Episode 375: Covered Calls: A Devil's Bargain

25:34And they're just focused on I'm getting 12 % from my bonds, which is obviously not true. I need to dig into what's going on there. I haven't looked at the fixed income products. It's really, really interesting to compare. One of the things that I'm going to do in a couple minutes here is compare the historical returns of covered call funds to the historical returns of the underlying assets that those funds invest in. When you look at that for equities, which is all I looked at for this episode, you can really see all the stuff we've been talking about where they both go down a lot when the equities go down, but the covered calls just don't recover in the same way.

26:10And over time, that becomes increasingly damaging for the covered call strategy. Bonds being less volatile, I'd have to look at some of their past returns for live funds to see what they look like. I don't know how much live history these ETFs have, but it will be interesting. It'd be interesting to look at as a follow-up. One of the interesting things that you do see, particularly with the higher distribution yield funds is that their net asset values decrease over time. In the fixed income example, when they have a lower expected return already, and if they have a really high yield, like if it's a 14 % yield or whatever it is, I would expect to see the net asset value or the price only value, not the total return declining over time.

26:53Anyway, it'd be an interesting thing to look up for a follow-up episode. Selling calls in your equity positions, it lowers the expected returns, eliminates the mean reverting tendency of stocks by capping the upside, really just not good for long-term investors. I would argue it makes covered calls quite risky for long-term investors for the same reason that the higher expected returns and mean reversion in stocks makes it a little bit safer for long-term investors. I think eliminating those things makes a covered call strategy quite risky for long-term investors. Now that might be hard to believe given the large distribution yields, like the Twitter DM question about how can a 14 % yield be bad.

27:32But it is absolutely crucial to remember that these distributions are not income in the way that bond interest is. Presenting it this way, which at least one of the funds that we'll talk about later on the fund website does present it this way. They show the yield of the fund next to the yield of a REIT fund, the yield of a T-bill, actual yields compared to covered call yields, which are just not the same thing. Those option premiums, like we've said, they come with the associated liability and the lower expected returns, and they have a much less favorable shape of the distribution of returns for long-term investors.

28:11It sounds like it's a similar thing with those classic sort of income funds that a lot of the distribution is return of capital. The mechanism is obviously different, but there too are often marketed with these 8%, 9%, 10 % yields, quote unquote, but it's not income if it's just money being returned to you. To come back to that original question, how can it be a bad investment to buy something with a 14 % yield? Because if you buy something with a 14 % yield and it falls in price 16%, then your total return is minus two, not 14. There's various reasons why that can happen, but we always have to look at those two sides of the return, the net asset value and the income.

28:52We'll talk about the total returns in a second. It's super interesting to see the actual historical total returns of a covered call strategy versus its underlying. One of the biggest problems I see for these funds, and it's interesting when you look at discussions online, I mostly look at discussions on Reddit because it's just such a rich place for random people to discuss things, but random people have interesting thoughts, even if they're not correct. Interesting to see how some people do go into income investing or fire financial independence, retire early subreddits, to ask about covered call strategies and they get a mixed bag of answers, but some people do get it.

29:27I did see some posts where people came in with some crazy idea about covered calls and were talked off of that ledge by some sensible comments. So it is interesting to see the diversity of opinions and discussions online. That being said, there still are discussions online in those fire communities and income investing communities that refer to the distributions from covered call funds as if they're income, as if they're perpetually sustainable, which as we've talked about, they're not. I saw one post where somebody was asking, and I think this is one of the ones where they were talked away from the idea by some sensible commenters, but they were asking about why wouldn't I borrow money at 5 % from my line of credit and invest in covered call funds with a 14 % distribution yield, which if you think that those things are the same, then that does make a lot of sense.

30:14But when you realize that the 14 % distribution yield is not a return and is in fact an indication of a lower expected return than the underlying equities, you realize it doesn't make a whole lot of sense. Yeah. I'm pretty sure if that was possible, somebody would have already be doing it. That's a pretty sweet arbitrage. Yeah. We're laughing, but I mean, it's not a terrible question in the sense that if you're not a sophisticated investor, it's easy to be seduced by things like that. And as we said at the top, Fun companies know that and they prey on the lack of sophistication when they create these products and market these huge yields.

30:51Totally. The combination of high distribution yields, lower expected returns, an uncapped downside and a capped upside means that someone who's spending the distributions, especially if they're really high kind of distributions, I think would be expected to deplete their capital fairly quickly. That's another reason why calling these distributions passive income or income is financial BS. One interesting point, and this is from an old academic paper from, I can't remember who, but one of the behavioral finance OGs that basically says that covered calls could be used as a psychological trick, basically.

31:24If you are aware of what you're doing and what the trade-offs are, this could be a way to help you spend down your capital using covered calls because that's effectively what they're doing. If you want to reduce your beta and you want to spend down some of your capital, maybe doing covered calls is not such a bad idea as long as you understand the trade-offs that you're making. If you couldn't psychologically bury yourself to spend from capital otherwise. So this would be, for example, if you were drawing down your portfolio at a four or 5 % clip, but the actual securities in the portfolio only pay like a two or 3 % yield, this would allow you to spend a little bit more.

32:02For sure, it would draw down your capital, but that's the point. And it would draw it down over time, not in five or six years. It would be over your retirement. It seems reasonable enough. Yeah. And it depends on the underlying too. One of the examples I'll give in a second is a Canadian bank ETF. Canadian banks have done so well, even with the capped upside, with a relatively modest distribution yield on the covered call strategy, the net asset value in that case has not declined over the life of the fund. that's a combination of good underlying performance and a modest yield. I think it is about 6%, like in your example just now.

32:38I talked to somebody recently who's very well-versed in ETFs and covered calls, and they were talking about how their dad uses a covered call with a whatever, 6 %-ish yield, basically for that reason, because they really like the income. If that's what's important to you, then maybe it's not so bad. I just think you have to go into it, understanding what it is that you're buying and what the effect is on expected returns. It's worth a quick pause here, I think, to ask, how is that income taxed? It depends where you are. In Canada, I believe it's typically going to be taxed as a capital gain distribution.

33:14In the US, it's derivative income. I think it does depend on where you are. That makes a huge difference. It does. Not nearly as punitive as it is in the US. We don't use covered call funds. I haven't looked at a whole lot of tax receipts for covered call funds. That's something people should be sure of before they use these strategies and get their own tax advice, but I'm pretty sure that's how it's taxed in Canada. So that's the theoretical piece. We talked about what's going on under the hood. While we don't really like the shape of the distribution from these products, it's really interesting to look at live funds.

33:49So what I look for is cases where we have a live product with a decent history to examine that also has an identically matched, well, there's one where I didn't have an identical match, but mostly I had an identically matched underlying ETF. So we have the covered call ETF, and then we have an ETF that's just a long only fund that owns the exact same underlying equities, but does not write any options. So BMO has a couple that launched in 2011. So it's a pretty good history to look at. The BMO covered call utilities ETF launched in October, 2011. Its distribution yield is 7.37 % compared to 3.43 % for the underlying.

34:32So it is a decent chunk higher, but not crazy, not as crazy as some of the ones. But more than double. Double, but it's not 14%. Yeah, that's right. Now, if you look at the performance chart, there have been some periods where the underlying equities don't perform so well, like when you talked through the example earlier, Dan, and the covered call fund has been able to outperform those periods because of those option premiums, but those periods tend to be really brief. And in the long run, they're far outweighed by the capped upside. So over the full period since inception, the covered call ETF has trailed the underlying by an annualized 2.6 percentage points.

35:10So it's interesting, right? We see that higher yield, 3.43 % on the underlying versus 7.37 % for the covered call strategy, but it's trailed in terms of total returns by 2.6 percentage points over the full period. And I also looked at rolling periods. So it's trailed the underlying in more than 70 % of three-year rolling periods with a one-month step. And if I increase that window to four-year periods, the covered call fund has underperformed in 85 % or just below 85 % of rolling four-year windows. So that's pretty telling. That's these sideways markets or prices don't increase, but I'm getting income in the meantime.

35:52Yes, those periods exist, but not very frequently. Yeah, exactly. You're much more likely to underperform than outperform by doing this. Yeah, over four years, seven times more likely. Yeah, exactly. And that underperformance is particularly pronounced. You can see it in the chart if we have it up in the video when the underlying equities drop dramatically and then recover, as we've been talking about, which as we've already mentioned, is a pretty typical characteristic of equity returns. I mentioned earlier that reducing equity beta by holding cash can get you to a similar place, at least from a beta perspective as a covered call.

36:27For this one fund, I ran a portfolio of 60 % BMO equal weight utilities and 40 % high interest savings account using a high interest savings ETF from October 2013, which was constrained by the ISA ETF through August 25th, 2025. So if you can see the image in the video, they track pretty closely most of the time, except that the covered call fund gives up extreme upside events and eats the whole meal on the downside. It's a pretty bad combination. If you want lower beta, it seems like holding cash and equity is a better deal than this. This is to me such an important point because there are so many products out there that purport to deliver equity-like returns without equity-like risk or our phrase like this, well, we cap some of the upside, but in exchange you get this benefit of income or lower volatility or whatever it is.

37:27And well, I was going to say it's not that it's totally wrong. In this case, it is totally wrong. But in some other cases, it's just a different way of framing a classic balanced portfolio. If you don't want all of the volatility of an equity portfolio, add some fixed income. Or in this case, I thought you were going to say that you ran the covered call ETF with like 10 or 20 % cash, but you ran it with 40 % cash, which is a huge drag on an equity portfolio. And yet that was actually what matched up with the total returns of these covered call ETFs. So that to me, I don't know, taking 60 % equity risk or 70 % equity risk, and then putting the rest in cash, bonds, GICs, whatever your choice is, just seems to me to be a much better trade-off in the long run.

38:19I agree. And I think you get a better outcome, which is what I found in my quick little model. Now, I'm not going to do that cash allocation for the rest of my examples, but I did happen to see that Jeff Tack from Morningstar, he's managing director for Morningstar Research Services. He did a post in his sub stack where he looked at a sample of 22 single stock covered call ETFs. This is where I got the idea to do this actually. He showed that a combination of cash and the underlying stock outperformed most of the funds, had lower volatility than all of the funds, and had a higher Sharpe ratio than most of the funds.

38:56If you want a lower beta, covered calls are maybe not the best way to do it. Do we know what proportion of cash or did he try that data with different allocations of cash? I'd have to look at his post. We will have in the video an image with his headline results, but let me see if I can find it. I thought the 40 % was a lot higher than I would have expected. Yeah. His were all in that range, but let me just see if he shows that in his table here. No, he just says plus cash. He doesn't say what proportion of cash. But if I remember from reading his post, it was a similar level to what I found. But yeah, I was honestly surprised by that too.

39:39I had the same thought as you did. I just did this pretty casually. I just did cash allocations until the return profiles matched up somewhat. I started at 90 % equity and 10 % cash. I was like, that seems pretty reasonable because this isn't a super high yield fund. And then, no, 70, no, and it just keep going down. 70, 80 would have dramatically outperformed. Yeah. And 60 where it was like, oh, these are pretty close at this point. Similar results to what Jeff from Morningstar found. So again, I'm not going to do that cash allocation thing for the rest of these examples. It was just analysis that I added later on after where I'd already written most of this.

40:13So I just did it for the one fund and then referenced Jeff's post, but you kind of get the idea, I think. There's another BMO fund that launched in January, 2011. It's a covered call Canadian banks funds, the one I referred to earlier. So it's got a current distribution yield of 6.13 % compared to 3.61 % for an ETF of the underlying equities. It's an equal weight banks underlying fund. The covered call fund has underperformed by an annualized 2.71 percentage points since inception and has outperformed in less than 1 % of rolling three-year periods since inception. So I didn't even do the four-year periods for this one because I don't know.

40:50I think it would have been zero. It would have been zero, yeah. So that's banks. And then there's a GlobalX S &P TSX 60 covered call ETF. That one launched in March 2011. It's got a distribution yield currently of 7.67%, or at least when I pulled the data, it might be different today. It's trailed the iShares S &P TSX 60 ETF by 3.65 percentage points since inception. And it has trailed in 92 % of three-year rolling periods since inception. We could go on through these examples, but I think you kind of get the idea. Covered calls are not good for long-term investors, particularly to be fair in cases where the underlying equities have gone up, which all these cases are.

41:29If you're going to invest in underlying equities that you don't think are going to go up, maybe you just shouldn't invest in them at all. I think it's pretty hard to predict that these underlying equities are going to perform just right so that my covered call strategy is going to outperform the underlying. But if that's true, it's probably going to perform worse than some other equities that would have performed better. It's just a bizarre expectation. I think if you scratch the surface of people who buy these ETFs, they would not say that that was their goal. I'm intentionally going to buy stocks that I expect will go nowhere because that's the ultimate or optimal condition for covered calls outperforming buy and hold.

42:08If we all agree that we start by buying stocks and then we decide whether to layer on the covered calls, how about if we start with stocks we think are going to go up or at least a diversified portfolio that we expect in aggregate will go up, then it's pretty hard to argue why you would want to layer on the calls because as you've just spent a lot of time showing, that is likely to reduce your return in 80 to 90 % of three and four-year periods, at least based on this sample. This might not apply everywhere, but it's a bizarre strategy when you think it through. Those ones are pretty tame. Distribution yields in the six to 7 % range.

42:47Someone told me that their father's using these parties of retirement plan. I'm like, if he likes and it feels comfortable, that's great. I think where these really go off the rails is when they start pushing for higher yields. If you remember from earlier, if you want higher income on your covered call strategy, you can sell options with lower strike prices resulting in higher income and higher short delta. In other words, targeting a higher income exacerbates all of the issues that we've talked about with covered calls. The lower strike price can give you higher distribution yields, but you also get less exposure to the underlying, a tighter cap on upside performance.

43:22which as we've described in lots of detail is not great. And almost inevitably, you are ensuring that the net asset value of your fund is going to decline. For sure. When you start pushing for these crazy yields, I think that's exactly what you would expect, which if you want that, great. But that's the expectation you should be setting for yourself, not that you're getting a 12 % or whatever, 14 % income. Or 12 % return, because it certainly is not a return. So the Hamilton ETFs yield maximizer ETF series, they target yields well over 10 % by selling at the money call options. So again, we're getting really tight to the price of the underlying, which is going to give you lots of income, but it's also really going to mess up the distribution of returns and really reduce your expected returns.

44:11I didn't look at a ton of their funds. I just looked at one. I looked at the US equity yield maximizer ETF as an example. it targets a distribution yield of 12%, and it has underperformed an S &P 500 ETF by an annual like 4.48 percentage points over its relatively short history, to be fair. I do also want to address JEPI specifically. This is an important one in the covered call world. It's the JP Morgan equity premium income ETF. This is a fund that really gained a cult-like following around 2022. two. In that year, it outperformed the S &P 500 by around 15 percentage points, serious outperformance.

44:49Which just means it lost less probably. That's correct. Yeah. Slightly negative return. Well, the S &P 500 was very negative. So I think that outperformance in that year combined with its prominently marketed high distribution yield, and this is the offender that shows on the fund website, this chart, we can show it in the video that ranks all these different sources of yield and JEPI is the highest yield source. And it's compared to all of these other assets where the yields are actually more closely related to their expected returns. And then this guy's sitting out there, look at my yield, which is in fact negatively related to its expected return, which to me is just egregious.

45:27That combination had a really big year and it's marketed on this really high yield. It's a fund that has its own subreddit. I always think those are especially interesting funds when there's like a culture around an ETF. The problem though, is that like other covered call strategies we've talked about, it has underperformed an S &P 500 ETF. In this case, by 5.92 percentage points since inception in May, 2020. This one's not a perfect comparison. This is the one I mentioned that I didn't have a great underlying comparison. The S &P 500 isn't quite right because JPI's underlying equity portfolio is actually actively managed.

46:06Now, I don't know if blaming the underperformance on active management or uncovered calls is worse, but in either case, we know that these things don't generally play out well for investors in the long run. They compound each other. You take a strategy that seems almost guaranteed to underperform and layer on the risks of active management. It's not a great combination. I can just hear people saying, you can't compare that to the S &P 500. It's actively managed. Like, Okay. So we want to blame it on active management instead of covered calls. Okay. I think that's funny. I laughed about that one when I wrote it.

46:38The most recent development, and it's not that recent, it's like I think around the last couple of years, they've started popping up in meaningful numbers is single stock covered call ETFs. That's exactly what it sounds like. Covered calls on single stocks in an ETF wrapper. Honestly, kind of cool that this relatively advanced investment strategy that you don't have to go and do it yourself. You can just buy an ETF. It's kind of cool. It comes back to the question of who does a financial innovation benefit, and it doesn't typically benefit end investors. It is still cool to see this type of sort of financial engineering at a product.

47:11I always think that's fun. Even if I think that they're silly and detrimental to investors, it's still cool to see. If your goal was to buy a stock and then sell calls on it, there's tons of evidence on this. Retail investors are absolutely clueless when it comes to using options. If you know what you're getting into, at least you have some professional actually buying those options for you. Robert Merton talked about this when he was on Rational Reminder in a completely different context, but he was talking about how leverage can be a good thing for long-term investors and maybe a good way to get access to leverage is through options, but he does not expect retail investors to be using options in their portfolios.

47:53He thinks that products should be created. That's an example where maybe you could create a leveraged equity product that uses options to get that exposure. And that would be cool. That's not what we're seeing here. But the concept that you can productize complex strategies, I think is kind of neat. Even if it's usually not good for investors, you can't say it's not interesting. So we've got these single stock covered call ETFs. Some of their distribution yields are absolutely astronomical, but as you might expect by now, so is their underperformance. And it is actually interesting, Dan, you mentioned return to capital earlier with other types of funds.

48:30For the final notes that I put together here, I only looked at one single stock covered call ETFs, but I looked at a bunch as I was browsing through examples, and a lot of them actually have significant return to capital in their distributions. So I guess they must be targeting yields regardless of the source. They're just saying, we're going to give you a really high yield even if we're giving you your own money back, which is itself interesting. It's hard to imagine these huge yields, and you've got an example or two here, but how you could possibly pay out those kinds of distributions just with premium options or option premiums?

49:02I don't know. They all have disclosures on the fund website that says, here's what the distribution was, this much of it was return to capital. Just to make it a relatively pure example, I chose one specifically that did not have return of capital, at least for this distribution. TSLY is the one I looked at. It writes covered calls on Tesla shares. Its distribution rate at the time when I wrote this is 48.59 % or was 48.59%, which is crazy. But since inception in November, 2022, it has underperformed Tesla, which is the underlying equity by more than 20 percentage points annualized. Ridiculous.

49:39The numbers are crazy. I don't know how you call that even an investment product. I mean, that's a speculative tool. And buying the individual stock is risky enough, but this, as we've been talking about, just exposes you to a whole lot of risk and doesn't even really give you any upside. The premium income is the only upside you're going to get if you're selling options at the money. You're not going to get any appreciation. Which is counterintuitively actually downside, not upside, at least on expectation. I'd love to hear from someone who's using these products, what their thought process is.

50:17I'd be surprised if listeners are using them, but if anyone listening is using a single stock covered call ETF, I'd love to hear from you about what the motivation is, what you're getting from it, maybe what we're missing. I personally just can't rationalize why you would invest in that product. If you want exposure to Tesla, why would you buy TSLY? I don't get it. You're capping your upside, you're keeping all the downside, you're getting premium income, but that premium income is more than offset by the upside that you're losing. In theory, I suppose you're getting that really large premium income.

50:51And if the stock stays the same or goes up just a tiny bit or down a tiny bit, you're ahead. So it's speculating on a specific movement pattern of the underlying stock. Which is you're specifically speculating on something that is completely random and unpredictable. There's a word for that and it's not investing. Yeah. The numbers on these single stock ETFs are just ridiculous, but I think they do highlight the previously mentioned relationship between high derivative income yields and lower expected returns. You got that massive yield, but you trailed by 20 percentage points annualized. Crazy numbers.

51:29The last point that's worth mentioning is that covered call funds will tend to have higher fees and transaction costs than funds holding their underlying equities. So for the sample of funds that I mentioned in this episode, excluding the single stock fund, and one note on this, it's in the weeds, I guess, but JEPI is a US listed fund. It does have a Canadian listed equivalent. In Canada, funds are required to report on their management expense ratio, which is their management fee and some other costs, and their trading expense ratio. US funds don't report the same way about their trading expense ratio, so it's not as easy to figure out what their explicit trading costs are.

52:08So for this comparison, I used the Canadian listed version of JEPI. So the MER and trading expense ratio for that fund in this little sample that I'm going to talk about in a second here is the Canadian listed version of JEPI. Probably unnecessary to explain that, but did it anyway. For this sample fund, so the BMO funds, the Global X fund, and the Canadian version of JEPI, and excluding the single stock fund, the average management expense ratio of the covered call funds was 0.63%. And the average trading expense ratio, the TER, which is something that you can find, all funds are required to file an MRFP, manager report of fund performance twice a year.

52:47They contain all kinds of cool details, but they are required to report on the management expense ratio and the trading expense ratio. So for any fund, you can go and look this up, any Canadian fund. The trading expense ratio for my little sample here, just equal weighted, was 0.16%. So that's 0.63 % for the management expense ratio, 0.16 % for the trading expense ratio. The funds in the comparison that I used just for the underlying equities, so the long only underlying portfolios, they have an average management expense ratio of 0.25%, a little higher because we have the JEPI thing in there, which has a bit of a higher fee and the banks and utilities, those are more specialized ETFs.

53:29But still, 0.25 % is the average MER compared to 0.63 % for the covered call funds. And the average trading expense ratio for the underlying equity ETFs was zero on average. Trading at stocks is cheap. Trading options is, I guess, more expensive. I'm actually a little bit surprised that the trading expense ratio on the covered call ETFs wasn't higher. I'm assuming that there's a lot of, well, especially if you're buying them at the money, you're buying and exercising them in rapid succession. And presumably there's some cost to that. But if it's what you do and you're doing it at scale, you can keep those costs at least reasonable.

54:0816 basis points is not enormous. It's not enormous. I agree, but it's high. You can find actively managed funds that have trading expense ratios in that range or higher, but that's high for any fund. You can find higher, but if you showed me a trading expense creation on a fund of 16 basis points, I'm like, well, geez, what's going on there? Maybe they're doing all their trades at online brokerages and paying 9.99. That would make sense. That last point is just to show that you're paying a pretty significant premium to access all of the downsides of covered calls. Those high income distributions have to be really, really psychologically important to you for this to make sense, or you have to be a sophisticated investor who believes they can harvest the volatility risk premium using these ETFs, which my understanding from people who actually pursue that risk premium would say that ETFs are one of the worst ways to do it because that's not what they're targeting.

55:04They're really designed for yield. I do want to say that some investment managers may successfully use covered calls or similar strategies to access a volatility risk premium. It's a pretty esoteric risk premium, and it's probably not required for the typical household saving for or living in retirement. You mentioned this in a blog post, Dan, from years ago that I loved where you said, I don't remember what the example was, but nobody failed to meet their retirement goals because of whatever, I can't remember what it was, small cap value stocks or something like that. fill in the blank there.

55:35Nobody really needs to engage in these kinds of strategies. It doesn't mean they're completely worthless. It just means why are you wasting your time with them unless you have a very high confidence level that they're going to improve your returns and by extension, improve your financial wellbeing. And boy, it's hard to make that argument here. I agree. Unless it really makes you feel good. I did find it interesting that this very educated finance person that I talked to recently was more than happy to have their father using covered calls for their retirement portfolios. Fair enough. If it makes you feel good and it helps you spend in a way that is fairly reasonable, then who am I to say that you're doing it wrong?

56:17We already mentioned this earlier, but I think one of the big issues with the volatility risk premium angle is that even if it is there, even if it was worth pursuing, these funds are not marketed to retail investors that way. They're marketed on their distribution yields, not on their exposure to the volatility risk premium, which most people would have no idea what it meant. They understand income, volatility risk premium, probably not so much. I've already said this, but I'm going to say it again. In my opinion, selling these products on their yield, marketing them on their yield, which as we've mentioned in the case of covered calls is inversely related to the strategy's expected returns, shows indifference to the truth.

56:54I'll say the word for real this time. It is bullshit, especially when it's held up to things like treasury bill yields or other yields that are better approximations of expected returns? It's kind of hard to imagine that regulators allow those kinds of comparisons. There are some pretty good regulations in effect that people cannot market bullshit. I don't have any specific examples here of fund companies doing that, but it certainly makes investors vulnerable if that's the only metric they're looking at. Totally. I guess they're in some ways comparable because they're packaging out relatively complex strategies.

57:30But if you look at structured products, they do the same kind of thing where they market headline rates of return. They basically market the best possible outcome that you could get if this thing pays off in the best way possible. If you get the exact specific return scenario that makes this thing give you the highest return, they'll be marketed on that, which is similarly a ridiculous thing for investors to buy when the actual underlying expected return profile of the asset is really quite unattractive. So taken together, all that information, I really don't think covered calls have anything special to offer.

58:01They get you to a place similar to holding a bunch of cash, except that your upside is limited and your downside is unlimited. They're more likely to be detrimental to most investors' expected outcomes than to improve them. Their high yields come at the expense of lower expected returns and historically lower realized returns in live products. The volatility risk premium, which could theoretically help covered calls recoup their lower expected returns, has not been anywhere near sufficient to offset the reduction in expected returns since around 2011, as you mentioned, Dan, when these products started to become really popular.

58:33And all of these downsides are not just theoretical, they show up very clearly in the terrible performance of live covered call strategies when those strategies are measured properly by their total returns, not by their yields. Seems like a pretty slam dunk on these products. I mean, they have such superficial appeal. But like so many other financial products, you really do have to understand at least a little bit about how they work. I don't think either of us is pretending we have a super crystal clear understanding of exactly what the mechanism of all these products are, but it really comes down to that old maxim, if it sounds too good to be true, it is.

59:11And nowhere is that more true than with financial products. 100%. I'll be interested in the feedback on this episode. I did a video a while ago on why trading options is generally a losing prospect for retail investors. I just talked about trading options in general, but the most common comment that I get on that video is what about selling covered calls? So hopefully this helps to address that what about. They are terrible too, just for different reasons than other forms of option trading. Not terrible, that's not fair. They have trade-offs that I don't find particularly attractive. Maybe somebody else really likes them.

59:50That sounds more generous than bullshit. I already called it that twice, so I'm stuck on that one. You even made me say it twice now. Yeah, I'm sorry, Dan. Gonna have to wash my mouth out with soap. Cameron's not going to be impressed. We do have one review. I'll read the disclaimer. You can read the review, and then I got some comments based on the review. We have a review from Apple Podcasts to read. Under SEC regulations, we are required to disclose whether a review which may be interpreted as a testimonial was left by a client, whether any direct or indirect compensation was paid for the review, or whether there are any conflicts of interest related to the review.

1:00:25As reviews are generally anonymous on Apple podcasts, we are unable to identify if the reviewer is a client or disclose any such conflicts of interest, which wouldn't exist anyway, because we don't pay for reviews, because that'd be super weird. That's not part of the disclaimer, but I think it's important. That would be inappropriate. Yes. So here's one review that we did not pay for from Daniel R. from the US. He says, Hello from down south. Thanks to Ben, Dan, Cameron, and everyone behind the scenes. This podcast has become my top recommendation for friends and family looking to improve their financial literacy.

1:01:00As a listener, I appreciate the depth and breadth of topics covered. Special shout out to episode 372. I had been procrastinating doing research on effective charities. Thanks in part to this episode, GiveWell will be receiving a monthly donation from my family. That's very nice. It made me want to mention something though that also came up in a previous review. I don't remember the details exactly. Now this reviewer did say thanks in part to this episode, which gives me some reassurance, but I think it's great that people trust the information that comes from this podcast and I'm grateful that we're considered a useful, credible resource for people to make decisions based on.

1:01:36I do hope though that people are not making final decisions about important things based on a single podcast episode. A previous review mentioned going all in on 100 % equity portfolio after listening to Scott Cederberg. I get it. That was a compelling episode. I was already in 100 % equity portfolio, so whatever. I can't really throw any shade on someone deciding to go 100 % equities, but it does make me a little bit nervous that listeners may hear things in the podcast and immediately go and act on them without doing their own research. I'm not saying that I think listeners are doing that. I'm sure we have lots of very responsible, thoughtful listeners.

1:02:10I'm just saying, I hope that they're not doing that. And someone posted in the Roush Reminder community a while ago, I can't remember what it was, but it was some rule of thumb that they follow where anytime they're going to make a major change to their portfolio, I don't even remember what the timeframe was, but they'll sit on it for 60 days. So thinking about going 100 % stocks because they heard Scott Sederberg, they're not going to do that for 60 days. They're going to sit on it, simmer, maybe take in more information, see how they feel 60 days later, or maybe it was 30 days, I don't know, whatever, some separation of time.

1:02:40Same for the give well thing. Instead of going and giving them all the money that you're planning on donating this year, you hear the episode, maybe you wait 30 days, look for other information, look for conflicting information. Anyway, I just wanted to say that it makes me a little nervous. Maybe someone listens to this episode on covered calls and they're using a covered call fund and they hear this episode and they go and immediately sell it and invest in something else. I don't know. I think we are doing our best to give useful, credible information, but it makes me a little uncomfortable being the final source of, I'm going to go and act on this now.

1:03:11Just a thought that I had. Yeah. Especially a decision like going 100 % equities. The issue is not, well, you're going to do your own research and find out that Scott Cederberg was wrong. That's not the point. The point is he's right, but that doesn't mean that 100 % equities is appropriate to everybody's risk tolerance. There's theoretically correct, and then there's correct for you in practice. And I think you're right. You don't always have the wisdom to tell that difference until you're a very experienced investor. So before you jump into 100 % equities, make sure you understand the risk. For anything that we talk about in the podcast, giving yourself time space, I think makes sense.

1:03:49Discussing stuff in the rational reminder community could be another approach. If you hear something, you're like, oh, I really want to do that, going and seeing what other people said in the Rational Reminder community, which is a place that a lot of really, really smart people participate in discussions. So hearing different points of view, why something might or might not make sense for one person. I mean, GiveWell is a good example where there's quite a lively debate about whether what they're doing does actually make sense or whether there are better ways to approach giving. That could be a good rule of thumb before making a decision based on an episode, go and see what the community discussion looks like.

1:04:21Related to that, actually, The asset allocation discussion led by Louis, where that included lots of comments from you, Dan, and from Ben Wilson, that episode sparked a pretty substantial discussion in the community. A lot of it ended up being about, there's a bunch of discussion about asset allocation, about stocks and bonds. There's some interesting comments about whether stocks and bonds are the only things you should be talking about in asset allocation, which is a valid point that I thought about as Louis was talking. But I think from a general perspective, thinking about riskier assets and less risky assets just to make the discussion more straightforward is fine.

1:04:55But it is a valid point that asset allocation is not just about stocks and bonds. And then a lot of the discussion in the community ended up being about whether it makes sense to pay off a mortgage or invest. That was interesting. Interesting comments about behavioral loss tolerance, whether that actually matters. Really interesting discussion about advisors and what effect advisors have on investors' portfolios. We talked about advisor fixed effects during that episode, but based on, I think, your comments and Ben Wilson's comments, a lot of people were saying that it sounds like we push people into more conservative portfolios than they would be otherwise when it's maybe better for people to be in more aggressive portfolios than they would be otherwise if they have an advisor.

1:05:35Anyway, it's just lots of really interesting perspectives on asset allocation, which is a very personal topic, which is, I think, why it sparks such lively discussion. I find the advisor question a really interesting one, actually. I would love to dive into that one a little more deeply by talking with other advisors, because my sense is talking with other advisors that I've certainly met people who are much more aggressive than I am personally. And my guess is the average equity allocation of their clients is also higher, even though you assume a large enough sample size, that's all going to even out.

1:06:13And then the second part of that is, is that a good or a bad thing? Is our job as an advisor to encourage people to take as much risk as they possibly can? Or is it to encourage them to maybe be a little more conservative under the assumption that they don't always appreciate how volatile stocks can be and or they don't need a 7 % or 8 % expected return in order to reach their goals? These are all really good, really compelling questions. And I think you could make good arguments on both sides. That's one I would love to explore in the future. More generally, what I would love to start doing as PWL continues to get larger and larger, we have a larger number of clients.

1:06:55We have really interesting data. It's just, what do we do with it? But one thing that I would love to do is start collecting information on clients' asset allocations before and after they become a client. Typically, if someone comes to us and whether they're a DIY investor or they're with another advisor, they have a portfolio, I think it'd be very interesting to see on average, how does someone's portfolio change from when they're onboarded to when they're whatever a year into becoming a client or even just from what their portfolio is when we meet them versus what is their investment policy statement when they're onboarded with PWA.

1:07:25I think that would be an absolutely fascinating data point to explore. The challenge there, of course, is getting the data on the way in because so many meatloaf portfolios that we see from new clients, the asset allocation isn't even clear. This is very hard to tease out. It's not like people are buying products like we use that have well-known asset mixes, ETFs or funds that only hold Canadian stocks or only hold international stocks. They're thrown into these kind of mishmash funds and we don't even really know what's in there. But at least overall, probably stocks and fixed income, you could probably tease out for most people with pretty good clarity.

1:08:05I have a tool in YCharts now. I just did this for an advisor recently where it was exactly what you just described. They had a client they were onboarding and their current portfolio was a mess. A ton of different holdings, individual securities, funds, you couldn't understand what was happening. YCharts has a feature where you can upload PDF statements and it will extract all of the holdings and then you can analyze it like you would any other fund in YCharts. So you can look at asset allocation, number of holdings, past returns, all that kind of stuff. It's possible the challenge is how do we systematize that?

1:08:37Anyway, and it probably takes, honestly, somebody dedicated to doing that type of work with PWL's data, but I think we could probably start gaining a lot of really interesting research insights. Even if we only looked at the asset allocations here post-move to PWL, and so look at each advisor and see what's the average age of your clients and what is the average equity allocation? because older advisors are likely to have older clients, for example, and make sense that they might be more conservative. But to just kind of adjust for age and then say this advisor, like his average client is 80 % equities and this other one, her average allocation is 50 or 60.

1:09:16That's probably the advisor's own bias creeping in there for better or worse. That advisor fixed effects paper, that's what they did. They controlled for a bunch of variables that you would expect to be the main determinants of someone's asset allocation. And they've found that the advisor fixed effects were dominant over all those other variables. I agree. You can do employment status and age and maybe a couple other straightforward variables and then see how impactful relative to those things the advisor is. I'm just dreaming here about cool stuff we could do in the future. Based on the community discussion on the asset allocation episode, I think it would be cool for us then to do an episode either on investing versus paying down debt, because I think that's an interesting topic, or, and maybe it's a separate topic, Maybe it's the same one.

1:10:00Should you pay off your house? Because I think that alone is a really interesting topic. This came up on the rent versus buy episode and you had said something to the effect that really jumped out at me, which was the advantage of being a homeowner is even lower once you've paid off your mortgage. I was like, whoa, that's really counterintuitive. But when you think it through, if you assume that leverage is one of the advantages of homeownership, then it must also be true that when the leverage is gone, that advantage is diminished. But a fascinating way to approach the problem that I think most people have not thought about.

1:10:37It's like the 100 % equities thing. If you're a robot and your goal is to maximize your returns, you should never pay off your mortgage. You should borrow as much as you can against your house to invest in stocks. Personally, I will probably pay off my mortgage soon and not borrow against my house. Me too. Obviously, we don't want to do the episode now, but I think it raises There's a lot of fascinating questions that I'd love to explore. Maybe I'll try and do that for the next, unless we do an AMA. Anyway, we'll work on that one. I think it'd be a really interesting discussion. And based on the large number of comments in the community on that specific question, I think a lot of people get value from it.

1:11:12It was actually interesting. A few people said things like, because I had said that in the community that I would pay off my mortgage as soon as possible. And people said that it was really good for them to read that because they had assumed that I would say that paying off your mortgage is a really bad idea because of how expensive it is to have home equity. And so they're like, wow, I really wanted to pay off my mortgage, but thought it was a terrible decision. Now I feel better about actually doing it. So it could be a valuable discussion for people to hear. By the time this episode is out, we will have had our meetups in Victoria and Vancouver.

1:11:45We're recording this on the 10th of September. So that's Wednesday on the Monday of the week that this episode comes out. I will have headed to Vancouver and Victoria with Cameron. We will have had our rational reminder meetups over there. So hopefully in our next episode, we can report on how those went. Cameron and Ben Wilson, who listeners now know from the recent episode, were in LA recently at Future Proof, big conference for financial advisors. so we may get some interesting insights from Ben and or Cameron on that conference when they come back as well. I think that's all I got. Anything else?

1:12:23No, I think that was a great episode. Thanks for all your work on it. Well, thanks for your contributions. Your concise, plain English explanations are so powerful. It's just how my mind works. Well, I love it. I think it adds a ton of value to the podcast. All right. Well, thanks everyone for listening. Thanks.

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