We accumulate over the better part of life. Save, invest, re-invest the proceeds, and keep the wheel going. That is the standard advice. And then suddenly, one day, we are asked to switch from accumulating to generating income.
It does not get any more difficult than that.
We have never practiced income generation before. And the faculties we have at 65 are much less sharper than at 45.
In fact, this switch is an impossible cognitive gymnastic that millions of people are asked to perform routinely. A big boon for financial services industry. Which handsomely sucks at taking into account the psychological elements of this transition.
Shifting from accumulation, to income, is such a fundamental shift in thinking, that it cannot be more exaggerated.
What is the biggest catch that makes it so hard ? (second to lack of practice)
I believe it is this idea that all your money working for yourself.
Compounding Lore
This idea is the compounding lore. Everyone talks about it all the time. Invest as much of money into a fund, as early as possible. And let it stay there, undisturbed. This is a fundamental detriment to the mental shift needed.
The biggest catch to the shift from accumulation to income is letting go of this idea of all your money working for you.
How so ?
Because income is not about money…… or only partially about money. More than money, income is about safety. About predictability. And when you want every dollar of yours to work for you, what are you fundamentally asking ? You are asking maximum risk for your money !
More than money, income is about safety. Safety and predictability around your finances.
Of course this idea is not new. I am not the first one espousing the use of safe funds, and de-risking your portfolio, as we approach retirement.
But the point I want to argue here, goes slightly further.
Income is about predictability…. And predictability, can be negative too !!!
Negative Predictability
Yes, negative predictability. Predictability, of a loss. If we knew that a certain predictable loss can happen to us, then that is also predictable and ‘safe’. What tortures the senses, what takes the control away, is this unpredictability and un-know-ability of the loss. And that is the reason that people struggle to make the markets works for them in retirement.
The thinking must flip…… rather than all the money working for you… All the money is just waiting to be spent. Andonly some of that money keeps working…… but maybe it can work hard-er, now that it has a safe cousin, not doing much of anything.
So the idea here is to become comfortable with a predictable, negative, outcome.
In a strange way, taking more risk (with negative outcomes) can provide that crucial layer of psychological safety, requires to be in the market. And make the best use of it.
The best example of it is, buying a lottery ticket. It has humongous upside, and a finite (pretty small) downside.
Fortunately you don't have to start buying lottery tickets as an investment strategy in retirement. There are much simpler , and more structured bets available.
For example? you ask ….
What Bet to make
Betting on human progress. Continuous upward trajectory of human progress in different areas of human endeavor. Which leads to great big new companies, more commerce, better commerce, more trade of value, and more dividends for everyone involved. Can you buy a lottery ticket on the bet that this wheel of fortune will continue turning.
Yes, the lottery tickets are available. For taking this bet. And these lottery tickets are known by the name of ‘call options’.
What does a call option consists of ?
Its a bet that the stock or index you have selected, will be higher than a certain price level (called strike), after a certain number of days.
There are good ways and bad ways to make that bet. We will discuss them in another article in the series. But this is essentially it. You buy a ticket, at a reasonable price, and bet that the arc of human progress will continue.
It does not quite give lottery like gains, where a dollar can turn to a million…. but it does give, very handsome gains. How handsome you ask ? A call option bought for a reasonable price, can easily double in value, over the course of a year. Giving a tremendous return of 100%. At the same time, it can also go to zero. A huge gain, for a possibility of a complete loss. And that is what we mean by capped downside, large upside.
If you can absorb this, then you have shifted from that grey area of market, where you have no control over your risk, and you are left at the whims of the market forces. Whenever and however they choose to act.
By being willing to absorb the loss, you can start converting a portion of your assets into income.
Repeatably, robustly, patiently. Welcome to the world of options income investing.