If you are looking for passive income, there are easier options than buying rental properties, managing tenants, or taking on leverage. Other approaches like private lending or individual dividend stocks also come with complexity and concentration risk.
The simplest route, especially if you have a Tax-Free Savings Account (TFSA), is owning a dividend-focused exchange-traded fund (ETF).
There are many dividend ETFs on the market, each using different screens and strategies. I prefer to stick with the basics. Low fees, broad diversification, and reliable monthly payouts. Ideally, the yield should be higher than the Bank of Canada’s current policy rate.
One ETF that fits this framework well is the iShares S&P/TSX Composite High Dividend Index ETF (TSX: XEI). Here are three reasons why it stands out.
Source: Getty Images
Above-average yield
If passive income is the goal, selling shares to fund spending defeats the purpose. The income should come directly from distributions. XEI does exactly that.
This ETF pays monthly distributions, which makes cash flow easier to plan around than quarterly payments. As of January 7, it offers a 12-month trailing yield of 4.4%. Inside a TFSA, that income is completely tax free and can be reinvested or withdrawn as needed.
Even in a non-registered account, most of the income is paid as eligible Canadian dividends, which are relatively tax efficient.
Broad diversification
Building a dividend portfolio stock by stock often leads to concentration. A handful of bank or energy stocks may look diversified, but it does not take much for sector-specific risk to show up.
XEI holds 75 different Canadian companies. As expected, financials and energy make up a large portion of the portfolio, reflecting the structure of the Canadian market. You also get meaningful exposure to utilities and telecommunications.
Importantly, the ETF is not overly top heavy. The three largest holdings each account for roughly 5% of the fund, which helps reduce single-stock risk compared with some dividend ETFs that lean heavily on just one or two names.
Reasonable fees
Fees matter more than most investors realize. Management expense ratios are deducted every year, regardless of how markets perform, and they quietly reduce long-term returns.
XEI charges a 0.22% management expense ratio. On a $10,000 investment, that works out to about $22 per year in fees. Compared with traditional mutual funds sold through banks, this is very inexpensive. Keeping costs low means more of your dividend income stays in your account working for you.
