Want Decades of Passive Income? Buy This ETF and Hold It Forever

I’m not too confident that a lot of these newer income ETFs with double-digit yields are going to hold up over time. In a bull market, sure. Covered call strategies can generate strong income because volatility is elevated and markets are rising. You give up some upside, but in exchange, you get those big distributions.

The issue is what happens when conditions change. These strategies are still relatively untested through a full cycle. If we get a real bear market, something like 2020, or worse, 2008, you could see income drop at the exact same time your portfolio is falling. That is not a great combination.

On the other hand, plain vanilla Canadian dividend ETFs have been around for decades. They are simple, transparent, and built on businesses that generate real cash flow. One of my favourites is the Vanguard FTSE Canadian High Dividend Yield Index ETF (TSX: VDY).

Over the past 10 years, with dividends reinvested, it has returned 13.7% annually. That is actually higher than the broader Canadian market, represented by the Vanguard FTSE Canada All Cap Index ETF (TSX: VCN) at 12.5%.

That kind of outperformance is not guaranteed, but it shows that dividend investing can work, if you’re smart about it. If the goal is to build decades of passive income inside a TFSA, this is one of the simplest ways to do it. Here are three reasons why.

Low cost matters more than you think

With dividend investing, fees matter more than most people realize. Every dollar paid in fees is a dollar that does not get reinvested or paid out to you as income. Over time, that compounds and drags on your total return.

That is why I tend to avoid higher-cost dividend ETFs. Some options on the market charge as much as 0.61% per year. That may not sound like much, but over decades, it adds up. VDY is much more reasonable at 0.22%.

On a $10,000 investment, that works out to about $22 per year in fees. It is a small number, but keeping costs low is one of the easiest ways to improve long-term outcomes.

A steady, above-average yield

The main appeal here is the income. On a trailing 12-month basis, VDY currently yields about 3.5%. The distribution is not fixed, since it depends on the dividends paid by the underlying companies.

But historically, it has been relatively stable and consistently above the broader market. Distributions are also paid monthly, which makes it convenient if you are using it for income.

Another advantage is tax efficiency. Because VDY excludes real estate investment trusts, most of the income comes from eligible Canadian dividends. That is one of the most tax-efficient forms of income in Canada.

Simple and hands-off

One of the biggest benefits of VDY is how easy it is to own. It tracks an index that holds about 56 Canadian dividend-paying stocks, with heavy exposure to sectors like financials and energy.

The index already applies its own screening rules, selecting companies based on dividend characteristics and weighting them accordingly. That means you do not need to pick individual stocks, rebalance your portfolio, or constantly monitor your holdings.

You simply buy the ETF. From there, you can reinvest the dividends to compound your returns, or if you are at that stage, withdraw them as passive income. For most investors, that level of simplicity is a feature, not a drawback.

The post Want Decades of Passive Income? Buy This ETF and Hold It Forever appeared first on The Motley Fool Canada.

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More reading

• What I’d Buy Instead of Chasing the Magnificent 7
• The 2% Monthly Income ETF That Canadians Should Know About
• 3 Canadian ETFs to Buy and Hold Forever in Your TFSA
• How to Budget for 30 Years of Retirement Without Running Out
• 2 Canadian ETFs to Buy and Hold in a TFSA Forever

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.