Tuesday Two-Fer

A look at a new ETF and a crappy 401k plan.

The CBOE is launching an ETF. It will be the Cboe Vest S&P 500 Dividend Aristocrats Target Income ETF (KING). The short version is that the fund will own dividend aristocrats (companies that have raised their dividends for at least 25 years) that have options outstanding. It will sell options against those stocks in hopes of generating a 3% yield for fund holders. The 3% would come from a combination of dividends from the stocks and option premium received. The fund will only overwrite 20% of its stock positions, meaning it would only sell two calls against 1000 shares owned not 10 calls, which will mitigate the effect of capping the upside.

The long standing ProShares S&P 500 Dividend Aristocrats ETF (NOBL) obviously targets the same stocks (not sure how many of the aristocrats have options) without selling options. NOBL yields 1.91% per ETF.com which is about 15 basis points more than the S&P 500. NOBL has an expense ratio of 0.35% versus the 0.75% that KING will charge. I am not necessarily critical of 0.75%, an options strategy is likely more expensive to implement, whether it should be 40 basis points more is up to the end user.

Assuming the ETFs have the same yield at the stock level the options would need to generate 151 basis points annually to make up the extra 40 basis points of fee and get the payout to fund holders to 3%. Where the 151 basis points would come from selling calls on just 20% of the portfolio that implies 755 basis points if calls were being written against the entire portfolio. Far from an apples to apples, an S&P 500 call struck at 2730 for May with the index at 2610 (5% out of the money) was bid at $21.80 earlier today. Making the huge leap that you could get the $21.80 six times per year with the index at $2610 means total premiums for the year of $13,080 versus a $2.6 million portfolio which in percentage terms is half of a percent. If KING were to write at the money calls, then using SPX as an imperfect proxy, the 2610s were bid at $79.00 so doing the same math the implied "yield" from options would be 1.8%.

Options from individual stocks tend to pay more but it is not clear to me that it will generate enough net option premium to get the fund yield up to 3% net of expenses. CBOE wouldn't launch KING if it expected it to fail but 3% might not be so simple to achieve. The strategy is appealing but it might make sense let it prove it can generate the 3% it targets. CBOE is a client holding.

Michael Batnick took a look at a 401k plan sent to him by a friend. He concluded the plan was terrible and then offered a brief critique of the choices. Lousy 401k plans are pretty common. Sometimes this is a function of conflicts associated with expensive funds, other times the task is left to someone in HR who may not have the training to choose funds for the plan and there are probably other factors too.

If you're getting a match to your contributions then you are still very likely coming out ahead. If your 10% contribution gets you a 2% match, that is like a 20% return. Obviously you need to make the effort to understand how your match works, assuming you get one but once you do, make sure you're putting enough in to at least get the maximum benefit from the match. From there I would argue for contributing to an HSA account and finally, if you can swing it a Roth IRA.

I mentioned HSA's yesterday as possibly being the greatest retirement vehicle there is. Your contributions are deductible and withdrawals for medical expenses are not taxed, regular IRA withdrawals are taxed. Also if you spend $1000 out of pocket today for a medical thing, you can keep that receipt for later and use it in the future to take a tax free withdrawal from the HSA. In theory a lifetime's accumulation of receipts for expenses could be used in the future to take from the HSA all the while letting the money in the HSA grow tax free or at the very worst tax deferred.

I am a big fan of Roth IRAs. The basic idea is that contributions are not deductible but then distributions are not taxable later. You will get varying opinions on this but when it comes time to withdraw money, presumably in retirement, having accounts with different taxation is hugely advantageous. Starting at 70 1/2 you have to take required minimum distributions (RMD) from traditional IRAs (this includes rollover IRAs) which is how the government gets its money, from taxing this distribution. So where you have to take money from this type of IRA I see this going toward supplementing living expenses if needed. To the extent the RMD is exhausted on living expenses, the fun/big stuff could be covered by the Roth IRA. If you pay for a car or a really big trip out of your traditional IRA you are essentially paying 25% more than the price because of taxes. If the car you want is $30,000 and your tax rate is 20% you would need to withdraw $37,500 to net $30,000. From your Roth you would need to withdraw $30,000 to net $30,000.

That is just one way of viewing it there are countless other ways but the order in which you withdraw from accounts in retirement should be done with a focus on tax efficiency when possible. Obviously if every nickel is in the same vehicle then there would be less tax efficiency to be had.

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