By its very nature a “10% Trade” is designed to generate extra income from high-quality dividend growth stocks.
You make the trade, collect the income, and then rinse and repeat — typically every six to 10 weeks.
Add it all up and you’re looking at potentially capturing 10%-plus yields from world class stocks like Wal-Mart (WMT), McDonald’s (MCD), Apple (AAPL), IBM (IBM), Microsoft (MSFT), Coca-Cola (KO), Pepsi (PEP) and more.
That’s the idea anyway.
The problem is, depending on which account you’re making your “10% Trades” in, you may have to pay taxes on all the income you’re generating.[hana-code-insert name=’adsense-article’ /]While this can be a good problem to have — because it means you’re making money — the taxes eat directly into your profits and the paperwork can be a headache.
But there may be a better way to make a “10% Trade”… and not only does it allow you to bypass the tax paperwork, but you can actually avoid the taxes themselves as well.
I’m talking about making your “10% Trades” in an after-tax account like a Roth IRA.
I currently own 13 core dividend growth stocks in my Roth IRA… and each and every year these stocks are delivering more and more income, which allows me to buy more and more shares (which in turn, generates more and more income).
The beauty is, when it comes time to withdraw from this account — I’m eligible in as early as 25 years from now — I won’t have to pay any taxes on this income.
That’s precisely why I want to accumulate as many shares of high-quality dividend growth stocks as I can in this account. And the sooner the better in order to let the wonders of compounding take place.
Thing is, if I want more shares than what the dividends alone can purchase, then I need to get extra cash in that account somehow.
That can be a problem.
You see, Roth IRAs have strict annual contribution limits. You can’t just add whatever you want to these accounts. In fact, depending on your level of income, you may not even be able to contribute anything new at all.
But that’s where a carefully selected “10% Trade” can come in handy…
Remember, by its very nature a “10% Trade” is designed to generate income. And if used properly, it can essentially be a “back door” way of contributing more to your Roth IRA than what you’re eligible to contribute.
At the end of the day, this could translate into significantly more tax-free income when it comes time to withdraw.
Consider the “10% Trade” I made with Target (TGT) yesterday in my Roth IRA…
“Back Door” Way to Contribute More to Your Roth IRA
While I’m no longer eligible to make contributions to my Roth IRA, my “10% Trade” put an instant $127.00 in my account yesterday, legally (not counting any commissions).
In addition, I’ll be adding another $52.00 to my account when Target pays its next dividend on September 10, 2014.
After that, depending on how the “10% Trade” works out, I may be able to repeat this process over and over again… essentially “contributing” more and more funds to an account in which I’m no longer eligible to make contributions to.
Keep in mind this extra “contribution” is possible thanks to just one single “10% Trade” that closes out in about six weeks. Imagine how much income you could generate by executing these kinds of trades over and over again across your entire portfolio, for years (or even decades) to come.
Then imagine, when the time comes, that you’ll be able to withdraw all this income tax-free.
That’s the power of making a “10% Trade” in an after-tax account like a Roth IRA.
An Opportunity with Target
I had actually been on the lookout for another potential “10% Trade” with Target ever since my last TGT trade closed out back on June 21.
Even though the stock price has risen since then, it’s still trading at depressed levels compared to the general market’s run-up.
In fact, over the past 12 months, U.S. stocks — as measured by the S&P 500 — are up about 19%.
Meanwhile, shares of Target — one of the best dividend growth stories of the last decade — are down roughly 14.5%.
Sell-offs like this can be a dream for dividend growth investors focused on the long-term. In short, they offer a rare opportunity to buy shares of a high-quality dividend grower at a bargain price.
Not only does Target have 46 consecutive years of dividend increases under its belt, but the company has increased its payout by an average of 19.8% a year for the past 10 years.
And despite its recent problems, Wealthy Retirement’s Marc Lichtenfeld thinks it will likely do whatever it takes to keep its dividend track record intact.
Indeed, just as Moneypaper’s David Fish predicted, Target recently announced that it will be raising its dividend yet again. The new payout will represent a 21% boost from current levels. According to Wyatt Investment’s Steve Mauzy, Target’s latest increase holds special significance. In short, “It signals that all is well within the company and that improvements are on the way.”
With all of this in mind, I think now could be a good time to make a move on the stock…
One option is to just buy shares outright at the market price.
Another option — one that adds a level of safety — is to make a “10% Trade” and get paid immediately for simply agreeing to buy shares today and then sell them at a higher price in the future.
Since I’m looking to safely “contribute” extra income to my Roth IRA, I chose the second option yesterday. Below are the details of the specific “10% Trade” I made…
Capturing a 24.2% to 25.1% Annualized Yield from Target
Yesterday, I bought 100 shares of Target (TGT) for $59.85 per share and simultaneously sold one August 22, $60.00 covered call for $1.27 per share.
After commissions, this “10% Trade” immediately reduced my cost basis to $58.67 per share.
There are only two possible ways this trade will work out and they both spell at least double-digit annualized yields…
Scenario #1: Target stays under $60.00 by August 22
If shares of Target stay under $60.00 by August 22 I’ll get to keep my 100 shares.
In the process I’ll also have received $127 in covered call income ($1.27 x 100 shares) and $52 in dividend income ($0.52 x 100 shares).
The covered call income — known as a “premium” in options speak — was collected instantly yesterday.
The dividend income will be paid on September 10.
If “Scenario 1” plays out, after subtracting the commissions, I’m looking at a profit of $170.30 — or a 2.8% return in 43 days.
That may not sound like a heck of a lot, but it works out to a 24.2% annualized yield from Target. That’s nearly SEVEN times the stock’s “regular” forward annual dividend yield of 3.6%.
Or look at it another way: I’m collecting over 3/4 of the stock’s “regular” annual income (2.8% yield vs. 3.6% yield) in about 1/12 of the time (43 days vs. 365 days).
Scenario #2: Target climbs over $60.00 by August 22
If Target climbs over $60.00 by August 22 my 100 shares will get sold (“called away”) at $60.00 per share.
I’ll have generated $127 in covered call income ($1.27 x 100 shares), $52 in dividend income ($0.52 x 100 shares) and $15.00 in capital gains ($60.00 – $59.85 x 100 shares).
By the way, even if my shares end up getting sold on August 22, yet the dividend won’t be paid until September 10, I’ll still be eligible to collect the payout. That’s because the dividend will be paid to shareholders of record at close of business on August 20.
In “Scenario 2”, after commissions I’ll be looking at a $176.60 profit.
From a percentage standpoint, after subtracting out the commissions this “10% Trade” will deliver a 3.0% total return in 43 days.
That works out to a 25.1% annualized yield from Target.
Bottom Line: Either way this “10% Trade” works out offers me the opportunity to not only “contribute” extra income to my Roth IRA, but I can also generate a 10%-plus annualized yield from a Dividend Champion like Target (TGT) — entirely tax-free. If I get to keep my shares, compound my income tax-free, and “rinse and repeat” this process to continue lowering my cost basis, great. Or, if I’m forced to sell Target for a 25.1% annualized profit, tax-free, no problem. This is why I’m such a fan of “10% Trades”… especially when I can make them in an after-tax account like a Roth IRA.
P.S. I realize the average financial advisor may think it’s crazy to trade individual stocks in a retirement account… no matter how safe the stocks appear. And in many cases they’re probably right — especially if you’re not properly diversified and you’re heavily dependent on the income from this account. So I urge you not to blindly follow my lead today without first speaking to a professional advisor or doing your own due diligence and research. In addition, I’m not a tax advisor and I don’t claim to be… so please consult a professional for any tax related questions you have.[hana-code-insert name=’sa-amber’ /]