One of the biggest advantages of dividend exchange-traded funds (ETFs) is convenience. Instead of researching individual companies and monitoring their payouts, retirees can purchase a single ETF that provides built-in diversification, relatively low management fees, and regular cash distributions.
Many Canadian dividend ETFs also pay monthly, making them appealing for retirees who want something resembling a predictable paycheque. The problem is that conventional dividend yields might not be high enough to cover your retirement spending needs.
That’s one reason more Canadians are exploring higher-yielding strategies involving covered calls and leverage. These products can generate larger distributions, but they also introduce trade-offs, including reduced upside, borrowing costs, and additional complexity.
Personally, I don’t think most retirees necessarily need to pursue these strategies. A conventional dividend ETF can still play an important role in retirement, provided you’re willing to think beyond the income it distributes. Here’s how I’d approach it.
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Why the 4% rule matters
One of the most widely discussed retirement planning guidelines is the 4% rule. The basic idea is that a retiree withdraws 4% of their initial portfolio value during the first year of retirement, then adjusts that dollar amount annually for inflation.
Importantly, the 4% rule doesn’t mean withdrawing exactly 4% of your portfolio’s current market value every year. It’s a starting withdrawal framework developed from historical stock and bond portfolio returns, typically over a 30-year retirement.
It’s also a guideline rather than a guarantee. Its sustainability depends on investment returns, inflation, retirement length, asset allocation, and the sequence in which market gains and losses occur.
Now consider the iShares S&P/TSX Composite High Dividend Index ETF (TSX: XEI). XEI holds a portfolio of 75 Canadian dividend-paying companies and makes monthly distributions. It also offers a relatively inexpensive way to access established businesses across sectors such as financials, energy, and utilities.
However, its trailing 12-month distribution yield is currently 3.4%. On a $500,000 investment, that works out to approximately $17,150 annually, or $1,429 monthly, assuming the trailing yield remains unchanged. That’s $2,850 less than the $20,000 first-year withdrawal suggested by the 4% rule.
For someone determined to live entirely off distributions without selling any ETF units, that shortfall might seem like a problem. But I think that’s the wrong way to evaluate retirement income.
Selling ETF Units Is a Normal Part of Retirement
One of the biggest psychological barriers retirees face is the idea of selling investments to fund living expenses. After spending decades accumulating assets, it can feel uncomfortable to start reducing the number of shares or ETF units you own.
However, retirement is precisely when those accumulated savings are supposed to become useful. There’s nothing inherently wrong with selling a portion of your portfolio periodically to supplement dividends. What matters is whether your overall withdrawal rate is sustainable relative to your investment returns, spending needs, and retirement horizon.
Consider XEI’s historical performance. Over the past 10 years, the ETF delivered an annualized total return of approximately 12.3%, assuming distributions were reinvested and without the impact of taxes.
That figure is substantially higher than its current 3.4% distribution yield because total return includes both cash distributions and changes in the value of the underlying investments.
Of course, that historical return isn’t guaranteed to continue. Future returns could be considerably lower, and withdrawing money during a prolonged bear market can increase the risk of depleting your portfolio.
But it illustrates why focusing exclusively on dividend yield can be misleading. A retiree holding XEI could collect the monthly distributions and periodically sell enough units to make up the difference between those payments and their desired withdrawal amount.
Using the earlier $500,000 example, that would mean collecting approximately $17,150 in annual distributions and selling around $2,850 worth of units during the first year, assuming distributions remain unchanged.
Ultimately, I think dividend ETFs can be excellent retirement income tools. But there’s no requirement that every dollar you spend must come from a distribution. A sensible withdrawal strategy should consider your portfolio’s total return, not just the cash it pays out.
