I want to become financially independent. My core strategy is to grow my passive income so that it will eventually cover my recurring expenses. To reach that goal, I'm taking a multipronged approach that includes investing in dividend stocks, exchange-traded funds (ETFs), and real estate.
I'm loading up on several dividend ETFs to grow my passive income, including JPMorgan Nasdaq Equity Premium ETF (JEPQ +0.39%), SPDR Portfolio High Yield Bond ETF (SPHY +0.30%), and iShares Core U.S. Aggregate Bond ETF (AGG +0.23%). Here's why I like this trio for passive income.
A premium income stream
JPMorgan Nasdaq Equity Premium ETF takes a unique approach to generating income. The fund writes out-of-the-money call options on the Nasdaq-100 Index. That strategy generates options premium income each month that the ETF distributes to investors.
That income has really added up over the past year. The ETF's dividend yield over the last 12 months is 9.5%. That's a higher yield than U.S. high-yield junk bonds (7.9%) and the U.S. 10-year Treasury bond (4.4%). However, the payments do ebb and flow based on the options premium income the fund generates, which fluctuates with volatility.
In addition to income, this fund offers price appreciation potential. The ETF also holds a portfolio of stocks the managers select based on data science and fundamental research. The fund's price rises as that equity portfolio's value increases. Because of that, the fund offers the best of both worlds: high income and upside potential.
Turning junk into income
SPDR Portfolio High Yield Bond ETF provides exposure to the high-yield (junk) bond market. These bonds have sub-investment-grade bond ratings because the companies issuing this debt have weaker financial profiles. That puts these bonds at high risk of default.
This fund holds a large basket of these bonds (over 1,900) diversified across sectors, issuers, and maturity. That diversification helps reduce the default risk. If an issuer defaults on its bond, it won't have a major impact on the ETF. Meanwhile, even if a severe market downturn negatively impacted financially weaker companies, the overall diversification of the fund should help mute the impact on ETF investors.
Investors get paid well to assume the higher risk profile of these bonds. The fund has a distribution yield currently above 7%. While the monthly distribution payments fluctuate based on interest payments received, the fund offers a relatively steady passive income stream.
Lower risk income
The iShares Core U.S. Aggregate Bond ETF focuses on the other side of the bond market: investment-grade bonds. These bonds have a lower risk of defaulting, making them ideal for those seeking a very low-risk income stream.
The ETF primarily holds U.S. government-backed debt, like treasuries and mortgage-backed securities (nearly 70% of its holdings). Its remaining holdings are from industrial, financial, and utility issuers. The fund currently holds over 12,000 bonds.
Given the lower risk profile of its issuers, the fund has a lower yield. Over the trailing 12 months, its yield has averaged 3.6%. The yield has trended higher in recent months (4.3% yield last month) as lower-yielding bonds mature, and the fund adds in higher-yielding bonds thanks to the currently higher interest rate environment.
While the income payments will vary from month to month, this ETF should generate a relatively steady fixed-income stream thanks to the low-risk profile of the bonds it holds.
Enhancing my income
I like to use ETFs to add different sources of passive income to my portfolio to increase the overall diversification of my income. This trio of ETFs provides income from options, junk bonds, and investment-grade bonds. That helps increase my income and reduce my risk. I plan to continue loading up on these and other dividend ETFs in the future to help me steadily march toward my goal of financial freedom through passive income.
