It is worth noting that even in the massive tech crisis, not once has Verizon suspended or even reduced its dividend payouts. In the most recent recession, not only did it not reduce the dividend, it raised the dividend 6.2% in 2008, 7% in 2009, 3.3% in 2010, and 2.7% in 2011.
Only a small handful of companies was so well positioned during the financial crisis that they were able to raise dividends. In other words, in 2009, while supposedly "bulletproof" companies like GM, AIG, Bear Stearns, etc., were going broke and destroying the accounts of their shareholders, Verizon gave theirs a 7% raise!
Finally, on popular request, I did a backtest of the covered call strategy that I have advocated in previous articles. I tested this strategy during the (almost) 10-year period from January 2003-July 2012. I assumed that we started with a 1000-share investment, and that we sold calls that were three months from expiration. To lower the risk of being called out of the stock, we only sold calls that were 10% out of the money. The following chart is a comparison between simply buying and holding, and employing my covered call writing strategy to maximize returns. For the sake of this chart, I am assuming that all dividends are reinvested and used to purchase new shares (everyone should be doing this anyway, but that's a subject for a future article).
So, Verizon is a particularly good candidate for this because of its relatively low volatility. In this entire period, the stockholder would only have been called out once, and would have missed out on $0.81 per share of upside (or $1424.79). This is a small price to pay for the $10,572 of options premium collected throughout the entire sample period, which can then be reinvested.
In the almost 10-year sample period, just a traditional 1000-share investment in Verizon would have increased in value from $39,150 to $66,005, for a very nice 68.5% gain. However, employing the covered call strategy would have resulted in an ending value of $78,448, a profit of over 100% in a ten-year period. In this situation, effectively using the covered call strategy resulted in $12,443 in extra profit.
Of course, there is always a risk of being called out. However, history shows that even through volatile times (like the recent banking crisis), when used on the correct stocks, a covered call selling strategy can significantly boost your returns. Compound these differences over a 20- or 30-year period and the difference will be even more drastic.
Disclosure: I am long VZ. I own VZ for my IRA and employ the covered call strategy explained in this article.