The issue I have with some income-focused ETFs is net asset value (NAV) erosion. That’s when the price of the ETF steadily declines over time if you’re not reinvesting the distributions.
What causes this? Typically, it’s a combination of high fees, excessive use of return of capital, or writing at-the-money covered calls on 100% of the holdings – all of which cap upside potential.
Ideally, you want an ETF that offers both a healthy dividend and a rising share price over the long term. It’s a rare find, but not impossible. Here’s one low-cost, monthly dividend-paying ETF from Vanguard that I like.
Invest in VDY and chill
I like the Vanguard FTSE Canadian High Dividend Yield Index ETF (TSX:VDY) for its simplicity and performance. It holds a portfolio of 56 Canadian dividend stocks, all screened for high yields.
Some benefits stand out immediately: a low 0.22% MER, an above-average 4.4% distribution yield, and monthly payouts.
VDY doesn’t disappoint on a total return basis either. Historically, it’s delivered an annualized 9.1% 10-year return, actually beating the S&P/TSX 60 Index –something most dividend ETFs fail to do.
Tax efficiency
I usually suggest keeping dividend ETFs like VDY in a registered account, particularly a Tax-Free Savings Account (TFSA), but I understand that some of you may have run out of room or prefer to reserve that space for growth investments.
The good news? VDY is actually pretty tax-efficient, even in a non-registered account. In 2024, the ETF’s distributions were either eligible dividends or capital gains, with no foreign income or ordinary income like you’d get from REITs or bonds.
Why does this matter? Eligible dividends qualify for the dividend tax credit, reducing the amount of tax you pay on this income. Capital gains are also tax-efficient, as only 50% of the gain is included in your taxable income.
The Foolish takeaway
VDY checks all the boxes for what a top-tier dividend ETF should be: tax-efficient distributions, low fees, monthly payouts, and competitive total returns. If you’re looking for a reliable way to generate passive income without sacrificing growth potential, this Vanguard ETF deserves a spot on your watchlist.
However, the only drawback is its lack of geographic diversification – it only holds Canadian stocks. To build a well-rounded portfolio, make sure to complement it with exposure to U.S. equities for broader market diversification and growth opportunities.
