Income Investors Will Love These Funds
According to a recent SoFi poll, of the five most popular investments right now, exchange-traded funds (ETFs) ranked last with only 21.1% of investors owning shares. The number one reason? They didn’t know enough about them.
Here are the results:
- Stocks: 53.7%
- Crypto: 44.1%
- Mutual funds: 38.2%
- Bonds: 26.6%
- ETFs: 21.1%
That struck us as odd, since ETFs are just funds that pool investors’ money and offer shares that mirror broad indexes like the SPDR S&P 500 ETF (SPY), hold assets (like physical gold ETFs) or feature baskets of stocks often spread across an industry, like the First Trust Global Wind Energy ETF (FAN).
Yes, its ticker is actually FAN.
The idea is that with diversified holdings, investor risk is reduced by spreading the investment out among various companies while simultaneously broadening your exposure to numerous companies. Some are actively managed. Some are passively managed. Some are tied to indexes, and some are thematic.
Regardless of how they’re structured, ETFs offer an alternative to investors who are hesitant to buy individual stocks because of justifiably low risk tolerances.
People work hard for their money. Well, most people. Some are gifted $413 million from their parents, file for bankruptcy six times and then become president on the basis of their stellar “business acumen.” But if you stop buying Starbucks and avocado toast and cut your Netflix subscription, yOu CaN tOo!
For the rest of us, allocating our hard-earned cash to a publicly traded company can feel like putting all our chips on black and hoping for the best. And while we’re not comparing the market to roulette, we’re cognizant of investing-induced anxiety.
ETFs can help alleviate that anxiety by providing exposure to an array of financial assets (e.g., stocks, bonds, commodities, etc.) without having to fret about which individual stocks, bonds or commodities to invest in.
But before we get to examples, we need to discuss the importance of …
Expense Ratios
These are the fees ETFs charge to cover administrative, management and marketing expenses.
For simple math, if you invested $1k in an ETF with a 1% expense ratio (unwise), you’d be charged $10 annually. Ten bucks isn’t breaking the bank, so you might be wondering why we said it’s not advisable.
Generally, you should avoid ETFs with expense ratios of 1% or higher, as over time, they can erode growth potential. The industry average is 0.47%, and for ETFs that pay dividends (which we’ll get to shortly), expense ratios can be offset by monthly or quarterly yields.
That’s one reason why the ~79% of you who aren’t investing in ETFs might want to reconsider.
Explosive Growth
According to Statista, the number of ETFs has grown markedly from just 276 in 2003 to 8,754 in 2022.
Why the surge in popularity? Thematic ETFs offer investors something other equities cannot: broad industry exposure via a basket of stocks with reduced risk due to diversified holdings.
So if you’re interested in a niche market segment but can’t decide on which company to invest in, rest assured, there’s no shortage of ETFs:
- Artificial intelligence: AI Powered Equity ETF (AIEQ)
- Cybersecurity: Global X Cybersecurity ETF (BUG)
- Home construction: iShares US Home Construction ETF (ITB)
- Food and agriculture: VanEck Future of Food ETF (YUMY)
- Electric vehicles batteries and metals: Amplify Lithium & Battery Technology ETF (BATT) and Global X Lithium & Battery Tech ETF (LIT)
- Solar energy: Global X Solar ETF(RAYS)
- Nonrenewable energy: Energy Select Sector SPDR Fund (XLE)
- Gold: SPDR Gold Trust (GLD)
In fact, there are so many ETFs, some are categorically comical:
- Weight loss treatment: The Obesity ETF (SLIM)
- Generational consumerism: Global X Millennial Consumer ETF (MILN)
- Video games: Wedbush ETFMG Video Game Tech ETF (GAMR)
- Space commercialization: Procure Space ETF (UFO)
The list could go on and on, but you get the picture. If there’s a market segment worth capitalizing on, there’s an ETF for it.
However, as wide-ranging as they are, today we’re focusing on income investing. Specifically …
3 ETFs With BDE (Big Dividend Energy)
As we pointed out two weeks ago, just because you can invest in something doesn’t mean you should. We’re looking at you, Bitcoin-leveraged ETFs.
Just like any other asset class, not all ETFs are made the same. First, some have untenable expense ratios when juxtaposed with their performance. Second, not all of them pay dividends.
For income investors, that last point is critical because of the thousands of ETFs, not all produce reliable let alone remarkable yields. Today, we’re highlighting three that do.
No. 1: Pacer U.S. Cash Cows 100 ETF (COWZ)
This ETF’s holdings focus on qualifying companies generating strong cash flow. Why’s that important? Because cash flow is what’s left after companies pay expenses, interest, taxes and debt. And among other things it’s used to pay dividends.
By extension, the companies held in COWZ demonstrate solid financial well-being, which has resulted in one- and five-year gains of 10.76% and 70.12%, respectively.
The ETF’s currently trading at an absurdly cheap price-to-earnings ratio of 7.52. It pays a 2.09% dividend vs. a 0.49% expense ratio. Its market cap is $15.09 billion and among its top 10 holdings are oil giants Marathon Petroleum and Conoco Phillips, CVS Health and Big Pharma mainstay AbbVie.
COWZ’s last ex-dividend date was Sept. 21, meaning if you purchase it between now a late Q4, you’ll qualify for its first dividend payment of 2024.
No. 2: JPMorgan Equity Premium Income ETF (JEPI)
JEPI is an incredibly popular income-focused ETF given its current 9.78% yield vs. its low 0.35% expense ratio. It features a monthly disbursement, so despite it last going ex-dividend on Oct. 2, you’ll qualify for December’s distribution if you purchase shares before November.
With a market cap of $29 billion, it’s managed one- and five-year gains of 3.05% and 6.67%, respectively, on the backs of top 10 holdings including AbbVie, Amazon, Adobe, Comcast, Mastercard, Microsoft, Progressive and UnitedHealth Group.
JEPI’s currently trading at a fair P/E ratio of 23.32, and despite being down 1.98% year to date, it recently used support in the $52 area to bounce higher affording investors a decent entry.
No. 3: iShares iBoxx $ High Yield Corporate Bond ETF (HYG)
HYG’s one of the most widely used high-yield bond ETFs. It tracks the investment results of an index composed of U.S. dollar-denominated, high-yield corporate bonds.
It pays a dividend yielding 5.91%, significantly offsetting its 0.49% expense ratio. The fund’s market cap is $15.55 billion and it boasts an incredibly low P/E ratio of 9.1
Among its top 10 holdings are Ford Credit (the financial services arm of Ford Motor Company), Tenet Healthcare (the third-largest hospital company in the U.S. and the largest operator of outpatient surgery centers) and large cap aerospace company TransDigm.
The ETF’s produced a one-year gain of 1.4% and a five-year loss of 14.31%. It’s notable that, due to high interest rates, panicky investors recently pulled billions of dollars out of high-yield bond funds like HYG.
“The outflows are being driven by investors’ worries that the recent spike in long-term interest rates might derail the economy, leading to higher rates of default by lower-rated bond issuers,” ETF.com analyst Sumit Roy said.
However, HYG — which tracks corporate credit — could be looking at a bottom if the chatter about the Federal Reserve ending or reversing its rate-hike cycle in 2024 holds true.
Bank of America recently revised its 2023 corporate bond fund projection to an 8% gain, and if inflation subsides next year, this ETF could prove to be a worthwhile watchlist candidate for income investors who have an appetite for elevated risk (and elevated yields).
TL;DR
The majority of investors shy away from ETFs because they lack an understanding of how they work. Once you learn how they can reduce risk and increase exposure, you should feel more comfortable investing in them. Be mindful of higher expense ratios, and if your goal’s income, research the three high-yield ETFs highlighted above.