The allure of passive income is undeniable, yet its true worth lies in its consistency and reliability. Consider the scenario of a passive investor who, enticed by a single stock offering a 7% yield, invests their entire capital in it.
This strategy might seem lucrative initially, but what happens when market volatility strikes and that stock not only plunges in value but also slashes its dividend? Suddenly, the passive-income stream becomes a trickle, jeopardizing the investor’s financial stability.
This example underscores a fundamental investment principle: diversification is key. For passive income, diversification goes beyond just spreading investments across multiple stocks. It involves incorporating a variety of income-generating assets into your portfolio.
These can include instruments like covered-call exchange-traded funds (ETFs), which provide income through option premiums; preferred shares, offering stable dividends; real estate investment trusts (REITs), known for their rental income distributions; and corporate bonds, providing regular interest payments.
Here are two ETFs I would combine to build a bulletproof passive-income portfolio with $20,000.
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A diversified ETF of income assets
BMO Monthly Income ETF (TSX: ZMI) is an excellent example of a diversified ETF that combines various income-generating assets in a single ticker.
This ETF’s structure, incorporating multiple other ETFs, allows for broad exposure across different asset classes and strategies, each contributing to the overall income generation and risk management.
- Canadian Corporate Bond ETF (25%): This component focuses on corporate bonds issued in Canada. These fixed-income securities provide regular interest payments, contributing to the stability and predictability of income.
- U.S. Dividend ETF (18%): This part of ZMI’s portfolio is invested in U.S. stocks known for paying dividends. The exposure to U.S. dividend-paying companies offers potential for both income and capital appreciation.
- Global High Dividend Covered Call ETF (15%): This global ETF employs a covered call strategy, which involves holding stocks and selling call options on them.
- Canadian Dividend ETF (13%): Focused on Canadian dividend-paying stocks, this ETF provides exposure to Canadian companies known for their stable and regular dividend payments.
- Mid-Term U.S. Investment Grade Corporate Bond ETF (10%): This portion invests in medium-term investment-grade corporate bonds from the U.S., with currency risk hedged to Canadian dollars.
- International Dividend ETF (9%): By investing in dividend-paying stocks outside of North America, this ETF offers international diversification, tapping into income opportunities from various global markets.
- Premium Yield ETF (5%): Utilizing a put-selling strategy, the opposite of covered calls, this ETF generates income through premiums from selling put options.
- U.S. Preferred Share ETF (5%): This component is focused on U.S. preferred shares hedged to the Canadian dollar, which combine features of both stocks and bonds.
As of November 30, 2023, ZMI pays an annualized distribution yield of 5.35%. It charges a very affordable 0.20% expense ratio and, as its name suggests, pays monthly dividends.
An ETF holding REITs
While ZMI offers a robust blend of income-generating assets, one key component it does not include is REITs. To address this gap, consider adding some!
For instance, if you have $20,000 to invest, allocating 80% ($16,000) to ZMI and the remaining 20% ($4,000) to BMO Equal Weight REITs Index ETF (TSX: ZRE), can be an effective strategy.
ZRE is particularly notable for its equal-weighted strategy. Unlike market cap-weighted indices, where larger companies have a greater influence on the index, an equal-weighted approach ensures that each of the 22 Canadian REITs in the ETF has an equal impact on its performance.
This method reduces the risk of concentration in a few large players and provides a more balanced exposure to the Canadian real estate market.
As of November 30, 2023, ZRE is paying an annualized distribution yield of 5.60% and provides monthly payments. However, it does charge a more expensive 0.61% expense ratio.
