There is a widespread fear among the FI community of “saving too much.” That is, working longer than you have to because you were too timid about the prospects for your portfolio. This fear is well founded in the Lizard King’s opinion as the conventional wisdom says the Safe Withdrawal Rate (SWR) is a mere 4%. I hope with this blog to demonstrate that a much higher consistent return is available with a mix of dividend stocks, municipal bonds, and selling options for income.
Let’s do the arithmetic. To sustain a 4% withdrawal rate, you need (1 / .04) or 25 times your annual income. That is quite a lot! This raptor retired at 40 with less than half that. This is an attempt to document how this is possible. Playing with the math, if you can expect annualized returns in the range of 10% (very achievable with the options/income approach!) you need only 1 / .10 or 10 times your annual income. This is only 40% of what the 4% SWR crowd thinks is necessary. For sake of transparency, my personal withdrawal rate is 7.4% based on today’s net liquidation value (about 13 and half times annual expenditures.) My annual return however usually clocks in between 10 and 12 percent after taxes. I reinvest this rather than live high on the hog to ensure I stay ahead of inflation (you should too.)
Leg one of this strategy is a healthy allocation to tax free municipal bond funds. Even in today’s ZIRP world, these currently yield around 6% tax free. (Hint: 6% is more than 4%.) In the 25% tax bracket most early retirees can expect to be in this is equivalent to a 7.5% yield. Used alone that would be thirteen and a third times annual expenses needed. Let’s not forget inflation though. We need a little extra.
Leg two of this strategy is dividend paying stocks. I like a mix of high yield with low growth such as MORL, BDCL, and various MLPs as well as low yield, high growth stocks such as DEO, PEP, and GIS. This gives tax advantaged (but not tax free) immediate income with an income growth kicker from the dividend raisers. Many dividend investors want to shy away from sub 3% yields and they miss out on 10% annual growth as a result. That is a double every 7 years or so and the income from distributions often doubles as well. A raptor can do very well with a dividend growth strategy. Don’t forget that the big slow moving blue chips that pay only a few percent almost always have very liquid options markets so you can pick up another 3-5% of bonus yield with out of the money covered calls.
Leg three of the strategy is to sell options for income. This incomes a mix of covered calls, cash secured puts, and diagonal calls. During a ZIRP world like today, 10-15% annualized returns after all is considered are perfectly normal. This gets your expenditure multiple down to between 10 and six and two thirds. But what about the future when interest rates are higher? You’ll do even better! I include below the “Black-Scholes” equation that closely mirrors how options are priced. Raptors who want to nerd out on the One High and Holy Mathematics of Finance (praise the markets, Amen!) can learn more at: Wikipedia
See the two “r” variables? Those represent the prevailing risk free interest rate. Without getting too deep in the sort of theory and math that belongs in a graduate level Finance class, the real rate includes the inflation rate. Thus a high inflation (interest) environment drives up options premiums and thus option yields!
Legs two and three are your hedge against inflation and your source of future income growth. Leg one is your volatility reducing stability anchor. Most of the municipal bond funds also do you the favor of paying distributions in equal monthly payments instead of variable quarterly payments making it much easier to budget.
Devour your prey, raptors!