A Blueprint for Finding Monthly Yield

11/15/2010 5:00 pm EST


Rob Carrick

Columnist, The Globe and Mail

Exchange traded funds have solved the predicament facing retirees who need investment income in a world of low interest rates, says Rob Carrick, columnist for The Globe and Mail.

Several ETFs in the Claymore and iShares families now provide monthly payments of bond interest and dividends. Combine them in the right way and you get a diversified retirement income portfolio with a yield above 4 percent.

Need a blueprint to show you the way? Then take a look at the Monthly Yield Portfolio developed by the ETF specialists at National Bank Financial. This portfolio is built using seven ETFs listed on the Toronto Stock Exchange, each of which makes monthly income payments.

The Monthly Yield Portfolio is cheap to own, with a total blended management fee of 0.45 percent. It’s also inexpensive to build. With online brokerage stock-trading commissions as low as $5 to $10 these days, you could conceivably assemble the Monthly Yield Portfolio for between $35 and $70 (if you pay the top $29 commission, the cost is $203).

You can get the lowdown on broker commissions in the 12th annual Globe and Mail ranking of online brokers, published this week and available online (at http://tgam.ca/BFrA). ETFs are the perfect thing to put in your brokerage accounts, a point that many brokers are starting to recognize by building ETF research centers for their client websites.

ETFs are stocks that provide the return of a particular stock or bond index, minus fees. Think of ETFs as building blocks that can be assembled in any number of ways to accomplish different investing tasks.

The Monthly Yield Portfolio was developed to address the problem of generating investment income at a time when a five-year Government of Canada bond yields about 2 percent and the best five-year term deposit rates run from 3 to 3.6 percent.

“Everybody wants yield, but in today’s market it’s hard to find,” said Pat Chiefalo, an ETF specialist at National Bank Financial.

Not just income, but monthly income. It’s much easier to manage your cash flow as a retiree if you’ve got investment income coming in each month, rather than every quarter or semi-annually. Many mutual funds pay income monthly, and now ETFs are starting to do the same.

Blended together, the ETFs in the Monthly Yield Portfolio produce a flow of cash with a yield of about 4.4 percent. This is achieved by judiciously mixing ETFs based on dividend stocks with bond ETFs. The overall mix is 33.7 percent government and corporate bonds, 11.3 percent preferred shares, 44 percent dividend stocks and the rest in real estate investment trusts and high-yield bonds.

Taking on a Little Risk Is Still Required

The heavy weighting in dividend stocks means this isn’t a portfolio for people who take the zero-risk approach to investing. You have to be comfortable with the stock market, although the focus is strictly on blue-chip stocks.

“The only equities we use are well-established dividend paying stocks, Canadian, US, and foreign,” Mr. Chiefalo said.

The biggest chunk of the Monthly Yield Portfolio goes into the iShares DEX Universe Bond Index Fund (XBB), which is a vehicle for buying exposure to almost the entire Canadian bond market. About 70 percent of the underlying index is accounted for by government bonds, with the rest coming mainly from the corporate world.

Rounding out the fixed-income portion of the portfolio is the Claymore S&P/TSX Preferred Share ETF (CPD), which holds dividend-paying preferred shares. Some investment types see preferred shares as being stocks, while others lump them in with bonds when building portfolios because they’re strictly income-producing vehicles.

Exposure to dividend stocks comes through a pairing of the iShares Dow Jones Canada Select Dividend Index Fund (XDV) and the Claymore Global Monthly Advantaged Dividend ETF (CYH). The former covers off Canadian blue chips, with a heavy emphasis on the big banks, while the latter ETF has a big weighting in the United States and Europe.

A small 11-per-cent weighting in the portfolio has been given over to “alternative” investments, which in this case means real estate and high-yield bonds. The real estate exposure comes through the iShares S&P/TSX Capped REIT Index Fund (XRE). A pair of high-yield bond ETFs, one from iShares and one from Claymore, account for the small 5.6-per-cent weighting in high-yield bonds.

Mr. Chiefalo said his approach in designing the portfolio was to choose the highest-yielding ETF with monthly payouts. The two high-yield bond ETFs were very close in yield and different enough in their indexing style that including both was warranted. For both, the risk level will be on par with the dividend stocks in the portfolio. High-yield bonds are issued by financially weak companies—that’s why they offer such high yields.

Tax Implications

Tax considerations suggest the Monthly Yield Portfolio will work well in a non-registered account, where you can take advantage of the dividend tax credit on payments from the Canadian dividend stocks in XDV. Also, the Claymore global dividend and high-yield bond ETFs have been designed so that their cash payments are primarily a return of capital and capital gains. That should mean a lighter tax hit than if you received bond interest or foreign dividend income.

Though diversified by asset type, sector and geography, the Monthly Yield Portfolio will fluctuate in price. Rising interest rates will put downward pressure on the bond foundation of the portfolio, while a stock market correction would upset the dividend stocks.

As a result, a certain level of investing savvy is needed for this portfolio. You have to understand that fluctuations in the price of the securities you own have no direct bearing on the flow of monthly income you receive.

The smart way to run this portfolio is to arrange it so that cash is automatically transferred from your investment account to your chequing account each month. Focus on the income, not on the portfolio’s ups and downs.

National Bank Financial designed this portfolio for people who want a regular monthly flow of investment income. It's built entirely with exchange traded funds, which are index funds that trade like a stock. You'll need a brokerage account to buy ETFs.

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