Investing in dividend growth stocks is probably the most "reliable" way of achieving financial independence in the financial markets. By robustly investing every dividend back into the stocks in question (and adding extra capital at every opportunity) back into one's dividend growth portfolio, one can double ones income in under 8 years depending on dividend yields, dividend growth rates and how much extra was added by the investor. This strategy should be implemented from a very young age. Why? Because one could just leave the underlyings (dividend aristocrats) alone and let the power of compounding do its work over time.
Yes, one wouldn't need to go into fundamental analysis and look at key areas such as income, cash and debt because even if dividend growth rates slowed significantly in a particular underlying, the " time" being "in" in the market would trump any short term weakness in the portfolio. We saw this in 2008 when many dividend aristocrats dropped significantly with the market but then recovered quickly when smart money entered in droves to pick up prime assets on the cheap..
However the beauty of this website is that it tailors to all investors. Many investors come here and look for solutions because they simply don't have 8 years in order to "double their income". In saying this, when I work with an investor looking to outperform the market over a particular timeframe, I get worried. Why? Because too much risk or leverage is the reason why so many accounts get blown out in this industry. Leverage refers to borrowing too much from your broker and risk refers to using high risk instruments such as out of the money options for example which are a strict no-no for someone attempting to build a foundation in this industry.
What if we could increase our returns safely without taking on extra risk?. Leverage is something I think about a lot when investing. The more leverage you have (while controlling risk), the better your return should be going forward. Here are some ways we use leverage (having our money work for us more efficiently) to our benefit in the financial markets.
- Theta Decay (All options go to zero so option sellers benefit from Theta Decay)
- Price Appreciation
The more you have the above three variables working for you, the more you will win in this game of investing. Let's go through how one could trade/invest in Wal-Mart (NYSE:WMT) for example which is a dividend aristocrat.
At the moment the stock is trading at just over $70 a share. Now options in this stock are usually cheap as Wal-Mart is not a volatile stock and it has traded is a narrow range over the last 4 years or so.
The stock announced earnings last month and doesn't go ex-dividend again until the 10th of August. This gives us plenty of time to implement an option strategy. Now I have seen many articles that discuss the merits of selling covered calls for up to 12 months out in time. I think this is an excellent strategy for the investor who wants to lock in some extra income plus also avail of a hands off solution. The strategy I am outlining here for Wal-Mart is more hands on but should also be more lucrative on a monthly income basis.
Ok so here is how it goes. You own 100 shares of stock which will cost you around $7k plus you have secured capital in your portfolio to pick up another 100 shares if needs be. You have a bullish stance. However we are not going to pick up the second batch of Wal-Mart just yet. We are going to use this capital to trade around our initial position and here is how we do it.
We are going to sell a 45 day strangle (the sale of one put option and one call option - July 29th Expiry). Here is how it looks from a visual perspective.
Source : Dough.com
Now what this graphic tells us that there is a 63% probability that Wal-Mart stays in between these two strikes by the time we reach expiration. The premium received is $149 but I would usually decide to take this trade off before expiration. For example if I could make $70 after 15 to 20 days, I would immediately book the profit. Simply taking profits early increases the probability of profit which boosts our income.
What is the worst that can happen? We could either lose out shares if Wal-Mart is trading above $73 at expiration or gain a further 100 shares if the stock falls to below $67. Either way, we keep the premium we decide to keep which is the goal here.
Doesn't this make more sense instead of going all in initially on a stock which gives a 50-50 chance of going up or down. I know some readers will not like the possibility of giving up their stock but this again is something that investors have to learn. Getting emotionally tied to one stock for the long haul can stifle returns in the long run. Why? Because stocks gets overvalued which usually mean higher pay-out ratios and lower dividends. Get over the idea that you need to hold the same aristocrats for years on end (unless you are a hands off multi-decade investor).
There is always another stock and this strategy forces you to make money off your underlyings.
One quick footnote. Watch implied volatility levels. This trade would only interest me if implied volatility was high which would mean we could more premium for our strangle. But one thing is sure. Trading in and around high quality liquid stocks with sound fundamentals is an excellent way to increase your income. Furthermore I usually skew my strangles to a bullish or bearish stance depending on where I believe the underlying will go over the 2 month period. Take profits early. Rinse-Wash-Repeat
To sum up, I'm going to be adding a few good dividend and growth stocks to the elevation portfolio over the next several weeks when I see value. It's imperative that they are not correlated and all don't have similar valuations to ensure that income is brought in every month, which, over time, will increase our share count. Follow along by pressing the "Follow" button above
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.