Ep. 79: Income With Discipline — Asset Location, the Covered-Call Arms Race & Where Durable Yield Actually Lives

You know, um, when people talk about building wealth, there's always this, I don't know,
this intense obsession with the paint job.
Oh, absolutely. The flashy stuff.
Right. The double digit yields the hot new ticker symbols.
It's, uh, it's like staring at the siding of a newly built house and just saying,
wow, look how shiny that looks.
Meanwhile, the foundation is just quietly cracking.
Exactly.
You're losing thousands of dollars through the floorboards.
I mean, Professor G's data in our source stack points out a pretty terrifying reality.
You could lose high five figures over the next 20 years and not because you picked bad stocks,
simply because you put the exact right income fund into the wrong tax account.
Okay. So let's unpack this because fixing that foundational crack is really the central mission
of our deep dive today. It has to be. Yeah.
We are pulling it from a huge stack of informed investing.co daily dividend and income newsletter
sources today. We've got transcripts from YouTube creators like, uh, Professor G,
Doug the retirement guy, the dividend stockpile.
Some really great stuff in there.
Really great. Plus some heavy hitting analysis from Kiplinger 247 Wallsaint and Motley Fool.
And the through line connecting all of this for you, the listener, is income with discipline.
Right. Because it's not just about getting paid.
Exactly. It's watching where the income comes from, how the IRS taxes it and, well,
whether the underlying price actually makes sense. And that discipline absolutely has to start with
asset location. Yeah. It is the single biggest leaky bucket in the average investor's portfolio.
Professor G actually calls it accidental placement.
Accidental placement. I like that. Yeah. People just buy a great fund, throw it into whatever brokerage
account they happen to have open and, you know, they inadvertently trigger a massive tax drag.
So let's look at the mechanics of this because the sources break this down into a few iron clad laws.
Let's look at the baseline first. SCHD. The Schwab US dividend equity ETF.
Right. The rule here seems to be that you could just put it anywhere. Why is SCHD so forgiving?
Well, it's all because of how the IRS classifies its payouts. You see, SCHD tracks US large cap companies
that have a history of sustained dividend growth. Right. And nearly 100% of the distributions it pays out
are what the IRS calls qualified dividends, which is the magic phrase, right? Oh, it's huge.
The government rewards you for holding these by taxing them at the highly favorable long-term
capital gains rate. So in a standard taxable account, it's highly tax efficient. In a traditional IRA,
it's tax deferred. In a Roth, it's tax free. So you literally cannot put SCHD in the wrong account.
Exactly. It's foolproof. That sounds easy enough. Yeah. But then we get to these covered call ETFs.
Like JP Morgan's JPI in GPPQ. Right. These are incredibly popular right now yielding around 8.5%
and 10%. But the sources are flashing massive warning signs here. They're saying these absolutely
must go into tax deferred accounts. What makes JPI so different from SCHD? It's really about how the
sausage is made. Around 83% of the yield you get from JPI is not a corporate dividend. Oh, it's not.
No, it is option premium. They are selling options contracts to generate that cash. And the IRS,
well, they treat option premium as ordinary income, meaning it's tacked exactly like the salary
from your day job. Precisely. It's tax at your highest marginal federal rate. So if you hold JPI
in a standard taxable broker's account and you're in, say, the 24% tax bracket, you are bleeding roughly
0.65% of your total return every single year straight to the IRS. Wow. It's a massive headwind. You have to
shelter that ordinary income inside an IRA. Wait, hold on. Stop the take for a second. Yeah.
I consider myself pretty well read on this stuff. And the absolute golden rule of retirement planning
is that you shelter your biggest, highest yielding assets in a Roth IRA.
You know, so they compound tax-free. Are you seriously telling me that putting a 14% yielding
fund like QQI or SBYI inside a rock is a mistake? I am. Really? Yeah. What's fascinating here is how
the tax code actually works for these specific highly engineered funds. QQI and SBYI do not
generate standard option premium like JKI does. Okay. So what are they doing? They use something
called section 1256 index options. These are contracts written on an entire index like the S&P 500.
So the underlying asset is different. How does the IRS view that? The IRS grants these specific
contracts a special 6040 tax treatment. So 60% is taxed at the lower long term capital gains rate
and 40% at the short term rate. But here's the real magic. Lay it on me.
The mark to market rule. At the end of the year, the fund has to mark the value of these contracts as
if they were sold, even if they weren't. Okay. This accounting quirk allows the fund to classify a massive
portion of its payout as return of capital or ROC. Oh, I saw that in the data. The sources show SBYI's
distributions are roughly 94% return of capital and QQQIs at like 97%. Yeah. But what does it actually
mean for the person listening to this right now? Well, return of capital is essentially the IRS looking
at your distribution saying we consider this to be your own money being handed back to you. So no taxes.
Right. You don't pay a dime of tax on it the year you receive it. Instead, it lowers your initial
purchase price, your cost basis. Oh, I see. You only pay taxes years down the road when you eventually
sell the ETF. And ideally, those are taxed at the favorable long-term capital gains rate. Wow.
So if you put QQI in a Roth IRA, which is already a completely tax-free environment, you are
basically burning its greatest superpower. Exactly. You're wasting a massive legally engineered
tax deferral. That's crazy. You actually want return of capital in a standard taxable brokerage
account. You do. That is the nuance of true discipline. And just to round up the placement rules,
the sources note that international dividend ETFs, tickers like VYMI, IDV, and DW,
those should also go in a taxable account. Why is that? Because foreign governments often withhold
15 to 30% of your dividends before they ever cross the border. In a taxable account, you can claim a
foreign tax credit to get most of that money back. But in an IRA. In an IRA that with held cash is
just prominently gone. You can't claim the credit. Man, that's free money just disappearing. And finally,
standard bonds, tickers like BND or TLT. Treat them just like JQI. Bond interest is taxed as
ordinary income, so shelter it in a tax-advanced account. Okay, so we know where to put these things
to stop the bleeding. Let's pivot to what we are actually putting in these accounts because, man,
the covered Col ETS base is turning into an absolute arms race right now. It really is. Doug the
retirement guy's transcript highlights a fascinating battle for dominance here. On one side, you have
the incumbent, Neo's QQQI. Right. It uses a very transparent passive index-based strategy with
that beautiful return of capital tax structure we just broke down. But now, JP Morgan has entered
the chat with a new challenger. Yeah, ROCQ. They literally put ROC return of capital in the ticker
symbol. They did. They are openly gunning for QQQI's specific tax advantage. They kind of have to.
I mean, JP Morgan clearly saw the tax drag on their older JPPI and JPQ funds. And ROCQ is their
actively managed answer to fix it. Okay, so how does it work? Well, instead of blindly tracking
the NASDAQ 100 like QQQI does, ROCQ selectively holds about 92 of the 99 stocks in the index.
And they write options on individual positions. They're aiming for a massive 14.6% yield. But the
catch there is active management. You are paying JP Morgan's human managers to pick the right
tech stocks. You know, maybe they overweight meta because they think earnings will crush it.
Which introduces manager risk. Right. You might get brilliant outperformance or they might make
the wrong call and completely drag down your principle. But if you think ROCQ is aggressive. Oh, boy.
The dividend stockpile interview with Matthew Tuttle introduces the absolute extreme end of income
engineering. Yes, the top alpha lift series ETFs tickers TSYX and TDX. I was reading this section of
the notes and my jaw dropped. It's wild. These funds are targeting 19 to 22% yields. And they are
doing it using institutional swaps. Now, wait, I'm an everyday retail investor. I can't just walk into
a Wall Street investment bank and demand a custom swap contract. How's a retail ETF legally pulling
this off? It's an incredible poo to financial plumbing, really. Tuttle explains that these ETFs enter
into agreement swaps with major investment banks. The ETF wants 1.3 times the exposure of an underlying
covered call strategy. So the ETF post cash collateral. If the underlying strategy goes up, the bank
pays the ETF 1.3 times the return. And if it goes down, the ETF owes the bank 1.3 times the loss.
They get the leverage without having to physically buy and sell the underlying options themselves.
And the sources mentioned the underlying strategy uses zero DTE options. What exactly are those?
Zero DTE stands for zero days to expiration. These are options contracts that are created
and expire on the exact same trading day. That's incredibly vast. It is. It's like buying a car
insurance policy at 9.30 a.m. that expires at 4.0 p.m. It captures the extreme rapid-fire volatility
of intraday market movements to generate massive premiums. You know, that sounds like borrowing a
formula one car for your morning commute. That's exactly what it is. You get incredible speed and
power. But if you tap a guard rail, the crash is catastrophic. That is the perfect analogy. And we
have to be brutally honest about the risks here. Leverage is a merciless, double-edged sword.
When the market drops, your losses are magnified by that exact same 1.3 multiplier.
Plus, with yields hovering around 20%, you are constantly fighting NAV erosion.
Right, where the actual share price rots away over time because they are paying out more than
the underlying assets can sustainably generate. Exactly. It really forces you to ask,
is the fund's return of capital a clever tax accounting mechanism like we saw with QQI,
or is the fund literally just cannibalizing itself? Just handing your own principle back to you to
fake a 20% yield while the share price collapses. Exactly. Which is why many discipline investors
eventually look at this synthetic engineering, get entirely exhausted by the complexity,
and pivot back to buying actual tangible businesses. Yes, quality single names. The 247
wall-sane article details how you could build a really robust passive income sleeve just by looking
at Warren Buffett's 5 highest yielding stocks. It's a return to fundamentals. Berkshire Hathaway has
over 65% of its portfolio concentrated in just six stocks. Wow. Yeah. And if you isolate the top
dividend payers, you get crap tints yielding over 7%. Serious XM, Chevron, Coca-Cola, and Constellation
Brands. Here's where it gets really interesting though. If we look at Buffett's Coca-Cola play,
the dividend is incredibly safe. I mean, they have over 500 brands. But the yield is only about 2.6
percent. Right. If you want a higher yield in a single name without using engineered ETFs,
you have to hunt for deep value. And the sources bring up a fascinating case study here.
Campbell Soup, ticker CPB. Yeah. Campbell Soup is currently yielding roughly 7%,
and it's trading it around 10 times earnings. Which is low, right? Very low. To put that in perspective,
its direct peers like PepsiCo and Hershey are trading at double that valuation. Campbell is sitting
your multi-decade lows. So what's the plan there? Well, management is pitching a massive turnaround.
They're pointing to stabilization in their core segments and the recent acquisition of Rao's premium
sauces. So on paper, it looks like a screaming buy. You get a 7% yield while you wait for the turnaround.
But what's the catch? Why did the analysis flag this as a potential value trap? It comes down to the
mechanics of their payout ratio, which currently sits at roughly 85% of adjusted earnings.
Okay. Can you break down why that specific number is a red flag? Sure. Think of a company's earnings
like a household paycheck. If a company earns a dollar in profit and pays out 85 cents to share holders
as a dividend, they only have 15 cents left over to reinvest in the business. Right. Now Campbell is
promising a massive operational turnaround. Turnarounds require heavy capital investment. You need
marketing, new supply chains, innovation, and they don't have the cash for that. Exactly.
If you are draining 85% of your profits just to keep dividend investors happy, you literally
cannot afford to fix your broken business model. I see. So if inflation spikes their ingredient costs
or sales dip even a tiny bit, that 15 cent buffer vanishes and they're forced to slash the dividend.
Precisely. A value trap looses you in with a high yield. But because the business is fundamentally
starved of reinvestment capital, the stock price just keeps dropping completely wiping out any
income you collected. So what does this all mean? How does the everyday investor actually tell the
difference between a Campbell suit value trap and a high quality genuine dip buy? That is the ultimate
test of valuation discipline. And the kipplinger article gives us some incredible macro context for
this. What do they find? Well, for the last 15 years, value stocks have been heavily out of favor
compared to tech and growth. But right now, the S&P 500 pure value index has a price to earnings
ratio of around 12. Okay. The pure growth index is sitting at 24. That is an egregiously wide gap.
Meaning that mathematically, value stocks are historically cheap right now. And the Motley full
source points to Home Depot ticker HD as the perfect example of buying a cyclical dip without
catching a falling knife. Yes. Why is Home Depot different from Campbell's suit? Because Home Depot's
underlying engine isn't broken. It's just temporarily paused. Home Depot has lagged the market recently
because of macro economic headwinds like interest rates. Exactly. High interest rates have frozen the
housing market inflation is hurting discretionary spending and homeowners have simply delayed major
renovations. Same store sales were completely flat in the first quarter. But the discipline here
is recognizing that their market leadership is totally intact. I mean, this is a behemoth doing
165 billion dollars in annual sales. Massive. And they have a solid 2.88% yield. When interest rates
eventually come down and people start moving or remodeling again, all that pent up demand comes
rushing back. Exactly. You are buying a dominant healthy retailer at a reasonable pe of 22
down from its historical highs. And kicklinger also highlights other beaten down blue chips with a
pessimism has just gotten too thick. Like who? Well sales force ticker CRM punished over fears of
AI disruption. JP Morgan and Morgan Stanley dragged down by private credit worries. Bechton
Dickinson tickered BDX and absolute powerhouse and healthcare supplies trading at just 13 times earnings
versus a historical norm of 20. But you know, even if a stock is a high-quality blue chip,
catching a falling knife is terrifying. You buy the dip and it just keeps dipping. How do the
sources suggest we avoid bleeding out while trying to find the bottom? They detail two very specific
tactics. First is position sizing. The first eagle strategy suggests capping your initial stake at
just 1% of your total portfolio. Just 1%. Yeah. If the stock price keeps dropping, that small size forces
you to pause and re-evaluate your original thesis objectively before you commit more cap. Oh smart.
And the second tactic. Technical confirmation. You don't have to be the hero who catches the absolute
lowest tick. You can wait for moving average crossovers. How does that work? It means waiting until the
stock's 20-day, 50-day and 200-day average prices all line and start trending upward together.
That gives you mathematical proof that institutional money has stepped back in and the bottom is
actually in. I love that. Wait for proof. Now we have covered a massive amount of ground today.
We've optimized tax location, navigated JP Morgan and 1.3x institutional swaps,
analyzed Buffett's dividend sleeve and dissected the anatomy of a value trap. It's a lot. It is.
But all of these granular tactics are entirely useless if you don't have an overarching strategy
holding it all together. And that brings us to the retirement education transcript, which perfectly
frames why so many people fail at this. It argues that investors generally fall into one of four
archetypes. Okay, let's see it. The first is not preparing. They know they should save but they
put it off. Assuming they'll just work forever or that social security will magically cover their
lifestyle. The second is saving but terrified of risk. They pile all their money into cash and CDs.
It feels cozy and safe, but inflation is quietly eroding their purchasing power every single day.
Exactly. Then the third is the 100% indexer. They consistently buy the S&P 500 every month. It's a
fantastic baseline. And they're light years ahead of the first two groups. But as they approach retirement,
they completely lack a strategy to transition that pile of growth into optimized sustainable income.
And then there is archetype four. This is my favorite. Oh, yeah.
Archetype four is like going to an all-you-can-eat buffet and putting a scoop of ice cream,
a slice of prime rib, and a bowl of clam chowder onto the exact same plate. A total mess.
You got a little bit of everything, but it is an absolute mess. They buy text stocks one month,
crypto the next, a 20% covered call ETF the week after. There is zero cohesion. They are
just chasing whatever is shiny. If we connect this to the bigger picture,
the solution to avoiding archetype four is giving every single dollar in your portfolio a specific
defined job. The transcript outlines a four-part framework every investor needs.
Let's walk through it. First, growth. This is the core of your portfolio. Broad market equity ETFs
designed to outpace inflation over time. Second, diversification. As a year retirement,
you need different asset classes, not just different stocks, to reduce overall volatility.
Third, targeted opportunities. This is for the investor who wants to try and beat the market,
but needs discipline to do it. The source mentions seeking alpha's alpha picks,
which uses quantitative data to find stocks with strong momentum and positive earnings revisions.
Right. It's a way to hunt for alpha, but it is strictly contained within a small, predefined
allocation so it doesn't wreck your portfolio. And finally, the fourth pillar. A deliberate
income plan. This is where you map out the transition from accumulation to distribution. It means
deciding precisely how much yield you need from foundational dividend stocks versus engineered
covered call ETF and ensuring every single one of them is placed in the mathematically correct
tax account. Which brings us right back to where we started. Getting paid by the market is actually
the easy part. Keeping that money, that requires true discipline. It really does.
It requires understanding the IRS tax code, knowing whether your yield is funded by real business
profits or decaying option contracts and having the patience to wait for proof before buying a dip.
It requires looking past the shiny paint job and aggressively inspecting the foundation.
So we want to challenge you to take action on this deep dive this week. Open up your accounts
and audit your portfolio. Just look at the placement of one single dividend or income ETF you own.
Just one. Yep. Do you have an option premium fund like JEPI sitting in a taxable brokerage account
quietly bleeding your returns to the IRS? If you do, move it. Fix the foundation.
And as you review your holdings, I want to leave you with this final thought. Consider this.
What if the highest yielding asset you currently own is actually making you the least amount of money
once you factor in taxes, inflation and the slow decay of its underlying net asset value?
That's a scary thought. It is. Ask yourself. Are you buying a yield or are you actually buying a
business? The foundation always dictates the future of the house. Thanks for joining us on this deep dive.