While passive income is far from a new idea, the term has only recently gained much attention ever since the world has been flooded with books, articles, documentaries, and videos on the topic. The promise of ‘retire early’ naturally makes people excited about the concept, but many ignore the fact, that it is easier said than done. Unfortunately, most suggestions found online simply do not work. In this article, our team set out to showcase some ways that are sure not to disappoint and will help you reach your goal of financial freedom.
Dividends for passive income?
Creating an investment portfolio containing companies that pay higher than average, constantly growing dividends seems like the ideal solution for people with some money to invest in their future financial freedom. But the reality is that most will not be able to pick the right companies to build such a portfolio and even if they do, amateur investors tend to buy and sell their holdings at the worst possible time. We are not saying it is not possible to create an income-focused investment portfolio that will help you retire early, but the reality is that if you are unwilling to dedicate a substantial amount of time to learning, you’ll likely fail.
Invest in high dividend, income-focused ETFs
Investing in ETFs is a much simpler, more tax-efficient, and lower-cost solution than picking stocks one by one. ETF stands for Exchange-Traded Fund and as the name implies contains funds that usually track specific indexes. By buying an ETF, you receive a bundle of assets, which will give you exposure to a well-diversified collection of assets. ETFs are historically less volatile and considered lower risk compared to most other investment alternatives. While most of these Exchange-Traded Funds focus is usually not on providing monthly or quarterly income, there are some that reward you with a hefty yield while also increasing the value of your original investment.
Why invest in covered-call ETFs
These types of ETFs write call options on their portfolio to reduce downside risk and volatility. Covered-call options funds are created for people who value receiving regular income, ‘dividends’ from their investment. Although, by doing so, some growth potential is sacrificed, the regular and reliable income that it provides more than makes up for it in many people’s eyes. Many of these pay monthly or quarterly and are historically less volatile than most other types of ETFs. To help you pick the right one for you, in the next following section, we’ll list some of the best income-focused ETFs.
Which covered-call ETF to choose: QQQX vs. QYLD
Global X Nasdaq 100 Covered Call ETF (QYLD)
QYLD is without a doubt one of the most popular ETFs among income-focused investors. Its portfolio comprises about 100 companies with a heavy focus on the technology sector (50% of its stocks). It was created in 2013 and has been making monthly distributions for about 8 years now. Its 12-month trailing yield currently stands at 13.78%. The fund manages over $7 billion with an extremely low fee of 0.6%. While its ‘dividend’ has been higher than most alternatives, the capital gains have been lacking compared to others like the QQQX. You should choose this fund if you value higher regular income, and you see capital gains as secondary.
Nuveen Nasdaq 100 Dynamic Overwrite Fund (QQQX)
QQQX is another popular alternative managing over $1 billion with a fee of 0.9% (0.3% higher than QYLD). With about 150 holdings, its portfolio is more well-diversified than QYLD while still leaning heavily towards tech giants like Apple, Microsoft, and Amazon. Since its focus is on providing high total returns (capital gains + distributions), the ‘dividend’ has been lower than QYLD, currently sitting at about 7-8%. That said, regarding both capital gains and total return, it has been doing better than its popular counterpart. You should choose this fund if you value higher capital gains, and you see regular distributions as secondary but still important.
Where to buy the index?
There are multiple options, but not many smart choices. Many so-called discount brokers offer amazing rewards to people opening new accounts and also provide substantially lower fees than some of the major brokerage firms. BUT, there have been several instances when newer, smaller firms went bankrupt with clients losing almost all their investments. Since fees are not a major concern when buying ETFs while security is probably the number one, we wouldn’t even consider small firms, regardless of the cost advantages. Out of the major players, the clear winner in our eyes is Interactive Brokers which is the leading online trading solution for investors all over the world. It provides direct instant access to stocks, options, futures, currencies, bonds, and also to our article’s main focus, funds (ETFs) as well. It also has licenses from multiple top-tier regulators and is considered one of the safest if not the safest option when it comes to choosing a broker. In the extremely unlikely scenario that the broker goes bankrupt, client securities accounts are protected by the Securities Investor Protection Corporation for a maximum coverage of $500,000.
Consider reinvesting the dividends – the magic of compound interest
Reinvesting your dividends can significantly boost your investment returns due to the compounding effect. Below we show a hypothetical scenario where we look at what would have happened if you had invested $10.000 in QQQX in 2012. It shows how much you would have made with and without reinvestments and also compares the results to the performance of NASDAQ.
As clearly seen above, reinvesting the dividends can make a major difference. Instead of $34.035 we could have pocketed $46.649 – which is a 37% difference – if we had let the compound effect do its magic. That said, looking at how NASDAQ did in the same period, it is clear that it would have been smarter long-term just to invest in the index following NASDAQ that does not apply the covered call strategy to provide regular dividends.
Conclusion
Picking individual stock to outperform the market is extremely difficult and most will fail trying to do so. If you are still committed despite the considerable amount of time and energy needed to be successful at it, check out The Falcon Method for educational guidance and stock picks. If you don’t wish to dedicate much of your time learning about investing, you should consider investing in ETFs. If your primary goal is gaining passive income, QYLD is probably a good one for you. In case you wish to focus on capital gains and do not need regular income from your investment, ETFs following NASDAQ or S&P 500 are probably the best pick. The middle-ground solution is QQQX which can provide decent dividends with fairly good capital gains potential.
Be aware: all types of investments carry risks, we have just gathered the opportunities to earn passive income in a fully transparent a legal way, but you must proceed with due diligence!