Episode 107: Safeguard Against Inflation with Kevin Simpson

Announcer:
This is The WealthAbility® Show with Tom Wheelwright. Way more money, way less taxes.

Tom Wheelwright:

Welcome to the WealthAbility Show, where we’re always discovering how to make way more money and pay way less taxes. Hi, this is Tom Wheelwright, your host, founder, and CEO of WealthAbility. So right now, big news in the marketplace is high inflation, volatile markets. We’ve got the Russia thing and Ukraine thing going on. I mean, all sorts of upsets in the market, everything that will lead to a destabilized market. So what we thought we’d do, is we’d actually bring in an expert on how to deal, actually take action, and actually deal with that kind of volatility, that kind inflation. How to make sure that your investments are more than covering inflation.

                And my friend, Kevin Simpson who, we’ve been introduced to each other recently, and Kevin has an amazing experience in the markets. And so Kevin, it’s great to have you on the show.

Kevin Simpson:

Thanks for having me, Tom. Excited for today’s program.

Tom Wheelwright:

So, if you could, Kevin, just give our listeners a little bit of your background and what you do.

Kevin Simpson:

Sure. This is my 30th year, believe it or not, in the financial business. I’ve been managing money professionally since 1992. My firm, Capital Wealth Planning is based in Naples, Florida, and we manage just over $5 billion for individuals through financial advisors. So, I don’t have a business that practices with retail investors directly, but most of our clients, if not all of them, are retail investors who access us through their financial advisors around the country.

Tom Wheelwright:

Got it. All right. So, let’s just delve right in if we can, Kevin. So first of all, market volatility. So I’m not a big, I don’t do a lot of investing in the stock market myself. That’s not my area of expertise. This is all you do. Give us some ideas. So, with this market volatility, which is presumably going to last for a while here, how do you deal with that? I mean, you talk about this in your book, but how do you deal with market volatility?

Kevin Simpson:

Well, before we talk about how to deal with market volatility, maybe we just take a second to see where we are, kind of how we got here. Because, for the past 32 years, we’ve had decreasing interest rates. It’s been pretty easy to be fixed income and a bond investor, and now everything’s changed. The party’s over. They did it. The Fed came out. They raised interest rates, a quarter of a point, which as you know, Tom, isn’t very much. But, it’s a precursor of what’s to come. We’ve had three years of a super-cycle, where the stock market has just been going straight up and it was a party. Free money does that. And the free money trade seemingly ended when we turn the calendar to 2022.

                It’s not just rising interest rates. It’s a problem of inflation. Inflation printing out now at about a 40 year high. On top of that, we have a Russian invasion of Ukraine, which is on a human level, just a horrific thing for us to have to watch on the news. It’s horrible. And from an economic standpoint, it comes at a very, very horrible time from an inflationary standpoint, coming off of an economic shutdown from COVID. So, you have all of these factors working against the economy, and the investor is scared, and rightly so. So, inflation and interest rates, and all of these things become problematic to your point. Volatility is not just here for a day or a week, but it’s here for the foreseeable future.

Tom Wheelwright:

Yeah, I was going to ask you. How long do you see this volatility going on? What do you see happening in stock market this year?

Kevin Simpson:

Well, I think the stock market could still end up flat to slightly higher, which would be a nice move, a phenomenal move from here, considering how poorly it started out of the gate. The economic conditions are still pretty sound. You have companies continuing to make money. There’s a compression of earnings, a deceleration of earnings, but there’s still earnings. So it’s a tale of two markets, like we saw back in 1999.

                These really high multiple stocks, sometimes they’re a little gambling names. They were incredibly grossly overvalued. And you look at the stock tape and you say, “Well, boy, these things are down 40, 60, 80% in some cases. They must be a buy.” Well, in most cases, they’re still not a buy. They never were a buy. But if you look at really high companies and that’s what I focus on, and I think I’m making a really long convoluted way of getting to answer your question. How do you combat inflation and volatility in the equity markets? You do it with really high quality companies that pay dividends. And, it removes some of the concerns of that volatility, whether the stock market’s up today or down tomorrow, the ability to generate cash flow through dividends is something that’s the cornerstone of how we invest. We want to get paid, no matter what the stock market’s doing.

Tom Wheelwright:

So you’re getting paid through dividends. What else are you looking at from a strategic standpoint, because I know you’re a very strategic investor. And when you look at being strategic, what does that mean in your world?

Kevin Simpson:

Well, there’s two ways that we introduce that into the portfolio management. One is, you want to own companies that are paying dividends, like we talked about. But far more important to me than a company that pays a dividend, because a dividend’s fine. I want to own a company that’s increasing its dividend over time, because that’s your inflationary hedge. That’s how you combat inflation. You have a growth component within your dividends so that you’re essentially getting a raise each and every year just by owning a high quality stock.

Tom Wheelwright:

Beneath the hood, I was just wondering. So, so you consider yourselves more of a fundamental investors? You’re looking at the fundamentals of the companies.

Kevin Simpson:

Absolutely. The portfolio I build is a fundamental from start to finish, but from a tactical standpoint, more to your original question, so not only do we have this, it’s kind of a one, two punch. So, we have dividends that are growing and we a cashflow component there. We also utilize covered call writing as a second component for more, a little bit of a hedge, a modest hedge in a portfolio, but it absolutely generates cashflow. So, that’s where the tactical component comes in more than anything else.

                So you get two to 3%. We target for dividends, another two to 4% we target for option premiums. So, you’re looking at a really high quality, high conviction portfolio that’s creating four to 7% cash flow, no matter what the market’s doing. Now, we prefer it when the market goes up, everybody’s really happy when everything’s green, you see that tape going by. But the reality is, that it doesn’t always go straight up. Sometimes stocks go down, and it’s during those periods that having that consistent cashflow becomes very, very important.

Tom Wheelwright:

So, I presume that when you talk about these, you talk about dividend pain, so more blue chip type of companies, and they tend to be stronger in their fundamentals. They tend to be stronger companies. So I would presume they tend to fluctuate less in the market than the technology stocks, the ones that are constantly fluctuating.

Kevin Simpson:

Yeah, they’re certainly less volatile, a hundred percent. You could call them a little bit boring. I don’t take that as an insult. You know, boring’s good sometimes, especially with investments over the long term. They’ve made investors extremely wealthy over time, by owning high quality companies with fortress balance sheets and great products. And even if there is a little less volatility, maybe they don’t go up as much. But, if you own a company that makes money over time, that stock price will go up.

                More importantly, in periods of volatility, they tend to be a little bit more resilient. They’re still stocks. They go up and down with the markets, but just as they might not go up as much, there’s advantages to volatility and reducing it, because it means that inherently, they typically will go down less than the broader markets. And that’s so much about how we think about things. Can we protect the downside? How can we protect losses? We can’t protect from losses. Maybe, how can we minimize losses, would be a better way of thinking about it.

Tom Wheelwright:

Got it. So, for those who are listeners who aren’t as familiar with the topic of covered calls, can you just kind of walk through the basics of a covered call?

Kevin Simpson:

Yeah. People think of the options as being risky. I mean, that’s a fairly common first instinct. But, they don’t have to be risky and covered call writing in fact, is de-risking a portfolio. It’s actually reducing the risk modestly, and like anything, there’s no free lunch. You’re modestly reducing their potential upside capture. Just like owning stocks that are a little bit more mature, they have a little less volatility. We use covered calls to further smooth out the volatility of the portfolio. And the way I talk about it is, I compare it to a lease option in real estate. So, if we purchase real estate for an investment purpose, just like we purchase a share of stock, we do so, Tom, with hope and intent of some days selling it at a price higher than we paid for it. Doesn’t always work that way, but that’s the goal.

                In the interim, we can generate passive income. Nobody knows it better than you guys in terms of the cash flow quadrant, and passive income in real estate. But the great thing is, generating rent each month is really terrific. Dividends and stocks are a similar parallel. Sometimes in real estate, you may have a tenant that wants to engage in a lease option. And a lease option’s a pretty simple way of entering into a contract that says, “Hey, we’d like to have the right, but not the obligation to purchase this property, generally at a price higher than it is today, for a set period of time.” And for that additional right, they’ll pay the landlord a nonrefundable lease payment, in addition to the rent. If the price of the real estate were to exceed that, then the tenant would call the option at that higher price, and everyone kind of wins.

                A covered call is the same thing. You’re selling someone the right to buy a share of stock that we own, at a price higher than it is today, for a period of time in the future. In real estate, a lease option might commonly be six, nine or 12 months. Covered calls can be any period as well, but for us, we focus really short on a 30 day cycle. So we’re engaging in a contract that says, “If we own a share of stock for a hundred dollars a share,” hypothetically, “We’ll sell a covered call for $105.” We’ll bring in money today, a non-refundable deposit, an option premium, maybe that represents 50 cents or a dollar per share. And if the stock exceeds that 105 over the next 30 days, we’ll be obligated to sell it for that profit.

                Which again, it seems like a win all around. Except, of course, if the real estate market triples, or the stock goes to 200, that 105 might not sound all that great. But someone far smarter than me told me, “You never lose money taking a profit.” And we try to do it in a very conservative and measured way.

Tom Wheelwright:

So, effectively you’re a landlord, and your real estate is blue chip stocks.

Kevin Simpson:

I think that’s a terrific analogy.

Tom Wheelwright:

You know, and I think this is a really good point to make for our listeners is that, what I hear from you is start with cashflow. So, you’ve got dividend paying stocks. Okay. So, same thing would be true in real estate. You’d want to have real estate that you have positive cashflow. And then what you have is, you actually sell the tenant, basically. This anybody who might be interested in a call, in a right to buy, as opposed to, right? And you basically sell that option to them. And so, that you’re constantly increasing your cash flow by doing two things, when you got the cash flow from the dividends, but you also have the cash flow from the covered calls.

Kevin Simpson:

It makes it sound so simple when you say it, Tom. That’s the crux of our business model. We love cashflow. The only thing different about the investments in stock portfolios than real estate is, you typically don’t get a statement in the mail every month showing you the value of your real estate. I imagine there’s some volatility there, too. Being in Florida, I can remember more than one occasion where it was pretty darn volatile.

Tom Wheelwright:

Well, right. But of course, it’s not as easy to get in and out of real estate as it is to get in and out of stocks. And so your volatility tends to increase with how easy it is, your liquidity in the marketplace. Right? So, what do you see? Now, you’re very strategic in what you do. You’re very focused in what you do. How do you see, how does that help you when you’re dealing with inflation? For example, how does that keep you ahead of the curve when it comes to inflation? Because, we can’t do anything about inflation ourselves, but we need to cover our inflation. We need to have our investments make more than the inflation.

Kevin Simpson:

Some would argue that the Fed can’t do anything about inflation now, either. I’m not sure I’m in that camp. I’d rather a Fed that’s reactionary than one that’s proactive, and trying to do too much, too quickly. But, as far as inflation is concerned, real estate in your world and on all of the great things that you recommend as far as hard assets, I think that’s a great inflationary hedge. When you deal into the stock market directly, it’s that rising dividend component that I think is the key to keeping pace with inflation. Now, inflation’s going to be a lot hotter, for much, much longer than we thought. In large part, because of what’s happening in Russia and the Ukraine. But the idea is that we probably are not going to head into a hyper-inflationary environment. It’s probably not going to go off the rails.

                The inflation has a tendency also to take care of itself. It’s Econ 101. If you raise prices, typically sales eventually will go down. There’s a breaking point. But I do believe that inflation’s going to be abating much later than we had hoped. It’s going to be here for the foreseeable future. Volatility is going to be here for the foreseeable future. And we just very uniquely, and if with good fortune, sit in the right place, I think, at the right time, because the whole strategy of our portfolio isn’t changing or adapting to inflation. I just think it’s the right process for an inflationary environment. So we’ve had really a great track record for the past 10 years, in terms of equity performance. But that is in some cases, over the past three years, symptomatic of just a really strong bull market where rising tides lift all ships.

                But, looking at these high quality companies, eight of the stocks that we own, Tom, have increased their dividends just this year alone. Ups is an example of a stock that raised its did dividend by 49%. I mean that to me is just incredible. McDonald’s, maybe not the most exciting stock on the planet, but for the past five years, they’ve increased their dividend an average of 8% per year. So, it’s just like getting an 8% raise each and every year, just by being a shareholder of a blue chip company. And that’s how we construct the portfolios.

                It doesn’t mean you can’t sell a stock. Sometimes valuations get a little bit high, even in these good blue chip names, and it’s fine to take a profit and look somewhere else. We’ve recently added Coca-Cola to the portfolio, because Coca-Cola, like McDonald’s, Starbucks, and Pepsi have pulled out of the Soviet Union recently. And the stocks are taking a little bit of a hit, because it’s impactful to their bottom line. We look at those as opportunities to add or buy positions, when there’s some weakness.

Tom Wheelwright:

Yeah. I think it’s such an interesting discussion because it’s so closely related to how we invest in real estate. Because again, what’s pushing real estate prices up? What’s pushing real estate prices up is lower cap rates, right? Lower interest rates. And, the other thing that’s pushing real estate up is higher rents. And, if you’ve got inflation, presumably your companies have inflationary profits. And if they can then produce more cash flow through the inflationary profits, and you can make sure you capture that cashflow, make sure you capture it through the covered calls, which I see as that amazing piece of insurance. We’d never think of not ensuring our home, or our car and yet people all the time don’t ensure their stock portfolio, which is a much more risky asset really than real estate. So, the chances of it going down are so much, it moves so much faster than real estate. So, I think that analogy is really amazing. And, what you’re doing is you’re just saying, “Look, it’s still cashflow.”

Kevin Simpson:

It’s a great point that you make about insuring the portfolio. Maybe on a future episode, we can talk about real insurance on equity portfolios, which is purchasing, putting, literally purchasing insurance, which almost no one does. Which is just crazy, because we do ensure everything else. You mentioned your car, your house, your life. The equity portfolios are so much more, in some cases, so much more volatile and so much more real. I mean, you just, you see that volatility, you’re inundated with it every day on the news, or the newspapers, or online. So, that to me is something that I think requires a lot more education. It’s not hard to do, but it’s not something that mainstream investors have a tendency to get involved with. Unfortunately,

Tom Wheelwright:

Hey, if you like financial education the way I do, you’re going to love Buck Joffrey’s podcast. Buck’s a friend of mine. He’s a client of mine. He’s a former board certified surgeon, and he’s turned into a real estate professional. So, he has this podcast that is geared towards high paid professionals. That’s who he’s geared towards. So if you’re a high paid professional, you’re going look, “I’d like to do something different with my money, than what I’m doing. I’d like to get financially educated. I’d like to take control of my money, and my life, and my taxes.” I would love to recommend Buck Joffrey’s podcast, which is called, Wealth Formula Podcast With Buck Joffrey. I hope you join Buck on this adventure of a lifetime.

                So, one of the other things we talk about all the time in real estate, it’s the cap rate, which is basically the return on your cash invested in real estate, if you’re going to buy it for cash. So, effectively we have the same thing with price earnings ratios. So, presumably I would think one of the things, when you say sometimes you sell stock, is it because that PE ratio gets out align with what you think it ought to be?

Kevin Simpson:

A hundred percent. I mean, it’s just that simple. Everything is based on mathematics and calculus, not emotion, and if you can take the emotion out of it, it’s really easy. We mentioned looking for companies that have low multiples, and looking for companies that have great dividends. I talked specifically about UPS and the dividend growth of 49%, which is crazy. The multiple on the stock is about 14.

Tom Wheelwright:

Oh, wow.

Kevin Simpson:

And, that’s …

Tom Wheelwright:

Low.

Kevin Simpson:

That’s a good entry point. So, when the stock market pulls back and depending upon how you invest in the markets, whether they’re down 10, 15 or 20% here, whether it’s a bear mark market or a correction, everything gets compressed, and all of these things become much more attractive, the cheaper they are, as long as they’re good companies that make money. You don’t want to buy cheap stocks, because they’re sometimes cheap for a reason.

                But, seeing opportunities and values. We added to Cisco and that has a PE of 20. It sounds kind of high, but it’s a tech stock. So, even though it’s an old school tech stock, tech stocks tend to trade with a little bit higher multiple. So, Apple or Microsoft, where that might trade between 27 and 30, you can find tech stocks at 19 or 20. They can be pretty good entry points. The Cisco situation is nice from a cash flow standpoint, because they also so pay a yield of about 2.75%. So, that’s a fairly healthy dividend for a tech stock.

Tom Wheelwright:

Interesting. So, where do you see this going over the next 12 months? And, what are you going to do about it?

Kevin Simpson:

Yeah, I think the volatility, not just for the next 12 months, but probably for the next three years is going to be somewhat range bound. I would expect markets not to be up, down 20%, but more up or down eight or 9%, which is somewhat more typical of the longer term trends of the market. So, if you see eight or 9% up year, and that’s a great year. If you add dividends and option premiums to it of four or five, 6%, you have a nice double-digit, healthy return. Markets are going to be down eight or 9% on any given year. It happens. We forget that, but it does, and it will. And, if you’re able to buffer some of that with call premiums and dividends also, five, 6%, well now, you’ve protected more than half of that draw down. And that’s a lot easier to come back from. The less money you lose, the easier it is to recover.

Tom Wheelwright:

That’s what Warren buffet always says, right? The key to investing is, not lose money.

Kevin Simpson:

Yeah. The two rules, don’t lose money, and see rule number one.

Tom Wheelwright:

Exactly. Exactly. So Kevin, tell us about your book, and tell us how we can learn more about what you’re talking about.

Kevin Simpson:

Tom, thank you for the plug. It’s called Walk Toward Wealth. And, it’s a great book that really talks about everything that we were discussing here today. How to invest in blue chip companies, how to look for dividend opportunities, dividend growth. How to introduce covered call writing into your portfolio. And the best thing about it is, that 100% of the profits go towards the Council For Economic Education, which is a fantastic organization. They’re dedicated to help educate and introduce financial literacy in K through 12. I don’t know about you, Tom, but when I went to school, I went to public school. There wasn’t a hint of financial literacy in our school.

Tom Wheelwright:

No, I love it. Kevin, thank you. You don’t have to do this. I know you’ve got plenty of things to do in your business, and really appreciate the time you’re taking to educate our listeners and people worldwide about really fundamentals. I mean, these are fundamental principles of investing, cashflow, and how to stay ahead in inflation and volatility. So thank you, Kevin Simpson.

                I hope everybody notices really, the easy comparison between real estate and stocks. It’s all about cashflow, when it comes down to it. It’s about cashflow. How do you maximize your cash flow? It’s not just about increases and decreases in stock prices. You’re going to have increases and decreases in price. But, when you can maintain the cash flow, what you can do, and you can always do it in such a way, you can always make way more money and pay way less tax. Thanks, everyone.

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