Aspiring to a 4% withdrawal rate means you will work too long!
music selection: “Drones” — Rise Against
weigh-in: 211.4 (1.8)
It is very possible to double the normal withdrawal rate of the Trinity study with active portfolio management. This trick can add several years to an early retirement. I’m going to review my approach to a high income early retirement.
There is an asset class that can be purchased below its market value and typically yields over 10% a year. This is the Closed End Fun (CEF). These funds have a fixed number of shares and trade freely on the market. Market sentiment can send them to a premium to the underlying net asset value but often sends them to a discount. You want to buy when they sell at a discount. I sometimes sell if a holding later trades for a premium. A couple examples are Virtus Global Multi Sector (VGI) and Calamos Global Dynamic Income (CHW). VGI sells for a discount to NAV of 7.73% and yields 11.88%. CHW trades for a discount to NAV of 10.07% and yields 11.07%. With yields over 11%, you can withdraw 8% annually and still have some wiggle room to buy more shares to stay ahead of inflation.
There is a second asset class, when bought right, leads to long term gains in the 15% range. This is insurance companies with long histories of profitable underwriting. Underwriting is measured by the “combined ratio” with a ratio below 100 indicating profitable underwriting. Since cash is collected upfront and claims are (sometimes) paid later, the insurance companies can invest this money in the interim for bonus return. This “float” is a source of leverage with a negative interest rate when underwritten profitably. There are several elite insurance companies that regularly produce a combined ratio around 90. AFG, WRB, TRV, and AXS are good examples of insurance companies with at least 40 quarters of profitable underwriting. These can be powerful wealth compounders when bought at fair valuation. Don’t pay more than 1.3 times book value. Long term returns in the 15% range give you a big edge over the long term return of the broad US market which historically around 9%. A good book about the power of this strategy is “The Davis Dynasty.”
A third asset class that can provide income in retirement is high yield stocks. I like MLPs, REITs, and BDCs for this part of my portfolio. Each of these use a legal organization that exempts them from federal taxes if they pay out substantially all of their cash profits as distributions to shareholders. The result is sectors that yield over 10% in many cases. You can live on the distributions at an 8% rate and still have some left over to grow your wealth for future years.
The final asset class that lets you manage a higher than conventional withdrawal rate is, of course, options. A lot of people think options investing is risky (and it can be when done wrong). At the raptor, we SELL options. Usually I write puts on companies I’d be happy to own at the strike price so I have limited downside when a trade goes against me. Lately, I’ve done very well by writing options on the third asset class above. Assignment means taking on a high yield underlying that can be held for a long period of time without being a drag on returns. Covered calls can juice returns. I target a minimum of 12% annualized for written puts but frequently do much better. The average for written puts I currently have open at the 17FEB2017 expiry is 28%. This is clearly a larger number than 8% and especially more than the conventional 4% number that is generally considered safe for retirees.
I hope there is someone out there that finds this useful and is able to retire sooner.
Devour your prey raptors!