Replace Your Fixed Income With This Dividend ETF

Key Points

• With the Federal Reserve slashing its benchmark interest rate for the first time since 2024, yields on fixed income are heading lower.   
• For income-focused investors, dividend ETFs can help offset losses from less productive debt securities like Treasury bills and CDs. 
• Because these funds often use options strategies to produce higher yields, it is important to be aware of the tax treatment for their dividends.

On Sept. 17, the Federal Reserve finally gave Wall Street what it had been asking for. The central bank cut its effective federal funds rate (EFFR) for the first time since 2024. Unsurprisingly, the market reacted favorably and is up 1.42% since that announcement. 

However, debt securities are becoming increasingly unappealing for income investors who had grown accustomed to higher-than-average rates on fixed-income products since the early days of the pandemic. And suppose the Fed continues lowering the EFFR throughout the remainder of the year. This is exactly what happened last year when it began a rate cut cycle in September and ended in December—many will be turning to the equities market to compensate for lost yield. 

Of course, a lot could happen between now and then. Market uncertainty has persisted all year, and inflation, which was approaching the Fed’s 2% target, is ticking back up. So a rate cut at next month’s FOMC meeting is no guarantee.

However, the odds of one are already priced in, with a nearly 90% chance according to the CME Group’s FedWatch Tool. So if you find yourself among those searching for better yields, the NEOS S&P 500 High Income ETF BATS: SPYI is one ETF worthy of your consideration. 

SPYI’s Eye-Catching Monthly Dividend

Unfortunately, the days of historically high yields on near-zero-risk investments are long gone. In May 2022, Series I bonds offered 9.62%. Today, they yield 3.98%. While that is still more appealing than one-year municipal bonds, which are currently yielding 2.06%, the rate for I bonds is almost certainly going down after Oct. 31, when they are adjusted for the next six months.   

So what’s a yield hunter to do? SPYI can offer clues. The actively managed fund, which carries a reasonable expense ratio of 0.68%, aims to provide shareholders with “high monthly income in a tax-efficient manner with the potential for upside appreciation in rising markets.”

That last part is important, but we’ll get there. 

First, let’s focus on that dividend. 

SPYI currently yields 11.67%, or $6.15 annually, with dividends paid in monthly installments. NEOS, the ETF’s manager, accomplishes that via an S&P 500 index fund options strategy that provides upside potential in rising equity markets.

Taking the covered call strategy one step further, NEOS buys out-of-the-money options, enabling the fund managers to capture more upside in the benchmark index than other comparable dividend ETFs, such as the JPMorgan Equity Premium Income ETF NYSEARCA: JEPI.

By contrast, JEPI only sells near-at-the-money S&P 500 calls, which can limit its potential appreciation. 

The result is evident in its moderate and sustainable dividend distributions. Since it was launched on Aug. 30, 2022, SPYI has gained 8.46% while paying an average annual yield of 10% to 11%. Since its all-time low on April 4, the fund has grown nearly 23%. 

A Deep Portfolio With Growth-Focused Holdings

Aside from their options strategy, where SPYI and JEPI also deviate, are their holdings. While JEPI does own growth stocks, it also includes cyclicals like financials and defensive plays like consumer staples in its top 10 holdings. 

On the other hand, SPYI’s top 10 holdings more closely reflect the S&P 500 itself, with tech, consumer discretionary and communication services behemoths such as NVIDIA NASDAQ: NVDA, Amazon NASDAQ: AMZN, and Meta Platforms NASDAQ: META with three of the top five allocations in the portfolio.  

By industry, SPYI prioritizes semiconductors (27%), software (22%), media (17%), and specialty retail (16%). So, while JEPI has around 125 holdings, SPYI has more than 500, which gives shareholders exposure to a broader array of companies while enjoying a more diversified cover call strategy than JPMorgan uses for its premium dividend ETF. 

Understanding SPYI’s Tax Treatment

If you are considering investing in SPYI, one thing to be mindful of is how the fund’s dividends are treated for tax purposes. Some high-yield ETFs’ distributions are entirely classified as return of capital (ROC) and are therefore considered ordinary dividends, which can be taxed at standard marginal income tax rates (up to as much as 37%). 

While SPYI’s dividends aren’t considered qualified and would be taxed at a lower long-term capital gains rate, the fund uses a tax-efficient structure. Under the U.S. tax code, Section 1256 permits the ETF to be subject to the lower 60/40 tax rate since NEOS’ fund managers embrace tax-loss harvesting. 

That means 60% of SPYI’s gains are taxed at the long-term capital gains rate, while 40% are taxed as ROC at the standard income tax rate. Conversely, the majority of JEPI’s distributions are taxed as ordinary income—another advantage SPYI has over its counterpart.