Key Points
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Most people use traditional stocks and bonds to generate income. Real estate, preferreds, and covered calls can also help.
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These asset classes, however, can behave differently from stocks and bonds, so they should be allocated modestly.
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In some of these ETFs, yields of 6% to 8% are achievable.
- 10 stocks we like better than Vanguard High Dividend Yield ETF ›
The 10-year Treasury yield is back around 4.6%, and it seems the Federal Reserve won’t cut interest rates anytime soon. That’s a good thing if you’re an income seeker looking for reasonable yields from your portfolio.
But it does create some complications around where you find that yield. Given current geopolitical and inflation risks, rates could still head higher, making traditional bonds a potentially poor investment. You don’t necessarily want to reach for any old yield in the equity markets, because those could come with volatility or even the risk of a cut.
Let’s take a little stroll around the passive-income exchange-traded fund (ETF) space to see where the good long-term buy-and-hold opportunities are. These four ETFs might be less familiar or come from asset classes you hadn’t previously considered for your portfolio. But all have an investment case.
1. Vanguard High Dividend Yield ETF
The Vanguard High Dividend Yield ETF (NYSEMKT: VYM) is a pure high-yield strategy. It starts with a broad universe of U.S. stocks, calculates a forecasted dividend yield for each, and then selects the top half of yields for inclusion in the fund. I’ve criticized this fund’s relatively lax screening process in the past. But there’s no questioning that its 2.3% yield is much above that of the S&P 500 (SNPINDEX: ^GSPC), and its 600-plus individual holdings improve diversification and help mitigate volatility.
The Vanguard High Dividend Yield ETF could be considered a more conservative entry into the high-yield equity space because of these factors. The fund is well diversified and currently allocates at least 8% across seven different sectors, providing broad exposure to multiple areas of the economy without the tech concentration you see in the S&P 500.
2. JPMorgan Equity Premium Income ETF
The JPMorgan Equity Premium Income ETF (NYSEMKT: JEPI) is not a traditional equity ETF. It’s a covered-call fund, which means it has a different risk/reward profile than other dividend ETFs. It uses a portfolio of low-volatility stocks as its underlying foundation and then writes call options on the S&P 500 to generate premium income. This approach results in a high yield, often above 8%, but shareholders will trade off share-price upside in exchange for that high yield.
Full disclosure: This ETF will probably underperform the S&P 500 during a bull market. But during a sideways or down-trending market like the one we saw in 2022, covered-call funds can really shine. That can make them a good risk diversifier in modest allocations. You probably don’t want to commit a large percentage of your portfolio to the JPMorgan Equity Premium Income ETF, but it can act as a nice income booster in the right circumstances.
3. Vanguard Real Estate ETF
Real estate investment trusts (REITs) are a popular high-yield option because they’re required to pay out at least 90% of their taxable income to shareholders. The Vanguard Real Estate ETF (NYSEMKT: VNQ) is the biggest REIT ETF in the industry.
This would likely be another ancillary portfolio, with an allocation of no more than 5% to 10%. The 3.4% yield is strong, but it’s important to remember that this ETF will be much more rate-sensitive. But the potential for additional volatility makes it a better long-term holding.
4. iShares Preferred & Income Securities ETF
Preferreds are generally considered hybrid securities, somewhere between a stock and a bond, and exhibit characteristics of both. They can be attractive because (1) they sit above common stock shares in the capital stack and get an earlier claim on assets in the event of liquidation, and (2) they typically offer yields above those of corporate bonds. The iShares Preferred & Income Securities ETF (NASDAQ: PFF) is the largest ETF in this category.
This ETF has a volatility level similar to that of intermediate-term Treasuries and currently offers a 6.5% yield. Similarly to real estate, it can provide a solid yield enhancement, but can also become vulnerable to economic events or changes in interest rates. The iShares Preferred & Income Securities ETF is also therefore better suited to a smaller long-term portfolio allocation.
Each of these ETFs can be strong yield producers, but they’ll also demonstrate very different behaviors. They’re intriguing, though, because they offer something different from traditional equities. From a purely passive-income perspective, they can be great additions if used carefully.
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David Dierking has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard High Dividend Yield ETF and Vanguard Real Estate ETF. The Motley Fool has a disclosure policy.
