Buying dividend stocks. Investing in real estate. Creating a YouTube channel. Receiving royalties from a book you wrote. Those are just a few ways that you can generate passive income. Different people will gravitate to different approaches.
However, I think that there’s one method of making extra money without much effort that especially stands out. Here’s the greatest passive income machine you’ll find right now.
The case for closed-end funds
Probably the biggest downside to some of the popular ways to generate passive income is that they aren’t all that passive. Writing a book or creating a YouTube channel, for example, requires quite a bit of work.
Another issue is that some alternatives won’t make you as much passive income as you might prefer. You can find solid dividend stocks and passive ways to invest in real estate easily enough. However, many of the safest choices offer annual yields of less than 5%.
Closed-end funds (CEFs) provide an answer to these challenges. They’re as easy to buy online as a stock. In fact, CEFs trade like a stock and are available through your brokerage. But they offer a lot more diversification than buying one stock does.
This special type of mutual fund also gives investors a variety of different ways to generate passive income. Some CEFs focus on dividend stocks. Others specialize in bonds or writing covered call options on stocks.
You can find many CEFs with annual yields of 6%, 7%, or even higher. Generally speaking, these funds offer significantly greater yields than the average dividend stock. And they don’t require much effort.
It’s quite possible to make close to $70,000 in annual passive income by investing $1 million in CEFs. Below are a few examples that illustrate how this can be achieved.
The Aberdeen Global Dynamics Dividend Fund (NYSE: AGD) owns stocks of companies across the world. Many of these stocks (although not all of them) offer strong dividends. Its top holdings include Apple, Microsoft, Alphabet, and AbbVie. The CEF’s yield currently tops 7.8%, which is increased by the use of leverage. Over the past 10 years, the Aberdeen Global Dynamics Dividend Fund has delivered a total return of more than 120%.
For investors who want diversification with bonds, the AllianceBernstein Global High Income (NYSE: AWF) is worth a look. This CEF invests primarily in corporate and government bonds. It yields 7.6%. The fund managers also adjust the portfolio’s risk level based on market conditions.
The BlackRock Enhanced Equity Dividend Trust (NYSE: BDJ) fund writes covered call options on stocks. Typically, at least 80% of the fund’s total assets are in dividend stocks. The CEF’s yield currently stands at 7%. It has delivered a total return of 195% over the past 10 years.
A few things to consider
There are many CEFs to choose from in addition to the three funds mentioned. Yields aren’t the only thing to consider when selecting a CEF.
Always find out what the annual expense ratio is for a fund. Some CEFs have expense ratios below 1%, but others can be higher. Also, look at the net asset value (NAV) versus price of the CEF. In many cases (including the three CEFs previously discussed), you can buy funds at a discount to their NAV.
Many CEFs use leverage (usually involving borrowing at short-term rates) to increase returns. Funds with high levels of leverage can be especially volatile. None of the CEFs referenced earlier have a leverage of more than 30%.
Finally, examine the overall performance of a CEF. Keep in mind that these funds typically won’t grow nearly as much as investing over the long term in stocks will. The passive income that they offer is the trade-off for the lower growth. However, the best CEFs will still be able to increase in value over time while they generate steady income for you month after month.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Keith Speights has positions in AbbVie, Alphabet (A shares), Apple, and Microsoft. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Apple, and Microsoft. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.