The TRUTH About Covered Call ETFs (QYLD, JEPI, etc.) - Watch Before Buying
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- เผยแพร่เมื่อ 9 ก.ค. 2024
- Covered call ETFs own stocks, typically from some underlying index, and sell call options on them to generate income. Here I'll explain why they're probably not great investments for most investors.
// SUMMARY:
A covered call ETF may be suitable for your portfolio if you desire a yield-focused strategy for current income, with the trade-offs being greater fees (the average covered call ETF expense ratio is 0.71%), muted long term total returns, less diversification, lower portfolio efficiency, and possibly greater tax costs. Because of these things, recognize that it inarguably makes little sense for the young accumulator with a long time horizon to own a covered call ETF.
Novice investors seem to have this idea that the “income” from these expensive buy-write funds are free money and that selling shares of a low-cost index fund like VTI to realize gains of an equal amount is somehow inferior to receiving a monthly distribution. Neither of these things is true.
This irrational preference of dividends as income is just a well-documented - and admittedly understandable - mental accounting fallacy. Removing that high yield, the capital appreciation component of some of these funds has actually been negative since inception, as is the case for QYLD.
The promises and benefits touted by these funds and their supporters - such as greater Sharpe ratios - often don't hold water under the smallest amount of scrutiny, such as their objective inability to outperform the underlying index of their holdings even on a risk-adjusted basis, much less a better diversified portfolio across asset classes like a 60/40. Basically, in market downturns, a covered call fund will fall with the market by an amount precisely equal to the market's drawdown minus the income received from the option premium.
Don't succumb to mental accounting bias; the premium received doesn't mean much if the market crashes. At the end of the day, total return is what matters. Period. I suspect income investors who own these funds perhaps simply aren't being honest with themselves by selectively ignoring their long term total returns compared to a benchmark like the S&P 500 or 60/40 and instead are just focusing on that juicy monthly yield. Discussing and celebrating that yield, such as in dividend-focused communities on Reddit, usually just seem to be a clique of confirmation bias.
To be fair, covered call funds certainly aren't the worst way I've seen to try to generate income. So some small allocation to a covered call fund may be warranted for the income investor or retiree.
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What do you think of covered call ETFs like QYLD, JEPI, DIVO, etc.? Do you own any? Like, Comment, and Share with someone who owns covered call ETFs.
Expecting a barrage of dislikes and a dumpster fire of a comments section on this one. Stay safe out there.
can you make a video on Yieldmax funds such as TSLY and APLY. They promise 30-70% yield, i would like to know your thoughts.
There's no way those funds are sustainable. Use your brain, if it sounds too good to be true, it definitely is.
@@jackieboy1593 Poor person thinking.
@@Kinosis79 Have fun underperforming the market and performance chasing.
I own JEPQ for and it has been doing well so far.
Thanks for sharing!
I just wanted to say that this was great work. Your writing and analysis is always very strong, but the deeper, more investigative aspect of this one went above and beyond! I actually used to think that these might be viable income options in retirement, but this piece clearly demonstrates that is NOT the case!
Thanks so much for the kind words! Really glad you found the info useful! :)
@@OptimizedPortfolio Keep up the wonderful work! :)
@@OptimizedPortfolio Please do a video about the viability of SPYI which is quite different in that it uses a call spread approach. The NAV has not only held up very well but has been rising significantly.
@@djayjp Thanks for the suggestion!
Hello 👋. I got a question for you, so if I wanted to invest in Vanguard etfs, would I need to have a Vanguard brokeage account for that? Or could I just invest those in like a Fidelity account or Charles Schwab?
Can buy them at Fidelity and Schwab.
related to this: could you do a video/blog on closed end funds.
Thanks for the suggestion! Yep.
The "ouch" on taxable income was nicely timed.
😎
QYLD can work in a tax-free account in which you need a fairly fixed income (the income will fluctuate) wherein the steadiness of the lower income may be valued more than higher non-fixed income.
As shown, covered call funds really aren't much steadier than the underlying index they sell calls on. A well-diversified multi-asset portfolio would be "steadier."
Not a great investment but I lost my job and have a mortgage to pay 😅 So, will make these part of my portfolio
Thanks for sharing!
🚀In covered calls we trust🚀Just kidding not a fan of mental accounting either.
Haha love it!
Isn't the strategy for JEPI/JEPQ different than QYLD, in that they theoretically will track closer to their index?
Yes, slightly. JEPI also technically uses ELN's with covered call mechanics baked in.
@@OptimizedPortfolio JEPI only has 20% in ELNs, correct? That means 80% is fully exposed to the market. I think that's the bigger difference between QYLD and JEPI/JEPQ.
Nice place!
Thanks!
If we are in a long market downturn because of a looming recession, the political climate, inflation & interest rate fears, etc, expecting high market returns from the S&P 500 during such a time simply because of what it's done historically wouldn't seem too rational. Usually during such cycles it sinks (I've seen it happen repeatedly). Then when things change for the better you have to then wait for your mostly growth stock portfolio to 'catch up' to where it once was, which seems to take forever, and even when it does you're back to starting at square 1 and hoping there isn't yet another looming negative cycle right around the corner. Perhaps I'm naive, but a high yield ETF would seem a better alternative during such times because at least the yield would still be something *positive* on the balance sheet. Am I wrong?
Agreed. None of what I said is meant to suggest I'm just blindly expecting high market returns. Sort of the opposite. My position is that a diversified mix of stocks, bonds, and possibly even other diversifiers like TIPS, gold, or managed futures will usually be more efficient and more effective than a covered call strategy, even over short periods. My other main point is to remember that words like "yield" and "income" are just mental accounting; total return is what matters. Viewing one asset in isolation as "something positive on the balance sheet" is the quintessential example of this cognitive bias. View the portfolio holistically. We're interested in how each asset contributes to the risk/return profile of the portfolio as a whole, and adding covered calls almost never improves it, especially over long horizons.
@@OptimizedPortfolio Okay, but the portfolio you mentioned above with all those different investment vehicles is ridiculously complex for most people to try to put together and maintain (gold? futures? TIPS? maybe that's simple for you but for the rest of us not so much). And even a portfolio like that isn't going to be bullet proof. I've had diversified mutual funds with stocks, bonds, T-bills, etc which went right into the toilet during market downturns (the 'total return' was a total crap). I don't know what the answer is, and with a short time horizon not being certain is frustrating.
@@zacworld2061 I showed in my QYLD video how even the simplest naive mix of 50% stocks and 50% T-bills is probably better than a CC fund. I'd argue a CC strategy is much more complex. Once again, the CC fund will fall right along with the market. Nothing is certain in investing. People can also easily "put together" a lazy portfolio or a target date fund once and not really have to do any "maintaining."
@@zacworld2061 It's actually way easier than it sounds, especially with M1 that does auto rebalancing. There's an ETF for each, simple.
Covered calls have been a great place the last 6 months in a registered account, almost time though for the next leg down
Indeed, these funds have looked pretty good recently with what markets have been doing.
I understand the long-term downside of covered call ETFs. I have JEPI and JEPQ in a few accounts. I started investing outside my 401k at the very end of February. If you look at JEPI and JEPQ from 3/1 to today you will see it's performing quite well compared to the S&P and Nasdaq. JEPQ is identical to QQQ and JEPI is slightly lower than the s&p for total return. Given this trend, I am going to start to DCA into the QQQ from JEPQ and JEPI to SCHD. How would you distribute each if you had 10k of each into other funds or stocks?
It would be more appropriate to compare a covered call fund's risk/return profile to a diversified mix like a 60/40, not 100% stocks. I've linked that backtest for YTD below to illustrate this idea. Also remember very recent past performance doesn't indicate future performance and is not a "trend." I personally wouldn't own QQQ, SCHD, JEPI, or JEPQ in the first place.
www.portfoliovisualizer.com/backtest-portfolio?s=y&timePeriod=2&startYear=2023&firstMonth=1&endYear=2023&lastMonth=12&calendarAligned=true&includeYTD=false&initialAmount=10000&annualOperation=0&annualAdjustment=0&inflationAdjusted=true&annualPercentage=0.0&frequency=4&rebalanceType=4&absoluteDeviation=5.0&relativeDeviation=25.0&leverageType=0&leverageRatio=0.0&debtAmount=0&debtInterest=0.0&maintenanceMargin=25.0&leveragedBenchmark=false&reinvestDividends=true&showYield=false&showFactors=false&factorModel=3&benchmarkSymbol=jepq&portfolioNames=true&portfolioName1=JEPI&portfolioName2=Naive+50%2F50+&portfolioName3=60%2F40&symbol1=JEPI&allocation1_1=100&symbol2=VOO&allocation2_2=50&allocation2_3=60&symbol3=SGOV&allocation3_2=50&symbol4=VGIT&allocation4_3=40
@@OptimizedPortfolio Thanks for the detailed reply. If you change the date in your back test to start February when I added these you will see they are very competitive with the other allocations. It’s a very small time period but this was when I started and wanted to test JExx funds as the only available data for them are during a unique period. I tested them during over the down periods and they seemed like a good hedge. The longer period from inception never tested well. The banking crisis hit and they were still performing well. SCHD has been in a constant decline. It was hard to justify moving out of those funds. To be clear JExx are allocated $ that is intended for stocks/growth assets. It’s surprising to hear you would never own QQQ. What growth funds do you prefer?
@@analyticsx3 Remember CC funds are in no way a "hedge" and again, backtests don't tell us what will happen in the future. Don't invest based on recent performance. I buy the global stock market with a small cap value tilt and long term US treasury bonds.
@@OptimizedPortfolio Thanks for the feedback. I’m moving out of these very soon. It’s easy to get caught on the near term results.
@@OptimizedPortfolio I definitely see your point after back testing and seeing your back test. Past two days I’m out of them and moved more into total market and value. The limited time frame they have been around clouds new investors from their long term value which gets beat easily by almost any equity fund.
you are right. Another trick by financial tricksters.
Arguably, yes.
There are ETFs like SPYI that write cc on part of the holding. These provide steady income and also room for appreciation
Sure. That's a similar setup to some of these funds discussed here. But again, that "income" can still be generated - probably in a more efficient manner - with traditional stocks, bonds, etc.
I own 50% VOO and 50% XYLD in my stock portfolio. Very new to investing. My reasoning is, hypothetically, even if there is zero capital appreciation, wouldn't a 10% yield after taxes be exactly equivalent to a 10% annual growth rate if reinvested? Or am I missing something with the math?
No. Yield is not total return. More importantly, we don't except long periods of "zero capital appreciation," and it sounds like you probably have a long time horizon. Writing a covered call is effectively just selling your upside. If you have a risk tolerance that warrants lower volatility and risk than 100% stocks, there are much more efficient ways to de-risk a portfolio.
A 10% yield with zero capital appreciation is EXACTLY the same as 0% yield and stock appreciation of 10%. The only DIFFERENCE is one is unrealized gains and one is real return. For his response to say anything different is shocking due to you asking a math question and math shouldn’t be arguable. He doesn’t like cash flow and that’s fine but don’t argue with math . To your question , Yes Ian it is the same
@@Daniyoyo Share price adjusts for any dividend/distribution paid, so the hypothetical "math" isn't useful in the first place and is completely unrealistic, as I illustrated multiple times. I love cash flow; I just prefer efficient ways of getting it.
@@OptimizedPortfolio in a covered call strategy , why are you looking at the share price ? The entire concept of a covered call fund is the buy and Hold strategy to generate passive income.
@@Daniyoyo 12% yield doesn't mean much if the share price is $1. Anyway, thanks for watching and commenting! Best of luck out there.
Some people don’t want to Hope a stock goes Up, hope the market appreciates over a specific time period and hope you sell at the right time to capture your unrealized gains. Cash income for cash flow is an alternative investing strategy period
This is a common straw man argument that makes no sense. A covered call fund still relies on market appreciation. Moreover, you can simply sell shares of your diversified portfolio to create that same "income" and "cash flow," as I've noted plenty of times.
@@OptimizedPortfolio a covered call fun relies on premium and market volatility to generate premium which is passed on to the shareholder via dividends. Covered call funds preform BETTER in sideways and even Down markets , so if your saying they rely on market appreciation this is simply not correct. It’s not a straw man argument when you actually look at the facts
@@Daniyoyo 12% yield doesn't mean much fi the share price is $1. The market still needs to go up over the long term. Anyway, thanks for watching and commenting! Best of luck out there.
@@OptimizedPortfolio they Logic means the exact same with a none yield high growth stock - best of luck to you to sir!
You would be market timing with QYLD. Over the long term, you are almost guaranteed to underperform the market.
What if you reinvest the distributions?
Backtests shown are with distributions reinvested. But fundamentally, if you're reinvesting distributions, why own a covered call fund?
@@OptimizedPortfolio what if you reinvest the distributions into the underlying assets?
@@karlbork6039 Then just buy the underlying...
@@OptimizedPortfolio yes but with CC premiums you have some downside protection.
@@karlbork6039 The only "downside protection" you have is the small option premium received, as I already explained in the video. Consider watching my video on QYLD to see how holding a naive 50/50 mix of the underlying and T-bills comes out ahead.
Bro not everyone wants to retire at 80 years old with 3 million dollars. I rather recive 2k a month at 45y/o and retire lile a king in colombia or any other cheap country. Everyone has different goals in life mine is not mass as much money as possible rather than actually live my life.
That's sort of the entire point. Funds like this would make it take LONGER to pull the trigger on retirement and would likely make for a lower SWR. You seem to have misunderstood the video.
@@OptimizedPortfolioI understand exactly where he's coming from. With a half million invested, you can have years to go with traditional investing. When investing solely for income, you can start considering retiring with 250k, or even less if aim for aggressive ETFs
I understand your thesis but you fail to account for the unknown. No one knows if you will be able to sell capital gains in the future as we have in the past. Look at Japan since the 80s high…it’s never come back to that high point from over 40 years ago. Imagine you were a Japanese retire who bought in the 80s high point. I feel a portion of your portfolio can be on in these CC alternative assets as they do well during a sideways market which very well could happen in the coming decade.
That's why I'm a fan of global diversification in equities of holding other asset classes like bonds. I'd never be invested in 1 single country in the first place. A CC fund also isn't going to magically save the Japanese investor in your example, as I explained. I would submit that my thesis is simply pointing out the evidence, mechanics, and math that many overlook. As I noted, some small allocation to a CC fund may be warranted for the retiree.