Why I Avoid Covered Call ETFs
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One of the coolest things about having a YouTube channel is the constant influx of questions I get about different stocks and ETFs. Not only does it expose me to new stocks I might not have discovered on my own, but it also gives me plenty of practice analyzing them.
Interestingly, some of the most frequently asked questions I get are about covered call ETFs, specifically JEPI and JEPQ. They have become quite trendy among dividend and income investors over the past few years. These ETFs typically come equipped with high dividend yields, usually in the double digits, which understandably piques investors' curiosity.
I used to be curious about covered call ETFs too. In fact, I used to own JEPI and XYLD, another covered call ETF, for quite some time before I eventually sold them and decided to steer clear of covered call ETFs altogether.
Here’s why I came to that decision.
Reason #1: I’m more interested in investing in individual companies.
With individual companies like Visa or Proctor & Gamble, for example, I can understand their business models, what they sell, why I connect with them, why the customer connects with them, and I can use all of this information to analyze their potential to generate returns well into the future.
Overall, there’s just something more tangible about them that I think is missing from covered call ETFs. Those don’t sell products or services, don’t generate cash flows, and aren’t the living, breathing entities that individual companies are.
At this point in my investing journey, I don’t want to put money into something so abstract. I’d rather invest in assets whose cash-flow comes from the strong operational performance of the business rather than something that generates income from derivatives.
For me, this is just more straight-forward.
Reason #2: I'm unsure about their long-term viability.
Most of the popular covered call ETFs are relatively new. JEPI was launched in 2020, JEPQ in 2022, and new ones seem to pop up every single day. As a result, it’s hard to gauge how these funds might perform over an extended period of time.
One of the earliest covered call ETFs, QYLD, has been around since 2013, leaving us with a 10-year track record to analyze. Over that time, its total returns have substantially underperformed the broader market, and its dividend payments, while fluctuating (this is natural for covered call ETFs since they all pay variable dividends), have generally trended slightly downward.
Source: Seeking Alpha
I try to look for investments that can potentially offer suitable total returns with growing dividends over time, and I’m not seeing that trend with many covered call ETFs, save for a couple.
This is another reason why I’ve decided just to avoid them altogether.
So, should you avoid covered call ETFs?
It’s hard to say definitively, but they're not all bad. The total returns from both JEPI and JEPQ (which seem like two of the better funds out there) have been respectable in their relatively short existence.
JEPI is barely trailing the S&P 500 over the last three years, while JEPQ is actually outperforming it. Plus, you’d have received much more dividend income compared to the S&P 500 during this time.
Source: Seeking Alpha
With that said, how these funds will perform over the long haul remains to be seen. Time hasn't been kind to QYLD, and it might not be kind to newer covered call ETFs either.
Overall, avoiding them altogether is just my preference, at least for now. If I were closer to retirement and more focused on maximizing my current passive income, I might feel differently.
Until then, I’m enjoying the process of learning more about individual companies, honing my skills as an investor, and continuing to build out my collection of stocks with the companies that resonate with me the most.
With that said, I want to hear from you: Do you own any covered call ETFs? Write to me here and let me know.
And if you're interested in learning more about the pros/cons of covered call ETFs, like JEPI, check out this video here.
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IN MY PORTFOLIO 📈
Portfolio performance provided by Snowball Analytics
ICYMI 🎥
The Stock Market Is MELTING - 3 Dividend Stocks I’m Buying
Earlier this week, we saw a huge stock market sell off. While it can be gut-wrenching to see your dividend stocks take such a big hit in a short amount of time, this situation can be beneficial for dividend investors.
In this video, I’ll explain why and I’ll share three dividend stocks I plan to load the boat on if the stock market meltdown continues to get worse.
CAREFULLY CURATED 🔍
📺 SCHD vs VOO - As a dividend investor, is your ultimate goal to beat the market, or is it more about generating a steady stream of passive income each month? Can you potentially have both? This video explores these questions while comparing SCHD and VOO to see how they measure up against these different objectives.
🎧 Terry Smith on Compound Interest - This was a fantastic interview with Terry Smith, often referred to as the British Warren Buffett, who talks in-depth about his investing strategy and the magic of compound interest.
📚 Why VICI Is Deep Value - As a Las Vegas local and with VICI Properties (VICI) being the latest addition to my portfolio, I'm extremely bullish on this company. Who better to learn about it from than Howard Jay Klein, who has spent 30 years as an executive and consultant in major casino operations like Bally's and Caesars Palace in Vegas?
SINCE YOU ASKED 💬
"Does stock price, whether ETF or individual stock, matter when choosing what to invest in? Is it better to buy more shares with lower price stock (say below $50/share) vs. a stock that is $200+ per share?"
- @TitleWaive1 | YouTube
Truth be told, a stock's share price doesn't really matter, and it doesn't tell you anything about the quality of the investment.
In other words, a $200 stock isn't necessarily a higher-quality investment than a $50 stock. The share price alone isn't a useful metric for comparing two different companies; it only affects the number of shares you can buy.
For example, if you have $1,000 to invest, you could purchase 20 shares of a $50 stock or 5 shares of a $200 stock. However, the fact that you can buy more shares of the $50 stock doesn't make it the better investment.
Ultimately, the total amount invested is the same, and you'd much rather have that money in whichever company is the higher-quality.
For a real-life example, let's compare Visa (V) and Walgreens Boots Alliance (WBA). As of now, Visa is priced at about $267 per share, while Walgreens is priced at around $11.50 per share. With $1,000 to invest, I'd much rather own only 3.74 shares of Visa than 86.9 shares of Walgreens.
Owning more shares of Walgreens might feel more impressive, but it's the same amount invested either way. It's far more important to own the higher-quality business, which in this case, is undeniably Visa (at least, in my opinion).
Have a question? Ask me here to see it featured in an upcoming newsletter.
HOT TAKES 🔥
Last week, I asked readers which stocks they have their eye on for the month of August. Here are some of the responses:
Matt said: I’m looking at buying HSY, V, and maybe PPG.
Graham said: My August pick has been on my watchlist for a couple of years but never got around to them. That company is Prologis Inc (PLD) which is by far the largest REIT by market cap. Realty Income is less than half their size, and the next closest is ⅔ their size.
Caden said: LW took a big hit last month. French fries aren’t going anywhere. I might start adding soon.
LAST WORD 👋
On my honeymoon a couple of weeks ago, I read The Ownership Dividend by Daniel Peris.
The book explains how and why the stock market shifted from a system focused on cash-based returns (dividends) to one driven by short-term share price movements. In a nutshell, the author points to a 40-year drop in interest rates and the rise of buybacks as the culprit, and argues that these forces are now largely exhausted.
As a result, he forecasts that the market is set to return to the more typical business-like relationships seen in the private sector and other mature markets worldwide, where investors and owners opt for a consistent cash return instead of relying on appreciation.
At any rate, this was one of the most interesting books I've read in a while, and I have a ton of book notes to log in my Investors Almanac. I think this is an essential read for every dividend investor, with many great takeaways that got me excited about the potential changes in the stock market if this paradigm shift unfolds as the author describes.
If you want to read it yourself (it's a quick read...less than 170 pages), you can get the book here.
