2023-04-18 04:37:34 ET
Summary
- QYLD is among the most popular income-producing ETFs among dividend-focused investors.
- The fund uses a covered call strategy to bring higher yields for income-focused investors.
- This fund has lagged the broader market since its inception, yet it is still a good option for providing income.
Few things excite me more than seeing dividend payments hit my brokerage account. I've been in the workforce for about three decades, and the thought that money that I've invested can produce a growing stream of income independent of any additional work on my part is an exciting concept.
I don't have enough passive income to replace my working income by any stretch, but if I can keep investing more over time, the gap between the two will almost undoubtedly shrink. Those with a long time horizon before they retire can invest almost exclusively in lower-yielding funds, but as someone who doesn't have 30 or 40 years before I'd like to retire, I invest in some higher-yielding companies and funds.
QYLD
One of those funds that produces a high level of income is the Global X NASDAQ 100 Covered Call ETF ( QYLD ). This fund holds the NASDAQ 100 index and then writes covered calls on the holdings to juice income through the premiums. Global X notes one of the major drawbacks to an investment in QYLD on its homepage: the limit to any upside potential. In other words, if the price of the index increases rapidly, the fund will have to sell its shares at a price that's below the current market price and then repurchase shares at a higher price.
Why would anyone want to have a limited upside potential? The answer to this is the same to the question of why someone would want to invest in Verizon ( VZ ) over Visa ( V ). The former pays, what has been to date, a relatively high yield that exceeds 6%; the latter pays less than 1%. Even with the higher dividend growth with Visa, it will take a long time for its dividend to catch up with Verizon's. Investors focused on income will find the slower growth of VZ an acceptable tradeoff. This is the same for those who invest in QYLD.
As noted above, this fund holds shares in the NASDAQ 100 index, which is heavily invested in tech stocks. It excludes financial companies, and it excludes companies that are not listed on the NASDAQ exchange, which leaves out some of the older companies that are listed on the New York Stock Exchange.
Invesco offers a fund that tracks the NASDAQ 100 outright, the Invesco QQQ ETF ( QQQ ). This fund has offered quite a bit of share price appreciation. Over the past 10 years, this fund has returned 359% . This is a return of more than 17% on an average annualized basis. However, those looking to receive passive income from QQQ will find the 0.62% yield a bit anemic.
The Global X QYLD fund has actually dropped in share price over the past five years (there is no ten-year record yet, as the fund launched in late 2013). The share price has dropped by a little more than 30% over the past five years, and this number is up a bit over a recent low of $15.00 per share. This compares to a 53% positive return on the Vanguard S&P 500 ETF ( VOO ) over the same time. Owning shares in QYLD would not make much sense without the dividend.
The dividend offered by QYLD has a trailing twelve month yield that is a little more than 12%. As someone who is looking to build an income stream over a specific net worth, this tradeoff is worth the investment, although I will admit that I also own stocks and funds that have much lower yields.
A retired person who needs $40,000 in annual income would need to invest about $1 million at a 4% yield to earn enough to produce the income needed when going with the 4% rule and looking to avoid selling any shares. If the yield was 1.6%, as it is with the broader market, the hypothetical investor would need to have about $2.5 million invested.
This differs from an investment in QYLD. With the 12% yield, an investor could hold $333,333 in QYLD shares and theoretically get the same $40,000 income. This is a huge difference. It should be noted that QYLD's dividend has dropped a bit with the share price over the past few years.
Therefore, an investor who is looking for a margin of safety in the possible eventuality that QYLD's dividend drops over time might want to have $400,000 or $500,000 invested to reinvest some funds at the higher overall dividend payment.
My Strategy
I own QYLD shares for the present-day income, but I do not reinvest the dividends in QYLD. I use the dividends the company pays to buy shares in other companies and ETFs. For example, I own shares in Schwab's U.S. Dividend Equity ETF ( SCHD ). Some of my dividends can go toward buying additional shares in this fund or shares in another company or fund.
Effectively, this allows me to increase the capital available to invest each month more rapidly than if I simply put all of my money into SCHD. If I were to reinvest all of the dividends into QYLD at the current yield, the number of shares I might hold could be expected to double. However, my hope is that some anticipated price appreciation and dividend growth in SCHD will provide a growing dividend stream to offset the lack of growth in QYLD's dividend over time.
It might be argued that an investment in QQQ might pay off more in the long run, and that might be true when looking at the share prices. However, dividend payments tend to have less volatility than share prices. Therefore, a drop in dividend income would tend to be less than a drop in share prices during a bear market. I do not want to rely on the 4% rule based on share prices and retire with a number that drops rapidly in the first year or two of my retirement. By focusing on higher dividend income, any such price volatility should not matter as much.
Conclusion
I do not hold all of my investments in QYLD. I have a work-based retirement plan that does not include this option. Also, I hold shares in funds and companies other than QYLD in my taxable investment account. However, it makes up a decent percentage of my taxable account holdings. My hope is that the dividend income will allow me to reinvest more capital from dividends while also adding additional capital from working income to provide a decent stream of passive income at an earlier age than if I'd simple invested in VOO or QQQ. I realize I'm likely giving up some share appreciation and net worth, but the passive income is worth it in my case. I might have a different opinion if I was in my mid-20s, but, unfortunately, I'm not.
For further details see:
QYLD: Why I Own It When It Lags The Market