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Longer term strategy.

Chris B. had a great question last week.  I’m going to try my best to answer it.

music selection:  “Tears In Heaven” — Eric Clapton

weigh-in:  213.4 +0.4 – devouring too much prey!

Chris asked, “With a 5.27% withdraw rate, you will soon have a decision to make. Is your end game to:
1) Scale back to a lower risk portfolio that will fall less in the next recession, and get to a point where you can set it and forget it, or…
2) Maintain a growth perspective and generate as much reinvestable income as possible here and now. Continue active trading of riskier-than-average assets in the foreseeable future?”

For recent past years I’ve been in a good position tax wise.  I’ve run out of tax loss harvesting and other shenanigans to lower my taxable income to a negligible amount and will have to start paying more.  I have about enough on deposit with Uncle Sugar to cover most or all of the 2017 liability but will have to save about a 1,000 a month for 2018 and beyond without a major Trump tax reform.

So my withdrawal rate will probably continue to fall to right around 5.00% this year before jumping up to about 7.5%.  Eight percent is right around what I think is sustainable for an income centric portfolio right now (higher is possible in a higher interest rate world.)  I won’t have much wiggle room but its not as dire as it looks.  Core expenses will continue to be covered by dividends, distributions, and interest income.  The part I’m paying taxes on will be gravy like trading profits from options and discounted bonds.  I’ll only pay a “high” rate when I’m successful.  If I’m finding it difficult, I’ll pay almost no taxes at all.

I don’t talk much about bond ETFs here because I don’t trade in and out of them.  My positions have been set and have ridden for years.  It might surprise some of you to learn I target a 60/40 equity to income ratio.  The income portion of my portfolio includes bond CEFs, preferred CEFs, funds that specialize in variable rate loans, and municipal CEFs.  These positions cover most of my budgetary needs.  So, I’m actually already in a ‘set it and forget it’ mode and plan to be more so over time as I add more income investments to maintain allocation.  But I’m also in growth mode as I have another 60% in equity names that pay high yield, offer good growth characteristics with a margin of safety (insurance stocks), and option writing.  These portions of the portfolio should outperform the market during a downtown.  Probably as a lower loss rather than a gain but should still provide some peace of mind.

I’d also like to point out that my approach to options investing is intended to lower risk rather than raise it.  If you invest in an underlying stock without a written put or call, you are exposed to a 100% potential loss.  When you write an option, you take income up front.  This effectively lowers your basis in the investment.  You have traded away some top end upside for safety against the risk of a market decline.  You have less risk than the non options investor, not more.

The real risk for me is with inflation.  We will probably have more inflation than the near zero amount we’ve seen for about 10 years.  This could be damaging to the 40% of the portfolio I have in mostly fixed income investments.  But it should lead to rising equity and fattening of options premiums (prevailing interest rate is a major component of options premiums).  I think I’m well positioned but will continue to be transparent so everyone can see whether my unconventional ideas are right or wrong.

Devour your prey raptors!

{ 2 comments… add one }
  • Chris B April 10, 2017, 6:30 pm

    Thanks for the reply! Basically you’ll scale the portfolio up at its current proportion of equity / income.

    I assume you’re thinking about doing a Roth ladder while your tax bracket is still in the 10% range. You need some kind of throttle system so you never pay taxes on more than your expenses.

    But your income could continue to outpace your expenses. Have you considered a SEP IRA for ‘Financial Velociraptor Inc’? That might allow you to defer taxes on 25% of your income and also increase the flow of assets from taxable to tax-sheltered accounts by escaping the $5,500/yr limit of traditional IRAs. This escape hatch would be useful if, for example, you earned $80k one year and wanted to shelter $20k from taxes instead of just $5,500.

    Regarding inflation, you’re already more insulated than many people because your housing costs are fixed and your transportation costs are probably low compared to commuters. If inflation hit 5%, your personal expenses might rise 2%-3%. Healthcare, insurance, and utilities are vulnerabilities, though.

    Consumer staples and insurance stocks could maintain value in real terms by raising prices with inflation. In general, if taxable income > expenses, you could mitigate that by trading dividend stocks for growth stocks and using the original tax shelter: buy-n-hold!

    • The Lizard King April 10, 2017, 6:39 pm

      All good points Chris. I’m not so sure I can pull of Financial Velociraptor Inc. for SEP purposes. The blog doesn’t make any money and the trading activities are not within an LLC or similar structure. I’m waiting to see what shakes out with Trump/GOP congress and tax reform before starting a Roth ladder. It could pay to wait a year or two to start if there is a significant reduction in capital gains taxes.

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