Warren Buffett once said that the act of “reaching for yield is really stupid” but “very human.” While I do agree with the Oracle that reaching for yield blindly just for the sake of boosting your monthly income is a foolish (that’s a lower-case f) endeavour, I don’t think that income investors should shun super-high yielders and subscribe to some arbitrary rule of thumb like the 4% rule.
You see, by shunning stocks with yields over X%, you could be leaving a lot of potentially sustainable passive income on the table. Warren Buffett’s comments (and the 4% rule) were meant to protect income investors from getting served with a dividend cut alongside steep capital losses. But if you’re a self-guided investor who understands the risk/reward trade-off on a given security, and you’ve got what it takes to put in the homework, I’d say it’s not as reckless as you may think to consider securities with 9% yields, especially after the coronavirus sell-off, which has raised the yield bar across many stocks and REITs.
Warren Buffett thinks the act of reaching for yield is stupid: Is he right?
I view chasing super-high yielders as akin to buying deep-value stocks or cigar butts. The endeavour can be very successful, as long as you’re aware of the pitfalls and ensure proper due diligence. When it comes to +9% yielders, you’ve got to pay special attention to the health of the balance sheet and how future operating cash flows will be affected by a worsening of the COVID-19 pandemic.
Neglecting either the former or the latter could land you in hot water, with a dividend cut alongside steep losses over a concise period. As such, yield chasers who want to bolster their income will need to roll up their sleeves and put in the due diligence or settle for the safety and security offered by lower yielders.
If you’re still keen on raising the yield bar with your income portfolio, consider scooping shares of the BMO High Dividend Canadian Equity Covered Call ETF (TSX:ZWC), a specialty-income ETF with a yield of 8.7% at the time of writing.
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The ZWC: A 9% yield that’s not skating on thin ice
I’ve covered the ZWC ETF ad nauseam amid the COVID-19 crisis, pounding the table on the specialty-income play for Canadians who saw their incomes take a hit as a result of the pandemic. In a nutshell, the “covered call” option-writing strategy caps upside potential in exchange for guaranteed option premium income upfront. The managers running the ETF write the options and are compensated with a MER of 0.72%, which is on the higher end as far as ETFs are concerned.
Option premium income is married with the dividends from the ZWC’s long positions, resulting in a yield that’s greater than the yield of the ETF’s aggregated dividends. More income at the expense of upside may not be the best choice for everyone, especially over the long term, as the stock market tends to go up over long durations of time.
However, if you’re a conservative investor who wants to hedge themselves from a flat market, a retiree who wouldn’t mind trading upside for more yield, or someone who just needs more income without bearing more downside risk, the diversified high-income REIT is well worth the price of admission.
Foolish takeaway on chasing yield and Warren Buffett’s warning
Chasing yield isn’t for everybody. If you don’t put in the due diligence, you could lose big money. With the ZWC, though, you’re delegating a big chunk of the homework to the smart managers at BMO. The ZWC is screened for quality and yield, among other “smart-beta-like” characteristics. With the “covered call” strategy thrown into the equation, the ZWC is a well-diversified high-yielder that won’t leave chasers of yield in tears should dividend cuts become normalized in this horrific pandemic.
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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Joey Frenette owns shares of BMO Canadian High Dividend Covered Call ETF.