We get many questions on Berman’s Call from investors who are seeking a higher percentage of their returns from yield versus capital gains.
The main class of ETFs that fall into this group uses derivatives (options) and sometimes leverage to increase yields. Sometimes, the added yield comes at a longer-term cost. It really depends on your time horizon for the investment.
Take a person that just retired who is 65 years old. In Canada, a person who has lived to 65 is likely to live at least 20 more years, according to the actuarial tables. Children born today have a life expectancy of about 83 years. So my assumption is a 20-year horizon with capital preservation (no drawdown of principle). We are mostly using the BMO ETFs as they have the longest history for high dividend exposure and covered call exposure.
| Yield only (not total return) | Canada (ZIC, ZDV, ZWC) | U.S. (VTI, ZDY, ZWH) | Europe (VGK, ZWE) |
|---|---|---|---|
| Diversified dividend | 3.16 per cent | 1.46 per cent | 3.33 per cent |
| Concentrated dividend | 4.47 per cent | 2.88 per cent | 3.77 per cent |
| Covered call | 7.11 per cent | 5.37 per cent | 7.16 per cent |
Source: BMO ETFs, Bloomberg
Simply loading up your portfolio on the biggest yielding ETFs or stocks is not necessarily the best strategy. My general rule of thumb is that if you are bullish on the outlook for the asset class, then simply using a covered call ETF may not result in the best outcome. If you just focus on the yield, you can be misled.
In the U.S., the uncovered ETF during the past decade returned 0.90 per cent more than the covered call only. If you are a taxable investor, typically the extra income from the covered call overlay is on account of capital and has no withholding like the dividend does. It also depends on whether you are a trader of a long-term buy and hold investor and if you need the current income to live off.
In Canada, you get a benefit from the dividend tax credit and there is no withholding tax. But if you do not need the current income, buying a dividend-only ETF will provide a longer term after-tax return.
In Europe, there are withholding tax issues, but in general, European companies pay higher dividends than in the U.S.