ETFs for Income.
Years of near-zero interest rates have crushed the income that can be achieved from traditional sources.
ETFs that deliver good dividend yield could be just the answer for those looking to take advantage of pension freedoms and generate income in retirement.
Some investors buy individual shares for income believing they can cherry pick but studies have shown most will fail to beat their benchmark.
Buying a large portfolio of blue chip stocks can be costly due to multiple trading fees and stamp duty and is not as diversified as an index tracker, and whilst actively managed income funds deliver diversification, most will not beat the market and annual management fees are steep.
Income investment trusts are popular but often trade at a premium or a discount to the value of their holdings which means you might pay over the odds to buy into a trust, or to sell it for less than it’s worth.
ETFs for Income
A portfolio of well-chosen ETFs that invest in different categories of income paying shares (or other assets, like government bonds) may offer the best all-round income solution.
With just a handful of ETFs, you can build a diverse income portfolio, with less risk and because fees are much lower than those of an actively managed fund, you’ll retain more of your income to reinvest or to spend.
Understand your ETF
ETFs divide between those that reinvest income for capital growth and those that distribute and even among ETFs targeted at income seekers there are choices, so it is important to understand the methodology of the products you select.
Many ETFs pay a dividend income – including many not specifically aimed at income seekers such as a FTSE 100 or MSCI World ETF.
Dividend yield is a critical factor in determining an ETF’s potential for income and relates the income paid out by an ETF to its share price:
Dividend yields might refer to the historic yield, based on the past 12 months, or the current yield, which is based on a forecast of the next 12 months’dividends – a good estimate for future distributions is the dividend of the past 12 months.
As prices fluctuate, the absolute annual distribution provides information about the consistency of the dividend.
When investing for future income, the current/forecast yield is a key indicator which can only be a ‘best guess’, rather than the more certain return from bonds or a fixed-rate cash savings account.
A high dividend yield is not always the best investment, even for income seekers, if the security of the income is uncertain, or if it’s too volatile.
Remember too that income is only one component in the potential gains from shares.
A lower yielding ETF might hold companies that attract investors for reasons other than income, and so could outperform in total return terms.
Nevertheless, the current dividend yield is a good starting point for finding interesting ETFs for an income portfolio.
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