The Index Fund I’d Buy Today If I Wanted Decades of Passive Income

A high yield today might look attractive, but the real question is whether it can last.

For individual companies, you can check that by looking at the payout ratio. That tells you how much of earnings, or in some cases free cash flow, is being paid out to shareholders. If that number is too high, the dividend may not be sustainable.

With exchange-traded funds (ETFs), it gets a bit trickier.

If you see a yield creeping into the double digits, it could involve leverage or covered call strategies. Those can boost income in the short term, but they also introduce more complexity, higher fees, and greater risk during market downturns.

If your goal is simple, steady income that you can rely on over decades, then sustainability matters more than chasing the highest yield.

That is where the iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (TSX: CDZ) stands out.

What is CDZ?

CDZ is a passive ETF that tracks an index focused on dividend growth. Specifically, it holds a portfolio of 96 Canadian companies that have increased their dividends for at least five consecutive years.

That five-year threshold is important to understand. The term “Dividend Aristocrats” is often associated with U.S. companies that have raised dividends for 25 straight years. That definition is tied to the S&P 500 and reflects the much larger U.S. market.

Canada simply does not have enough companies with that kind of track record to build a diversified ETF. Lowering the requirement to five years allows the index to maintain breadth while still focusing on companies with a demonstrated commitment to growing their payouts.

The facts on CDZ

Even though the ETF focuses on dividend growth rather than yield, the income is still meaningful. On a trailing 12-month basis, the yield sits at about 3.3%, and distributions are paid monthly.

From a tax perspective, the income profile is also fairly clean. Looking at recent distributions, most of the income comes from eligible Canadian dividends, with smaller portions from capital gains and return of capital. There is little exposure to ordinary income or foreign income. That makes it relatively tax-efficient, particularly in taxable accounts, though that matters less inside a TFSA.

That said, the ETF is not without drawbacks. The most obvious one is cost. With a 0.66% management expense ratio, it is more expensive than many plain vanilla index ETFs. That fee reduces both the income you receive and the total return over time.

Still, if the goal is dividend sustainability, this ETF does a solid job of delivering on that objective. Reinvesting a growing stream of dividends year after year can be a powerful way to build wealth. Over the past five years, the ETF has delivered an annualized return of 12.3%, showing that this approach can work in practice.

The post The Index Fund I’d Buy Today If I Wanted Decades of Passive Income appeared first on The Motley Fool Canada.

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More reading

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• How to Build a $50,000 TFSA That Pays You Consistently

Fool contributor Tony Dong 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.