Pensioners and other investors seeking high-yield passive income investments for their self-directed Tax-Free Savings Account (TFSA) should consider adding Canadian high-yield Exchange Traded Funds (ETFs) focused on dividends to their portfolio.
ETF benefits
An ETF trades on the TSX just like a stock. The difference is that the ETF represents a basket of stocks in a particular segment or index rather than a single company.
The idea is that investors can get access to a wider range of stocks through a single investment. This can reduce risk, since the share price movements of the stocks in the ETF help balance each other out. Volatility can still occur when the broader market jumps or plunges or a particular sector in the market hits a rough patch or catches a big tailwind. The ETF should, however, help protect against the impact of an implosion in a single stock.
ETF providers charge a fee for managing the portfolio, so there is an added cost.
Some ETFs focus on holding dividend stocks and use options to increase returns. The ETF sells options on the holdings in the portfolio to generate extra revenue. The result is a higher payout for investors who own the ETF.
ETFs often pay distributions monthly, even though most of the holdings in the portfolio pay dividends on a quarterly basis. This is useful for retirees who want to get a steady stream of monthly income from their TFSA investments.
BMO Canadian High-Dividend Covered Call
ZWC (TSX:ZWC) is one example of an ETF that gives investors exposure to a basket of top Canadian dividend stocks through a single holding.
At the time of writing, the ETF has net assets of about $1.6 billion. The annualized distribution yield is 7.67%, and the management expense ratio is 0.72%.
The objective of the ETF is to hold Canadian dividend stocks with high liquidity across a number of sectors. In addition, the ETF actively writes covered call options to boost income for the portfolio and provide some hedging against market volatility.
Over the past year, ZWC has traded in a range of roughly $16.50 to $18.50 per unit. At the time of writing, investors can buy ZWC for about $16.75.
The top 10 holdings are familiar TSX dividend names, including TD, Royal Bank, Enbridge, Canadian National Railway, CIBC, Bank of Nova Scotia, BCE, Manulife, Canadian Natural Resources, and Bank of Montreal.
There are 103 stocks in the overall portfolio. Financials make up nearly 39% of the group. Energy is about 18%. Communication services make up roughly 11%. Industrials represent 9.6%. Utilities, materials, consumer staples, and consumer discretionary stocks round out the sector allocation.
Are ETFs a good option for passive income?
The ETF space has ballooned in recent years with all kinds of offerings from a variety of providers. It is important to read through the fine print to make sure the ETF is right for your investing strategy, but using high-yield covered call ETFs to generate regular monthly income is worth considering if your portfolio is already largely focused on the types of companies that the ETF holds.
The earnings from the options help offset the management fees. In the case of ZWC, the yield is attractive today, and the core holdings are top-quality Canadian dividend stocks.
