There are simple and complex ways to generate income. If you buy exchange-traded funds (ETFs), you can hand off much of the work while still mixing simple and complex strategies as you look to build your income portfolio. On the "simple" side of the equation, a great option is Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD). On the "complex" side, you might consider covered-call writing Amplify CWP Enhanced Dividend Income ETF (NYSEMKT: DIVO).
Here's a quick look at these two ETFs.
1. Schwab U.S. Dividend Equity ETF: High quality and high yield
The Schwab U.S. Dividend Equity ETF starts its stock screening process by limiting itself to only those companies that have increased dividends for at least 10 years. Real estate investment trusts (REITs) are eliminated from consideration. This approach inherently focuses the selection process on financially strong businesses. That, however, is just the first cut to create the pool from which the ETF selects its final portfolio of 100 stocks.
The next step takes things way deeper, as this dividend equity ETF creates a composite score for each potential investment. The score compares cash flow to total debt, which highlights financial strength. It looks at return on equity, which identifies companies producing strong results. It ranks each company's five-year dividend growth rate, which highlights both financial strength and income growth potential. And then it adds in dividend yield. The top-100-ranked stocks make it into the portfolio, weighted by market cap.
All in, Schwab U.S. Dividend Equity ETF is a good way to focus your portfolio on financially strong high-yield companies without having to do all the work yourself. The ETF charges an expense ratio of just 0.06% for all of that work, and it offers a trailing dividend yield of around 3.4%. You can get higher-yielding dividend ETFs, but the added quality focus here sets Schwab U.S. Dividend Equity ETF apart from the pack.
2. Amplify CWP Enhanced Dividend Income ETF: How you would do covered calls
Amplify CWP Enhanced Dividend Income ETF uses a far more aggressive approach: covered calls. Only experienced investors should try their hand at covered calls, which can be pretty tricky to work with. Or you can just hire someone else to generate income with covered calls for you, which is what Amplify CWP Enhanced Dividend Income ETF offers.
There are some ETFs out there that handle covered calls in a programmatic fashion, which is fine. But that's not how most investors would go about selling covered calls if they did it on their own. (A covered call gives the buyer the right, but not the obligation, to purchase stock in the future.) Amplify CWP Enhanced Dividend Income ETF takes a different approach, actively building a portfolio and selectively selling covered calls against the portfolio.
There's no formula to explain the stock selection process here other than that Amplify CWP Enhanced Dividend Income ETF tends to buy high-quality dividend stocks. Management then looks to strategically sell covered calls on the stocks it owns. The goal is to generate income from the covered calls in a way that creates attractive risk-adjusted total returns over time. The trailing dividend yield is 4.5% today.
The one drawback here is the cost, as the ETF has a fairly high expense ratio of around 0.56%. However, given the hands-on nature of the approach, that's not surprising or outlandish. And you have to balance the cost against the fact that the ETF can provide an attractive flow of monthly income for you to live on in retirement -- without the necessity of doing all the extra work of selling covered calls yourself.
A strong pair of income-producing ETFs
If you are a conservative investor, the obvious pick here would be Schwab U.S. Dividend Equity ETF. It has a clear approach that is focused on mixing quality and yield. For more aggressive types, adding in Amplify CWP Enhanced Dividend Income ETF can add a little bit more yield with an approach that would mimic what you would do if you tried to sell covered calls on your own. Taken together, this pair would provide a solid, low-effort income foundation for your portfolio.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
2 High-Yield Dividend ETFs to Buy to Generate Passive Income was originally published by The Motley Fool