Exchange-traded funds (ETFs) are excellent passive investment vehicles. They hold baskets of stocks or other investments, which helps provide diversification and reduce risk. Because of that, you don't have to spend any time managing these investments.
Many ETFs are designed to generate income, making them ideal investments for those who want a portfolio that will provide them with reliable passive income. The Vanguard High Dividend Yield ETF (VYM -0.55%) and the iShares Preferred and Income Securities ETF (PFF) are two excellent dividend ETFs.
More than just dividend income
The Vanguard High Dividend Yield ETF focuses on holding common stocks with higher-than-average dividend yields. The fund currently offers a yield of around 2.7% -- more than double the average yield of the S&P 500, which has hovered recently around 1.2%.
To put that into perspective, a $1,000 investment into this ETF would generate about $27 of dividend income each year. That compares to around $12 of dividend income for an ETF that tracks the S&P 500. This ETF provides that higher income stream at a low cost. Its expense ratio is 0.06%, meaning it charges investors $0.60 of fees annually for every $1,000 invested in the fund.
The fund's portfolio currently includes 536 stocks, but with heavier allocations to its top holdings. The five largest positions are:
- Broadcom (4.4% of the fund's assets): 1.3% dividend yield.
- JPMorgan Chase (3.6%): 2% yield.
- ExxonMobil (3%): 3.4% yield.
- Home Depot (2.2%): 2.1% yield.
- Procter & Gamble (2.2%): 2.3% yield.
Those top five account for more than 15% of its total assets. However, it's worth noting that these are some of the highest-quality dividend stocks in the world. They have long streaks of growing their payouts and have strong financial profiles.
That dividend growth is important. It has enabled the fund to distribute more income to investors each year. In addition, the fund's price has trended higher fairly consistently over time.
While that past performance is no guarantee that the fund will continue to generate growing streams of dividend income, its higher concentration in the highest quality, high-yielding dividend stocks bodes well for the future. It should be able to provide investors with a rising income stream while also increasing the value of their investment.
A higher-yielding, relatively stable income stream
The iShares Preferred and Income Securities ETF holds preferred stocks and hybrid securities. These investments behave like a combination between a bond and a stock. They tend to have higher fixed payouts, and they are riskier investments than bonds but not as risky as common stocks.
This ETF has a yield of around 6% -- much higher than the Vanguard fund -- and makes its distributions monthly. Its expense ratio is higher, too, at 0.46%.
The fund currently has 441 holdings -- mostly positions in preferred stock issued by leading financial institutions such as Wells Fargo, Citigroup, and JPMorgan. Financial institutions make up nearly 75% of its portfolio. The fund also holds preferred and hybrid securities from industrial companies (nearly 16%) and utilities (almost 10%).
The fund's monthly payments tend to be relatively stable.
Likewise, as the chart shows, the fund's price also tends to be relatively stable. Changes in interest rates are the main factors that impact its price. As interest rates rise, the values of the fund's holdings tend to decline, which increases the income yield. That's because preferred stocks have higher risk profiles than bonds. Their higher yields compensate investors for taking on that greater risk.
Purely passive income
The Vanguard High Dividend Yield ETF and the iShares Preferred and Income Securities ETF are ideal for generating passive income. The Vanguard High Dividend Yield ETF offers a steadily rising income stream, while the iShares Preferred and Income Securities ETF supplies a higher-yielding, relatively fixed stream of passive income. The funds can be a great income-generating tandem.
