Safely Generate Passive Income

Dividend Earner

Dividend Earner

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What stocks would you consider to generate passive income that can provide around $4K – $5k per year from a $50K to $100K investment in a taxable account.

This is a common question for retirees. In the case above, the $5K per year is a specific target for an annual expense with the goal to not impact retirement.

There are four specific points in the question needing to be discussed.

  • What passive income means?
  • $4K to $5K per year
  • $50K to $100K investment
  • A taxable account is preffered

On the passive income point, I want to be clear that we specifically mean income in the form of dividends or distributions from investments in a taxable account.

Generating passive income is to receive income from your assets such as real estate, fixed income investments such as bonds or GICs, or investment that pay a dividend.

When it comes to setting goals, be specific. $4K is not $5K. In fact, $5K is 25% more than $4K. 25% is a large margin. For the purpose of the question, the target will be $5K and we will also assume it’s before tax.

Last but not least, an investment of $50K to $100K is a very broad range. It makes me think that $50K is probably achieveable but the desired amount would be $100K. We will split the difference and go with $80K.

Feedback to all investors, be specific with your numbers when setting goals. It’s ok to change it later and adjust the plan.

What Do We Need?

Based on the parameters we have, we need a yield of 6.25%. The formula is income desired dividend by total investment.

If you remember the previous Q&A question about an acceptable high yield exposure, 6.25% is approaching the risky investment category for normal dividend stock.

To generate this much income, you need to focus on specialised investing strategies which usually ignores growth over time in order to provide a specific income now. It’s active ETFs with covered calls as an example.

One Investment Criteria Missing

In the question, there is a critical, and necessary, criteria that is missing and not always implied.

Since the income is needed every year for a specific expense, an inflation rate needs to be assumed. What rate to use is a bit personal and in this case, we will go with 3%.

That means your passive income should increase by 3% annually in order to keep up with inflation. It looks like this.

Year 1$5,000
Year 2$5,150
Year 3$5,304
Year 5$5,463
Year 6$5,626

Investment Options

To reach the goals above in the table we need to filter investments with a yield of 6.25% and an income growth of 3%. How many do we get to match that from the Dividend Snapshot Screener?

There is a total of 6 common shares and 23 income trusts including REITs with a yield of 6.25% but only 3 with an income growth over 3% (barely over).

From a market capitalization angle, only three are mid-cap and the rest are smaller including many micro-cap. It’s not looking good to find quality stocks.

It’s clear we will need to be creative in generating the income and getting growth along the way. Feel free to look into how you can super charge your passive income to know more about the options available (Covered Call ETFs).

A blend of dividend stocks and ETFs will be needed. The dividend stocks will provide the growth and the ETFs will provide the higher income.

Investment Breakdown

We now know that finding an investment with 3% income growth and a yield of 6.25% is rare or just plain risky.

We need to approach the account composition differently. More math.

From experience, we can probably find some company with a 5% yield and a 3% dividend growth with some bank stocks, utility stocks, or telecom stocks.

What breakdown do we need if we have some holdings with a 5% yield. Say we do 50% with 5%, how hight does the other 50% need to go? It’s 7.5%.

If we assume a 7.5% yield doesn’t have growth, then the 5% yield now needs 4.5% growth for inflation.


Investment Review

A filter from the Dividend Snapshot Screeners has the following results. The filter is bound to change depending on the markets but today’s that what we get.

The filters are:

  • Dividend Yield greater than 5%
  • 3 & 5 Year CAGR Dividend Growth greater than 4.5%
  • Market Cap Group is greater than Mid Cap

You cannot find the 3 and 5 year CAGR Dividend Growth for free unless you fetch data and do the math. This is where I truly believe that DIY investors need the right screening tools to succeed on their own.

On the 7% yield screening, most are micro cap or small cap. It’s not a problem to hold them with a large portfolio but for a small amount like we are planning for here, only one investment is matching.

From here, we need to look at ETFs. I have to switch tool and use Stock Rover here as the Dividend Snapshot Screeners do not cover ETFs.

Using Stock Rover to filter ETFs, I can find 27 candidates after excluding anything not focused on North America. These are the ones I would consider for tax considerations in a taxable account (ie avoid US income)

  • HEE – Horizons Enhanced Income Energy ETF (Active Covered Calls)
  • HEX – Horizons Enhanced Income Equity ETF (Active Covered Calls)
  • ZWU – BMO Covered Call Utilities ETF (Active Covered Calls)

Feel free to consider ETFs with US holdings, just be aware of your tax consideration for the income. I personally like the healthcare covered call ETFs.

Reader Selection Review

Here are suggestions the reader had in mind. As you can see, REITs are often the first stop to increase income and I prefer covered call ETFs as you don’t get the risk of real estate. Borrowing for REITs is just about to go up …

  • MFC – Manulife – Only question is if they drop the dividend again as they did once in the past.
  • AQN – Algonquin Power & Utilities Corp – Not recently loved by investors, is there something to be worried about …
  • BCE – BCE – The usual income play for many retirees. Stable and boring.
  • BNS – Scotia Bank – Has its ups and downs. A Canadian bank and with timing can provide a good yield.
  • EIT.UN – Canoe EIT Income Fund – A unique fund seeking income with active management.
  • RSI – Rogers Sugar – A company that pays the same dividend over and over and trades within a stable range in general. No income growth.
  • NWH.UN – Northwest Healthcare Properties REIT – A REIT which I am not found of. Better options with covered call ETFs.
  • SRU.UN – SmartCentres REIT – A REIT which I am not found of. Better options with covered call ETFs.

Rogers Sugar is a good stock to hold for income as a proxy to earn interest as it’s a stable holding but know that it doesn’t increase the dividend unlike the other stocks on the list.

  • HHL – Harvest Healthcare Leaders Income ETF (Active Covered Calls)
  • ZWC – BMO Canadian High Dividend Covered Call ETF (Active Covered Calls)

On the ETF front, I do like HHL but you need to be aware of the tax hit you may get.

A tax calculator from WealthSimple was shared with me if you want to use it to figure out the tax impact based on your income.

Passive Income Portfolio Example

From the above, here is a what a portfolio can look like today. Do note that it’s based on today’s yield in a market correction.

The two common stocks are part of the retirement model portfolio as a note.

TickerYield TargetRatioIndustry
EIT.UN7.5%25%N.A. Equities

This is the tax distribution for Canoe EIT Income Fund in 2020 as an example.

  • 0.00% of the distributions received are taxable as “other taxable income” (Investment Income);
  • 0.00% of the distributions received are taxable as “other taxable income” (Not Investment Income);
  • 4.0% of the distributions received are taxable as “actual amount of eligible dividends”;
  • 0.00% of the distributions received are taxable as “actual amount of non-eligible dividends”;
  • 0.00% of the distributions received are taxable as “foreign business income”;
  • 0.00% of the distributions received are taxable as “foreign non-business income”;
  • 0.00% of the distributions received are taxable as “foreign non-business income tax paid”;
  • 53.3% of the distributions received are taxable as “capital gains”; and
  • 42.7% of the distributions received are return of capital. (100.00%)

Follow Up Consideration

One follow up from the reader was whether or not to buy 1 stock to do it all. Unfortunately, the options available will not provide the necessary yield with inflation beating growth.

As such, one holding cannot do it and it’s pretty risky to do it with one holding. You could go with two if you wanted where one is covering the 5% and the other is covering the 7.5% but I prefer to have one more in each.

If you want to focus on ESG investing (Environmental, Social, and Governance), you can swap out Enbridge in favor of Power Corporation today but you could easily choose between the others too.

2 thoughts on “Safely Generate Passive Income”

  1. The only Canadian Dividend stocks which fit your requirements of 6.25% min yield with a 3% min DGR are FCD.UN, SYZ & FN. The 3 have at least a 10 year dividend growth streak as well, FCD.UN (10 yr), SYZ (12 yr) & FN (10 yr). FCD.UN may not be suitable in a taxable account. I own it in my TFSA & RRIF.

    As for stocks which exceed a 5% yield and 4.5% DGR (both 3-yr & 5-yr) I count a total of 8. ie; FCD.UN, SYZ, FN, ENB, GWO, MFC, POW & BCE. I own all but SYZ & FN.

    If you add high yield Cdn based ETFs which I own to the mix they are: HDIV, HHL, BASE, ZBAL.T, ZWH & ZWB. Each has a yield over 6%.

    • Indeed, I excluded those as too small companies with small and mid market cap. I would not build a portfolio with just those three. They can work as growth but they can also be risky with wild swings.

      The key is about seeing the dividend grow and with high yield it is not easy if you have a fixed amount that must generate a fixed income.

      The excercise is very specific to an $80K account and generating $5K. Would you put $80K in those 3 small cap stocks?


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