Do you want to generate consistent, monthly income in your tax-free savings account (TFSA)?
If so, you need to structure your TFSA so that the income comes in on a regular basis. While it’s tempting to run out and buy monthly-pay stocks in order to achieve the goal of frequent income, that approach comes with certain risks. In this article, I explore the best way to structure your TFSA so that you get practically constant (i.e., monthly) income.
What practically constant means
Before going any further, I should clarify what I mean by practically constant.
“Practically constant” in the world of dividend and interest-bearing securities basically means monthly. That’s the most frequent basis on which readily accessible securities pay their dividends. There are some arcane Wall Street instruments out there paying weekly dividends, but they are generally covered call or other options-based ETFs that have peculiar characteristics, including tax benefits that only U.S. holders can enjoy. For the purposes of this article, I’ll stick with common stocks and option-free ETFs built upon them.
Monthly pay stocks: Opportunities and risks
If your goal is to receive monthly income, you might be thinking about investing in monthly pay dividend stocks. I’d advise against that, for a few reasons. First, picking “monthly pay” as a security selection criterion limits your investment universe significantly: few stocks pay monthly. Second, such a criterion is not related to long-term return maximization or risk minimization. Third and finally, a lot of monthly pay stocks are of poor quality. With that out of the way, here’s how you actually can get monthly, “practically constant” TFSA income.
The better way to do it
The best way to achieve “practically constant” monthly income is simply to diversify widely. Stocks have different payout schedules; if you hold hundreds of them, you’ll probably get a little bit of dividend income coming in each month. Even though the vast majority of stocks pay quarterly, a 200-stock portfolio will likely cover every payout schedule possible. Also, most REITs pay monthly, and an adequately diversified portfolio will include some REITs.
Consider the ETF route
As we’ve seen, a highly diversified stock portfolio would likely have some dividend income coming in each month, which is “practically constant” as far as common stocks are concerned. However, actually building a several-hundred-stock portfolio from scratch would be a painstaking exercise.
The better way to get your “practically constant” monthly dividend income would be through exchange-traded funds (ETFs). Many ETFs pay their dividends monthly, and they typically have quite a bit of diversification under the hood, which mitigates risk.
Take the BMO Canadian Dividend ETF (TSX:ZDV), for example. As the name implies, it’s an ETF built on Canadian dividend stocks. Its holdings include a lot of banks, utilities, telcos and energy companies – exactly the types of stocks that have tended to work well in Canada. ZDV has a 2.9% dividend yield, which is close to but slightly higher than that of the broader TSX index. It holds 62 positions, which is a considerable amount of diversification. The ETF has a 0.39% management fee, which is not rock bottom but not overly high. Finally, most germane to this article’s topic, it has a monthly payout schedule, which is practically constant by the standards of option-free ETFs.
So yes, “practically constant” monthly income is possible. Though get it with diversified REITs and ETFs, rather than a haphazard collection of monthly pay stocks.
