2 Nifty Retirement ETFs You're Likely Unaware Of

Summary

• Retirees may struggle to generate enough income in a low interest rate environment.
• High yielding stocks and funds often carry higher risk.
• Two innovative ETFs may assist retirees to make enough income without jumping in the deep end of the risk pool.

Generating enough income in a low interest environment is a real challenge for many retirees. Bond yields are likely not adequate for most. Popular dividend ETFs, such as the SPDR ETF (SDY), likely carry too low a yield at less than 2.5%. You could always target higher yielding funds and stocks…but this often carries higher risk due to higher exposure to value traps. Another problem stems from some of these higher yielding funds being overweight in a small number of sectors. An example of this is the Invesco High Yield Equity Dividend Achievers ETF (PEY) with almost 50% of the fund residing in 2 sectors.

There are two funds, however, that I believe to deliver the promise of slightly higher yields while mitigating much of the above mentioned risks. The two ETFs at the top of my list for retirees are as follows:

• AAM S&P 500 High Dividend Value ETF (NYSEARCA:SPDV)
• Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF (BATS:KNG)

What are some of the key reasons why I recommend these 2 particular funds?

AAM S&P 500 High Dividend Value ETF (SPDV)

What SPDV does differently than its peers is to find, not just high dividends, but high sustainable dividends. It does this by including stocks which have a combination of high dividend yield and high free cash flow yield. I believe free cash flow analysis to be one of the most important, yet under-served, aspects to dividend investing.

Free cash flow is the left-over cash which can be used for such things as dividends and buybacks. Due to accounting rules, a company could generate high earnings but have zero cash for dividends. Despite a low payout ratio (which is based on earnings), which many believe to be the hallmark of a sustainable dividend, the dividend could actually be in serious danger of being cut. As dividends are paid out of cash, it only makes sense to measure the company’s ability to pay the dividend based on cash and not earnings. This is one way that SPDV can seek higher yields and dividend sustainability. The SEC Yield sits at 3.49%.

Another great feature of SPDV is the sector weighting. The fund seeks to balance the sectors as much as possible.

With a low expense ratio of 0.29%, I can’t think of one good reason why this ETF shouldn’t be a staple in every portfolio – but particularly for retirees. And I would be remiss if I didn’t mention that the performance since inception against other high yielding S&P 500 products has been great.

I attribute much of the performance gap between SPDV and its big AUM competitor, ALPS Sector Dividend Dogs (SDOG), to be based on the free cash flow yield factor. If you are still invested in SDOG, I would recommend putting some or all of that capital into SPDV. If you compare the two funds, you will find that SPDV is similar in most ways and superior in a couple of others. Namely fees, free cash flow yield and trailing recent performance.

Read this article to find out more on the importance of free cash flow.

Also be sure to do your due diligence by digging deep on the AAM website about the SPDV ETF.

Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF (KNG)

Dividend growth investing is a sensible way to save up for retirement. You select companies with a long history of consecutive annual dividend increases to optimize for future income growth. Popular dividend growth ETFs such as the S&P 500 Dividend Aristocrats Index (NOBL) focus on large-cap companies which have a minimum 25 years of back to back annual dividend increases.

This is great if you started early and have a high yield on cost. But if you didn't start a good many years ago, the problem comes from a paltry dividend yield that his currently just above 2%. Wouldn’t it be great to invest in these high quality large-caps which have an outstanding dividend history and get a higher dividend yield? That is exactly what KNG seeks to accomplish.

By writing options against a small portion of the portfolio, you hold that same group of blue chip dividend growth stocks but with a target dividend yield of the S&P 500 plus 3%. This currently puts your dividend yield just shy of 5%.

You should know that writing options against the portfolio will reduce the potential for capital gains. But the fund only allows a maximum of 20% of the portfolio to have options written against it and that number currently sits at just a hair over 10%. So you are not giving up an undue portion of your upside capital return potential in exchange for a sensible way to meet your income needs in retirement.

The expense ratio is 0.75% which might seem high compared to a passive cap-weighted ETF, but you need to remember that writing options takes a lot more hands-on management than most ETFs. The expense ratio is definitely not too high for what you are getting – a viable method to generate enough retirement cashflow in a low interest rate environment.

Be sure to check out the web-page for the Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF here.

Conclusion

If you are looking to invest in high quality companies found within the S&P 500 that will generate enough retirement dividend cashflow, then you should seriously consider SPDV and KNG. Both ETFs optimize for a higher sustainable distribution without focusing on higher risk stocks.

SPDV is a low expense ratio ETF which seeks stocks with higher sustainable dividends while balancing this between sectors. KNG targets the Dividend Aristocrat index while juicing income by writing options on a small portion of the portfolio. To my way of thinking, both of these new and innovative ETFs deserve a place in most retirement portfolios.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.