Unconventional dividend funds can pay generous yields to fund your lifestyle, but there are trade-offs. Make sure you know what they are and confirm they don’t conflict with your investing priorities.
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The average dividend yield of the S&P 500 is 1.1%. Relative to history and what you can earn today on cash in a high-yield savings account, that’s low. In 2018 and 2016, the S&P 500 yielded an average of 2.09%. Way back in 2008, the average yield eclipsed 3%.
Low yields in the S&P 500 are partly a function of high stock prices—but knowing that doesn’t help you build a solid income portfolio. Fortunately, you still have options. High-yield dividend ETFs use a range of strategies to produce distributions of 3% or more. Six interesting and popular funds are introduced below.
iShares S&P 500 BuyWrite ETF (IVVW)
IVVW by the numbers:
- NAV: $44.32
- Coverage: S&P 500 and call options
- Expense ratio: 0.25%
- Distribution rate: 23.10%
- 1-year return: 13.11%
- Net assets: $262 million
IVVW holds shares of iShares Core S&P ETF and sells call options on those holdings to generate income. The call options bind the fund to sell shares at a certain price for a period of time. If the asset appreciates above that agreed-price, known as the strike price, the fund records a loss, which offsets some of the capital gains.
If share prices stay the same or decline, the fund simply keeps the income earned from selling the call options.
Covered calls, as they’re known, perform best in flat, rough, or modestly down markets. In strong markets, the fund will still generate income but have lower upside. The strategy can also be adjusted to suit market conditions, giving up more or less upside in exchange for higher or lower income.
Invesco QQQ Income Advantage ETF (QQA)
QQA by the numbers:
- NAV: $53.84
- Coverage: Nasdaq 100 and call options
- Expense ratio: 0.29%
- Distribution rate: 9.95%
- 1-year return: 20.92%
- Net assets: $650 million
QQA invests in the Nasdaq-100 fund QQQ and sells call options to generate income and reduce downside risk. The fund includes the 100 largest non-financial companies listed on the Nasdaq exchange. This group of equities has historically been volatile and high growth—over the past year, it gained 46%.
Combining Nasdaq-100 exposure with a strategic call option strategy combines elements of growth, income, and slight downside cushioning. The call options are designed to provide consistently monthly income and reduce drawdowns, which might soften losses in a bear market. As with IVVW, the call writing activity reduces upside potential.
Invesco S&P 500 Equal Weight Income Advantage (RSPA)
RSPA by the numbers:
- NAV: $51.62
- Coverage: S&P 500 (equal weight) plus call options
- Expense ratio: 0.29%
- Distribution rate: 9.39%
- 1-year return: 12.01%
- Net assets: $732 million
RSPA’s strategy is like QQA’s, but the underlying asset is an equal-weight S&P 500 fund. Equal-weight funds hold all index equities in the same proportion, rather than weighting them by market capitalization. Equal weighting eliminates concentration risk in the fund and allows smaller companies to participate equally in the fund’s performance.
Fidelity International High Dividend ETF (FIDI)
FIDI by the numbers:
- NAV: $28.02
- Coverage: Large- and mid-cap international stocks that pay dividends
- Expense ratio: 0.18%
- Distribution rate: 4.12%
- 1-year return: 34.05%
- Net assets: $297 million
FIDI has a more straightforward strategy than IVVW, QQA, and RSPA. The fund does not sell call options—RSPA achieves higher yields by investing in international value stocks. The top sectors represented are financials, energy, consumer discretionary, and consumer staples. Norwegian energy company Equinor ASA is the top holding, weighted at 4.1%. Nestle, Toyota, and Mercedes-Benz are also in the portfolio.
Vanguard Global ex-U.S. Real Estate ETF (VNQI)
VNQI by the numbers:
- NAV: $47.09
- Coverage: Non-U.S. real estate
- Expense ratio: 0.12%
- Distribution rate: 4.60%
- 1-year return: 15.08%
- Net assets: $3.7 billion
VNQI invests in international companies that own, manage, develop, and lease real estate. The fund tracks the S&P Global ex-U.S. Property Index. The top countries represented are Japan, Australia, Hong Kong, and the United Kingdom.
VNQI pays dividends annually, which may be a drawback. Many U.S. real estate funds pay dividends monthly.
Invesco S&P Emerging Markets Low Volatility ETF (EELV)
EELV by the numbers:
- NAV: $29.07
- Coverage: Emerging markets
- Expense ratio: 0.29%
- Distribution rate: 3.50%
- 1-year return: 20.10%
- Net assets: $445 million
EELV tracks the S&P BMI Emerging Markets Low Volatility Index, which includes the 200 least volatile stocks of the S&P Emerging Plus LargeMidCap Index.
Emerging market stocks can have high growth potential but they are also known for being unpredictable. This fund looks to capture the gain opportunity while minimizing volatility risk.
Financial companies comprise 38.3% of the portfolio, followed by consumer staples at 12.9%. The top three countries represented are China, Malaysia, and Taiwan.
Risks of High-Yield Dividend ETFs
High-yield dividend ETFs tend to carry the headlining risk of income volatility. The cash payments may fluctuate wildly, which can be problematic if you’re relying on them to pay bills.
Opportunity cost is another concern. Depending on the fund strategy and market conditions, income ETFs can underperform on a total return basis. This can be a reasonable trade-off if you are taking withdrawals and want to minimize liquidations. But if you are a long-term investor who doesn’t need the income, it’s counterproductive to prioritize distribution yield over total return.
Bottom Line
Unconventional dividend funds can pay generous yields to fund your lifestyle, but there are trade-offs. Before you invest, make sure of two things. You should know exactly what the trade-offs are and confirm they don’t conflict with your investing priorities. Once you’re comfortable on those two points, you’re ready to turn on that income machine.