Better Passive Income Buy: VYM Vs. JEPI (NYSEARCA:JEPI)

The Vanguard High Dividend Yield ETF (NYSEARCA:VYM) offers investors easy access to a broadly diversified portfolio of dividend-paying stocks at a compellingly low 0.06% expense ratio. Meanwhile, the JPMorgan Equity Premium Income ETF (NYSEARCA:JEPI) also offers investors easy access to a broadly diversified portfolio alongside an attractive yield, but costs 0.35%, or nearly six times as much as VYM does.

That said, JEPI seeks to compensate investors for their greater expense by implementing a more sophisticated active investment strategy by which it generates a superior dividend yield and also pays out its dividends on a monthly basis as opposed to merely a quarterly basis like VYM does.

In this article, we will compare these opportunities side by side and share our view on which is the better buy.

VYM ETF Analysis

VYM currently offers a ~3% dividend yield and has consistently grown its quarterly dividend payout over time, proving itself to be a very reliable income and total return compounder for investors:

The company also has plenty of liquidity as it has $50.4 billion in assets under management and benefits from the reputation that comes with being managed by highly regarded Vanguard. The fund’s low cost, simplicity, reasonable current dividend yield, and proven track record of growing shareholder dividends and underlying principal value make it an attractive pick for the passive investor looking to generate a passive income stream from the stock market.

VYM’s top holdings include some major dividend stalwarts like Exxon Mobil (XOM), Johnson & Johnson (JNJ), and JPMorgan Chase (JPM) among many others across its 444 holdings. Furthermore, its largest position is only 3.31% of its total portfolio and its top 10 holdings only make up 23.49% of its total portfolio value, making it a very diversified investment. Furthermore, its focus on large-cap stocks with strong balance sheets and proven dividend growth track records makes it a relatively conservative investment from a long-term perspective.

Given these qualities, its sector breakdown is not surprising at all, with the weightings being heavily towards financials, health care, and consumer defensive stocks and technology, consumer cyclical, and basic materials stocks occupying a smaller percentage of the portfolio. This is because financials, health care, and consumer defensive stocks are generally much more defensive in nature and therefore are more capable of growing their dividends through all sorts of difficult economic environments and make those stocks a better fit for this ETF. Meanwhile, technology stocks often don’t even pay a dividend – or at least a very small one – and consumer cyclical and basic material businesses are very cyclical and therefore often do not pay out a substantial dividend either.

JEPI ETF Analysis

Meanwhile, JEPI attracts investors with its 11.8% trailing twelve-month dividend yield that it pays out on a monthly basis. The prospect of getting nearly 1% of your investment returned to you via dividends on a monthly basis is a pretty attractive prospect, especially when the portfolio generating that income is as well diversified, professionally managed, and very easy to invest in and sell like JEPI is.

While not nearly as well diversified as VYM is in terms of total holdings at 131, it still has plenty of diversification (some studies have shown that you only need 20-25 stocks to have a sufficiently diversified portfolio). Furthermore, its top 10 holdings only make up 15.42% of its total holdings, which is significantly less than the percentage occupied by VYM’s top 10 holdings. On top of that, its top holding is a U.S. Government money market fund, making its portfolio even more conservatively positioned. Only 0.13% of VYM’s portfolio is in cash and cash equivalents while 2.23% of JEPI’s portfolio is in cash and cash equivalents.

The rest of its top 10 and indeed its broader portfolio is primarily a well-diversified mix of industrial, financial, health care, and consumer defensive stocks. It also has greater exposure to technology and utilities stocks than VYM does.

In addition to its slightly more concentrated and differentiated portfolio allocation approach relative to VYM, JEPI’s “secret sauce” that enables it to pay out such a juicy monthly dividend is that it sells out of the money call options on the S&P 500 that enable it to generate a higher dividend yield. This is effectively trading some of the ETF’s upside potential in exchange for higher cash flow generation each month. This results in more consistent total returns in the short term since it helps to smooth out the spikes and plunges of the market, but likely does little to add or subtract from the fund’s long-term total return potential. JEPI also utilizes equity-linked notes (for more on these, read this detailed article on the subject) as part of its option selling strategy, but does not disclose the proprietary details of how they structure them for the fund.

Investor Takeaway: Which Is The Better Buy?

While misleading as a sole metric for determining future performance, it is worth noting that VYM has significantly outperformed JEPI since JEPI went public in 2020:

It is also worth noting that JEPI has only slightly outperformed VYM over the past year, despite the broader stock market (SPY) being in a downturn during that period:

These charts confirm what we would assume when looking at how these funds are built. VYM is likely to outperform JEPI during periods of high volatility (which has generally characterized the stock market since JEPI’s inception) and strong bull markets, whereas JEPI is likely to outperform VYM during down markets since its covered call sales will generally expire worthless each month when the stock market is trending down.

That said, JEPI only slightly outperformed VYM over the past year which is quite intriguing given that the conditions should have been pretty favorable to JEPI relative to a long-only fund like VYM during that period, so this makes us question the virtues of JEPI’s approach. Furthermore, over the long term, we assume that JEPI’s approach will neither add nor subtract value from the fund’s total returns given that it is spread over such a broadly diversified portfolio (making it very difficult for its active managers to distinguish themselves) while its nearly six times greater expense ratio will drag on total returns over time.

As a result, from a long-term total returns perspective, we expect VYM to outperform JEPI over time. If that is our primary concern, VYM is clearly the better buy. However, the major pro for JEPI is that it is designed to deliver more consistent total returns and cash flows to shareholders over time. As a result, retirees looking to live off of the 4% rule for example will find JEPI’s approach to be very attractive as they can live off of the cash flow with plenty to spare and then reinvest the surplus cash accordingly.

Furthermore, the greater leveling of returns helps to mitigate some of the market risk involved. If you need to withdraw 4% from your portfolio every year, it is better to know that during prolonged bear markets, that 4% will be coming from options premiums, not from eroding your shares of stock. Granted, the upside potential will be significantly capped during bull markets, but for retirees, they generally value downside protection over upside potential as they are focused on providing for living expenses through all conditions rather than trying to amass a fortune.

While some might say: just buy bonds then and be done with it. There are some reasons why JEPI is better than bonds. First and foremost, many conservative bond funds do not offer enough income to support a four or five percent rule retirement. Second, JEPI offers superior long-term total return potential than bonds while still providing the same cash flow benefits during down markets. Ultimately, our preference is for VYM if you are in the wealth-building phase of life, given that its lower cost structure gives it a significant edge in long-term total return compounding. We also prefer VYM if you can fully fund your retirement with its 3% annualized dividend yield. However, if you are a retiree who needs more than the 3% income yield that VYM provides, we think that allocating at least a portion of your portfolio to JEPI makes sense.

Perhaps for most retirees, a core position in VYM with a complementary position in JEPI to boost the portfolio’s overall income yield makes the most sense. We take a similar approach at High Yield Investor: complementing high quality total return compounders with some higher-yielding instruments to produce a portfolio that has crushed the market since inception, alongside a very attractive ~7% dividend yield.