I’ve always been a fan of ETFs (Exchange Traded Funds) because I think they give me “more bang for my buck”. They allow me to invest in multiple companies in a single fund and are usually low cost. However, I have also recently been thinking that high-dividend-paying ETFs could be the easiest way for me to earn passive income.
An ETF is a fund that tracks an index or sector and can be bought and sold like a share through most online brokers.
The thinking goes that if I can find a well-diversified, low-cost ETF paying a healthy dividend then this could truly be a way for me to earn some passive income. Passive income can be thought of as regular income from an asset, like a share, that requires little effort or maintenance.
In this case I am looking for an ETF that will provide long-term dividend streams. There are a few options in this space but I was instantly drawn to iShares FTSE UK Dividend GBP UCTIS ETF (LSE: IUKD). This ETF aims to replicate the return in the FTSE UK Dividend + Index by investing in the 50 companies with the highest dividend yields in the FTSE 350.
There are a number of reasons for me to go straight to this ETF, including its low expense ratio at 0.40% good trading volume and its size as one of the largest ETFs in this category.
Diversification is good. The fund is comprised of 50 companies across several industry sectors, which should provide resilience in case any individual company falters. This is reinforced by a 5% cap on any individual company in the fund, helping to reduce the risk further.
That’s even before we come to the current dividend yield, which is a whopping 5.76%.
There are risks of course. Some of these high-dividend-paying companies will be mature, successful businesses that are great at generating free cash flows. However, some will feel they have to maintain high dividends to keep their investors happy when the company is not growing. In the long run, companies like these are unlikely to be successful.
At the outset, the long-term performance does not look good and over five years the share price has fallen about 15%.
Firms that are in this ETF and can pay good dividends tend to be more established companies in traditional sectors. For a few years now, money has tended to move out of these into high-growth sectors like technology.
However, that performance excludes the dividends, which when included shows that a five-year investment into this ETF would have made a healthy total return.
That leads me back to the beginning. Is this ETF one of the easiest ways to earn passive income right now? For my portfolio, I believe it probably is, but I am not going to invest. Yet.
For me, I am in the prime of my working life and (hopefully) have many more years of working ahead of me. In this case, I am leaning towards forgoing the passive income stream in favour of focusing on high-growth companies in high growth sectors. However, as I approach retirement, I will definitely look at this ETF further!
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Niki Jerath has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.