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BRIAN:  Welcome to “Save for Retirement Radio,” where you get the transparency you deserve.  With over 35 years of experience in financing and investing, we help you stay up to date on market news and retirement strategies.  I’m Brian James Decker, owner and founder of Decker Retirement Planning and host of “Save for Retirement Radio.”  With me is my co-host, and one of the advisors here at Decker Retirement Planning, Clayton Bradshaw.

 

CLAYTON:  Welcome back.  We’re excited to be here today.  Today, so, last time, we talked about estate planning and the approaches that people can take when they’re trying to pair up their estate documents with their retirement plan.

 

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CLAYTON:  But this week, we were going to talk about another approach that you can take with some risk reduction, but I think it’s a timely topic because we just saw a pretty quick decline in the NASDAQ this last week.

 

BRIAN:  Yeah, in three days, it dropped 10 percent.  So, what’s happened is the market’s taking full market cycles, and instead of it happening in months or years, it’s happening in days.

 

CLAYTON:  Yeah.

 

BRIAN:  Days and weeks.

 

CLAYTON:  Right.  Because we just saw this earlier this year.

 

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CLAYTON:  So, today we want to, we want to, kind of, dive in and dissect that what led up to the NASDAQ continuing to peak at all-time highs after losing almost 30 percent at the beginning of the year, then peaking again, and then taking a 10 percent haircut, all in the course of three days.  So, we’re gonna talk about that, and then we want to talk about as well some approaches that folks can take to mitigate their potential to, to lose money heavily when these, when these kinds of events happen.  Because it seems like they, they could become the new norm.  That these market cycles that we got used to that were seven to eight years between these massive drops were now seven months between these massive drops.

 

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BRIAN:  Right.  So, for example, in 2020, we had the fastest 30 percent drop ever in the history of the markets, from February, what was it, 21st…

 

CLAYTON:  Yeah, mid-February to the end of March.

 

BRIAN:  …to March 29th.

 

CLAYTON:  Yeah.

 

BRIAN:  Five weeks, 30, 30-plus percent.  Then the NASDAQ made over 50 percent since March 29th.  In, what was that, less than six months.  That’s never happened before.  And now you have a 10 percent drop in three days.  So, volatility is picking up.  There is one, I think it’s funny.

 

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BRIAN:  There’s one theory that people that are getting these COVID checks to sit at home are logging on to Robin Hood and trading their accounts.  Have you heard this?

 

CLAYTON:  Yeah, I love the Robin Hood story.

 

BRIAN:  Yeah.

 

CLAYTON:  It’s, “Let’s blame Robin Hood for all of this stuff.”

 

BRIAN:  Yeah.  So, the bubble in, the tech bubble that burst in ’99 to 2000, that was legit, right?

 

CLAYTON:  Right.  Yeah.

 

BRIAN:  Those were no earnings, anything-dotcom, you inflated the, and it just all fell apart.  Well, Robin Hood, I agree with you, is probably not true.

 

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BRIAN:  But the, what is true is the sentiment has skewed towards the bullish side so much that the normal daily call volume, so a, there’s puts and calls.  Quick definition, and you check me on this for the language to make sure it’s understandable.  So, a call is where it’s highly leveraged, where you’re 10-to-1, basically, to control the stock of Microsoft.  So, instead of paying 300 dollars a share for Microsoft, now you’re paying 30 dollars to control that amount of Microsoft stock.

 

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CLAYTON:  Sure.

 

BRIAN:  Okay.  So, with high leverage, the daily average call volume went up, not exaggerating.  There is a chart that shows this spiking up more than eight times.  It just spiked up.  Well, every time you have a call option, you have to hedge that by buying the stock.  So, the, it fed on itself and it jumped the NASDAQ way up.

 

CLAYTON:  Yeah.

 

BRIAN:  After the market took a three-day, 10 percent hit, there was a famous, it went viral, post from Robin Hood.  A guy who said, “I’m not doing this anymore.  I just lost a ton of money.”

 

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CLAYTON:  Sure.

 

BRIAN:  So, it’s almost like they didn’t know that the market could drop.

 

CLAYTON:  Yeah, it’s been interesting to watch ‘cause I’ve seen some of the various posts over the last few months, because the, Robin Hood’s had its own, kind of, swath of issues that it’s run into.  I mean, you had, there was a strategy for a while, and I don’t know what the status of this is anymore, but you could infinitely, well, it was theorized that you could infinitely lever up your investments, the trading that you were doing.

 

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CLAYTON:  You could trade on margin, which is like you’re trading with a credit card, and then you could lever that up, so that, I watched a guy.  He bought one of these options on Apple stock, and it went the wrong direction, and he had levered up 25 times.  So, he put in two grand, with margin, and then levered up, so he lost 50,000 dollars in about a second and a half.

 

BRIAN:  Wow.

 

CLAYTON:  It was incredibly, it just, it blipped, and it was gone.

 

BRIAN:  Wow.

 

CLAYTON:  And he was just sittin’ in his car, and just using his phone to watch this kind of stuff.  So, those are the kinds of things that with Robin Hood, it’s something that, I think people treat it, like, almost like a cell phone game, and they don’t realize that it is actual money that is impacting them in one form or another.

 

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BRIAN:  So, we advise our clients, when it comes to risk, that call options, buying calls and puts, are like gambling in Vegas.  It’s not investing.  It’s total speculation and entertainment.  It is not investing.

 

CLAYTON:  Right.  Well, and even in the news, you see when somebody buys an option, it’s, they gambled.  They even say that they gambled with an option.  It’s legalized gambling.

 

BRIAN:  Yeah.

 

CLAYTON:  That’s what options trading is.

 

BRIAN:  Okay, so, I remember when I was being trained to be an advisor.  This was 1986, it was in Twin Cities, in Minneapolis, and the guy said, “All right, class.”

 

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BRIAN:  There was maybe 40 of us in the class.  He says, “We’re gonna talk about stock options.  Calls and puts.”  And then he said, he flipped his, the right foot.  He flicked open one of those plates on the bottom that you plug in on the floor, and he said, “Imagine, class, if that’s a rat hole.”  And he took off his wallet, his car keys, his watch, his tie, his hat.  He’s throwing everything down the rat hole.  And it, it stuck with me, the visual.

 

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BRIAN:  He says, “If any of your clients ever want to do stock options, you tell ‘em that, that you should just get paid 4,500 dollars ‘cause that’s your commissions that will last about six months, and in six months he’ll be out of money, and you’ve just saved him several hundred thousand in losses.”  And he just went off.  He said, “I’ve been in this business 30 years.  I’ve never seen someone ever make money in a 12-month period in stock options.  Ever.”  He was, he was vein-popping passionate about that topic.

 

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BRIAN:  So, now I’ve been in the business 35 years.  I never once have seen, heard of anyone making money in the options market, naked calls and puts, over a 12-month period, not one time.  Ever.

 

CLAYTON:  Yeah.  It’s pretty risky stuff, and so, especially when you’ve got this amount of volatility.  And was it, I think it came out within the last week, that it was that guy that worked for SoftBank, that Japanese investment firm, that he was the one that had a penchant for it.

 

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CLAYTON:  And he put a lot of options on the tech market, and drove it up because he was throwing, I mean, he was able to move it because he was throwing billions and billions of dollars at this, which, people take note of.

 

BRIAN:  SoftBank was the whale.

 

CLAYTON:  Right.  And so, people notice that, and they jumped on it, which is what drove all this up, and then everything corrected, which it does.  I mean, that’s what we’ve seen historically every seven to eight years, it’s happening, it seems, a little bit faster than that now.  As technology, or as information, spreads a lot faster.

 

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CLAYTON:  But then we just took a 10 percent drop, so everybody that was on the trailing end of that, that got in right at the end, just lost 10 percent.  If they were levered up at all, it compounded their losses.

 

BRIAN:  Yeah.  Can we hit covered calls while we’re talking about options?

 

CLAYTON:  Uh-huh, yeah.

 

BRIAN:  So, the sophisticated people, Clayton will say, “Oh, don’t be the gambler; be the casino.”  And so, what I do is I buy the stock and I sell the options.  And so, now, I don’t buy the risk; I sell the risk.  And it all sounds great.

 

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BRIAN:  I remember hearing about this, I was sitting in the back, and after someone spent 45 minutes slide production talking about covered calls, I raised my hand in the back and I said, “So, if I have this right, you get, you limit your upside, you keep all the downside, and you create a synthetic dividend for yourself of maybe two or three percent.  Is that right?”  And he said, “That’s right.”  And I said, “So, in any bull market, you are going to underperform where you would have been if you would have kept the stock.  Right?”  And he said, “That’s right.”

 

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BRIAN:  And in any bear market, you have all the downside that you have in a downside market.  And he said, “That’s right.”  And I said, “What am I missing?”  And he said, “You’re missing the synthetic divided.”  And I said, “That’s only two percent.  That’s only two percent, and it doesn’t protect you in the downside.”  So, in the last 20 years, there’s been two markets, Clayton, that a covered call portfolio would have outperformed the S&P.

 

CLAYTON:  Sure.

 

BRIAN:  2015 and 2018.  And that’s it.  So, we don’t recommend, we would do it for our clients…

 

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CLAYTON:  Well, what else have we gone through in the last 20 years?  Let’s look at these major drops that we’ve hit. [OVERLAP]

 

BRIAN:  Yeah.  Fifty percent downside, twice.

 

CLAYTON:  Right.

 

BRIAN:  And then in 2018, we lost 20 percent Q4.  We lost 10 percent Q1 in 2018.  And then in 2020, we had a 30 percent drop February and March, no downside protection with covered calls, and yet people in retirement really think that that’s a winning strategy.  It underperforms a long strategy, and you have, and you retain all the downside losses in a down market, and it makes no sense to me.

 

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CLAYTON:  Well, and I think, too, in talking to folks, is they’ve come in and they say, “Hey, this is the – what about this strategy?”  And half the time, it ends up that they heard about it from their neighbor while they were trimming their hedges.  Their neighbor was, like, “Well, this was what I do.  I do a covered call strategy.”  And then they look in the driveway and see that the guy drives a Mercedes, and they think, “Well, he must know his stuff with investments.”  And it just kills me when I hear that kind of stuff.

 

BRIAN:  Yeah.  Oh, here’s another one.  Buying naked calls.  So, when you’re actually selling naked calls, so when you sell a naked call, you’re, you’re obligating yourself to buy a stock under where the stock price is.

 

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BRIAN:  And so, when, as the stock market goes up, you’re collecting all this premium.  But when the market goes down, you’re obligating yourself to buy all that stock.  So, let me repeat that back.  You’re not participating in the upside, and you get, you get a boatload of obligation when the markets come crashing down.   That also doesn’t make any sense to me.

 

CLAYTON:  Yeah.  Highly risky.  Legalized gambling, because you’re, you’re just hoping that the market keeps going the direction you want it to go.

 

BRIAN:  Yeah.  Why not participate in the up markets and protect yourself in the down markets?  Why not do that?

 

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CLAYTON:  Right.  And I think, so, before we get into, kind of, risk, how, ways you can protect yourself and those risk-protection strategies, what other risks are people facing right now with the market doing what it’s doing, and the…

 

BRIAN:  Ah!

 

CLAYTON:  …high volatility?

 

BRIAN:  Okay.  Here’s the biggest, in my opinion, there’s three huge risks, and we haven’t talked about this.  One.  Actually, four huge risks.

 

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BRIAN:  One is, with the states leveraging themselves up and having additional leverage and problems, financial shortfalls because of COVID business closures, there is serious credit risks with the states and the municipal bonds.  Credit risk for the first time in my career, I’m seeing that 10-year municipal bonds have a higher yield than 10-year taxable CDs, and that should never happen.

 

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BRIAN:  But it is happening, because the credit risk, the risk of you not getting all your money paid back because of a municipality shortfall, is going up.  So, one thing, one risk to be aware of, as a retiree is credit risk.  Anything to add on that?

 

CLAYTON:  No, I think that’s one’s, I think we’re good.

 

BRIAN:  And by the way, the way that you can see, you should cover this.  How can you tell if your municipal bonds are at risk of default?  There’s a line in the sand.

 

CLAYTON:  Yeah, so, this, you just go to your monthly statement and you look.  So, par is 100.

 

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CLAYTON:  So, if you’ve got something that’s doing well, it’s going to be trading above par, right?  That’s something that you’re, you want to see that as, there’s trading at a premium on your, so 103, 110, 115.  But if you see that you’ve got a municipal bond that is paying right now three or four percent, but it’s trading at 95 or 90?  That’s when you need to be worried about the stability of that bond.

 

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BRIAN:  Right.  And if you talk to your person that sold you that bond, what are they gonna predictably say?

 

CLAYTON:  Yeah.  “Oh, you just need to, you just keep it, just ride it out, just hang onto it.  It’ll be fine.”

 

BRIAN:  Yeah.  Right now, there’s four states that are breaking par.  Right now.  California, Illinois, New York, and New Jersey.  Right now, those bonds are breaking par.  So, I hope that if you have any of those four states in your portfolio, for your municipal bonds, I hope you’re checking those to see if those bond prices are breaking par.

 

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BRIAN: ‘Cause if they are, you have fair warning that those should be sold.  This is supposed to be your safe money.  Do you remember the Puerto Rican issues?

 

CLAYTON:  Yeah.

 

BRIAN:  That four or five years ago…

 

CLAYTON:  Yup.

 

BRIAN:  …just cascaded below par.  Now, cows are out of the barn.  Everybody knows that Puerto Rico’s broke.  And those bonds today, three, four, five percent coupon Puerto Rican bonds, are trading at 25 cents on the dollar.  75 percent losses in quote-unquote safe money.

 

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BRIAN:  So, the first risk that I think is an underlying risk is the credit risk specific to municipal bonds.

 

CLAYTON:  Right.

 

BRIAN:  Anything else on that?

 

CLAYTON:  No.  That one’s, I think we’ve covered it.

 

BRIAN:  Okay, the second is the high-yield risk.  A lot of people think that bonds are safe.  No.  Some bonds are.  Not all bonds.  And so, how would you like to have a JC Penney bond that yields 13 percent?  Would that be a good deal?

 

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CLAYTON:  That sounds, that sounds great.

 

BRIAN:  Yeah.

 

CLAYTON:  No.

 

BRIAN:  Right.  So, there’s a lot of bonds.  If you were to stack up the amount of bonds that are rated, you have your Triple-A, Double-A, Single-A, Triple-B.  Those are all investment-grade.  Once you go Triple-B minus, the next rung below that is Double-B plus.  There are more bonds right on the edge of investment-grade to junk.

 

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BRIAN:  Now if you’re a municipal, sorry.  If you’re a mutual fund holding corporate bonds or investment-grade bonds, what do you have to do if a bond slips from Triple-B minus to Double-B plus?  You have to sell it, right?

 

CLAYTON:  Right.  ‘Cause we’ve got to maintain that investment-grade status.

 

BRIAN:  Right.

 

CLAYTON:  This one always kills me, is, I think it’s interesting how bonds have this, this gradual rating scale, but yet there’s a fine line, there’s a black-and-white line in the sand that says if bonds are over this level, they’re investment-grade, I’m using air quotes, “investment-grade”.

 

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CLAYTON:  If they’re below this level, they’re high yield.  But the amount of bonds that are sitting just right above –

 

BRIAN:  Right on the edge.

 

CLAYTON:  Right at that edge, it’s, they know what obligation they’ve got to do, and they maintain on paper just enough to keep ‘em over that, because they know that everything changes once they go south.  But they’re one step away from going south.

 

BRIAN:  Right.  Now it’s not just us, but once there’s a situation in our economy where we have a 2008 type of recession, and we might be a couple months away from that, because small business, medium-sized businesses are just hanging on, a lot of them.

 

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BRIAN:  And they haven’t declared bankruptcy yet, but if we get to that point, there’s a domino effect that can happen to create a problem with the investment-grade bonds.  So, if we have enough of those bonds slip from Triple-B minus to Double-B plus, you won’t have enough buyers.  The sellers will be 10-to-1, and the bids will drop immediately.

 

CLAYTON:  Yeah.

 

BRIAN:  So, if you think that you’re safe owning a bond, find out what the credit is.  Know that the high-yield risk, in my opinion, hasn’t been higher since 2008, and we’re on the verge of having another one shouting, “Fire!” in the theater, and you can’t get out the door.

 

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BRIAN:  You can’t get those bonds sold, the bids drop.  And we had in 2008 some high-yield bond funds that went broke.  Do you remember that?  There were two high-yield bond funds, I know two’s not a lot.  But there were two high-yield bond funds that went to zero.  Because they, there were no bids.

 

CLAYTON:  Right.

 

BRIAN:  So, that’s the second risk.  That I wanted to talk about.

 

CLAYTON:  And, really quick, I want to add, too.  We want to make sure that our listeners, that you can have all of this information and that you can utilize it and benefit from it as much as possible.

 

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CLAYTON:  But keep in mind that we are happy to, to look over your statements with you and help make sense of it or confirm what you may have already figured out.  Feel free to give us a call.  Our number, 833-707-3030.  Again, that number, 833-707-3030.  We can just do a free, 15-minute call, and we can talk through your statements with you, make sure that you’re able to make sense of them and that you know what you have and where.

 

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CLAYTON:  It, I mean, it comes down to doing a risk assessment, really, is just to make sure you know where your risks are.

 

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Decker Retirement Planning Inc. is a registered investment advisor in the state of Utah. Our investment advisors may not transact business in states unless appropriately registered or excluded or exempted from such registration. Decker Retirement Planning Inc. is an investment advisor registered or exempt from registration in each state Decker Retirement Planning Inc. maintains client relationships. We can provide investment advisory services in these states and other states where we are registered or exempted from registration.