Having realistic expectations, especially when it comes to passive income from your investments, is key to not setting yourself up for huge disappointment.
Of course, the draw of ultra-high-yield investments can be difficult to pass up, especially when can crunch the numbers and consider how much more we’d have to spend at the end of any given month or quarter with the supercharged dividend or distribution. In my view, dividend growth is perhaps one of the most underrated traits in the investment world, especially when you consider how much more emphasis is placed on the upfront yield.
If you are, in fact, a long-term investor, how large a dividend could grow many years into the future, I believe, is just as important, if not more so, than how much you’ll get back in passive income in the current year. Either way, some of the market’s top dividend growers grant investors an incentive to play the long game.
So, what’s the key to setting the right bar for passive income? Should you target an average portfolio yield of 4%? Maybe 5%? Should it depend on where rates are? And how do covered call ETFs (and other yield boosters) fit into all this? What about falling knives with a higher risk of being put on the dividend chopping block?
Ultimately, it comes down to the income you want to earn in the near term, the dividend appreciation you could get further down the road, and, of course, the capital risk you’ll be exposing yourself to.
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Starting things off with a strong foundation
All considered, I do think that going for a dividend-focused ETF such as the Vanguard FTSE Canadian High Dividend Yield ETF (TSX: VDY), which boasts a reasonable, though not amazing, yield of 3.2%, could make sense to have as a core foundation to a passive income portfolio built to last. Note that similar dividend-focused funds offer yields in a similar ballpark (with big stakes in financial and energy names).
Shares of the VDY are currently in a bit of a downtrend after peaking over the summer. And while the ETF, which is heavy in banks and pipelines, does sport a lower beta of 0.80, which entails less correlation to the rest of the market, investors should be ready for anything, especially after a multi-year period of overperformance.
With a good mix of dividend growth potential (in the fund’s constituents), a not-bad yield in the 3% range, and past-year share price momentum (up 29% in the past year despite the latest mini-correction), it’d be all right to stop at the VDY.
That said, for those looking to stretch the yield a bit further (and it can go further as rates begin to rise on both sides of the border), I think stock-picking could be your best friend as you look to improve your yield-to-risk ratio.
Boosting that yield with high-quality passive income plays
Indeed, Enbridge (TSX: ENB) is the elephant in the room when it comes to yield boosting, with a nearly 6% yield, which I think could fit nicely alongside the VDY and other dividend behemoths, like those featured in the VDY. I’d take it a step further by maybe even considering a REIT, such as SmartCentres REIT (TSX: SRU.UN), which offers a stellar 7% yield at the time of this writing.
A covered call ETF, such as the BMO Canadian High Dividend Covered Call ETF (TSX: ZWC), might also make sense, with a yield in the ballpark of 6% and a strategy that caps upside for extra premium income on top of dividends paid.
As rates rise and yields fluctuate, perhaps it is reasonable to start with a 3.2% base (with something like the VDY) and go from there. Perhaps a hard-hit (and increasingly affordable) pipeline play and a REIT (they tend to offer very rich distributions) can help one achieve the perfect portfolio and hit his/her passive income goals without taking on too much risk.
Any way you look at it, Canada is the place to be for those looking for bountiful, but high-quality yields these days.
