With the strong stock market performance in FY2013, many super funds are reporting great returns of 15% or more for FY2013. The negative returns of FY2008 and FY2009 are all but forgotten and some people are asking – is it worthwhile to do our low risk income strategy which only targets a return of 10-15%? Our income strategy typically under-performs “buy and hold” in a rising market. This is because option premiums are lower and capital gains in the stock are capped when you write covered calls. To make things worse in FY2013, interest rates were cut (something that normally does not happen in a bull market) so the returns from the cash we set aside to cover our puts would have been lower as well.

So is it worthwhile to trade our income strategy? I would say it depends on your investment goals. If you only wish to out-perform the market index then this strategy is probably not for you. If you wish to get a consistent 10-15% return in all market conditions, then this strategy might be right for you.

We ran the Vanilla model portfolio (traded using the most basic form of our income strategy) from April to Sept 2012. When we wrapped up this model portfolio in September 2012, we were on track to getting an annual return of 15% even though the market went sideways during that period as shown in the chart below. Even if we factor in lower option premiums and interest rates after September 2012, we should have been able to get a 10% return in FY2013 for this model portfolio.

The main goal of our income strategy is to generate a consistent positive income in all market conditions. While we may miss out on some gains in strong bull markets, we make up for this in flat and bear markets. While many super funds may have had a great return in FY2013, the same funds would probably also have had negative returns in FY2008 and FY2009 as shown in the table of past 10 years returns below (click to enlarge).

Source: APRA’s Annual Superannuation Bulletin (June 2012)

Below is a chart from an e-book my husband and I wrote in 2010 which illustrates the impact of negative returns. The green bar represents a fund with a consistent small positive return of 5% per year and the blue bar represents the median return of balanced funds in Australia which had a negative 19.7% return during the 2008 calendar year. You can see how hard it is for the blue bar to “catch up” with the green bar even after just one year of negative returns.

Source: SMSF Investment Master Plan

We know stock markets can move in 3 directions – up, down or sideways. The goal for our low risk income strategy is to be like the green fund above as we believe that slow and steady will still ultimately win the race.

2 Responses to Is doing our income strategy worthwhile?

  1. Bruno says:

    Hello Christina
    How are you? I like your latest article but find the comparison periods a bit short: e.g. the Vanilla portfolio didn’t run for a full year and your chart above runs only for 4 years while the APRA chart runs over 9 years. Possibly, due to the recent bull market, your low risk strategy would be showing to be lagging but you might catch up and importantly, you’d never have the one big negative year to catch up on. And that is (IMHO) the biggest advantage of your strategy! So on that note, how do you see the coming 6 months? Are you preparing for the end of the bull market? Are you trading any differently or does your strategy not need to adjust to current/expected market conditions?
    Food for another article perhaps?
    Looking forward to your insights.
    Bruno

    • Christina says:

      Hi Bruno

      Thanks for your feedback on the article. Yes, I agree six months is a short time. The performance of this strategy over a longer period of time (FY2009-FY2012) can be found on Pg 16 of my ebook. Perhaps I can talk more about this in my next article.

      There is of course increased risk of a big correction, especially after a hard rally. There are many ways to manage that risk which includes buying insurance puts as shown by the ANZ trade in the All Stars Model Portfolio in Feb 2013. I also cover other methods of risk management in my training videos and mentoring sessions.

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