By Al Root

"Target income" funds are the new-new thing for dividend investors -- and they just might be worth a look.

Equity income is hard to come by these days. The S&P 500's dividend yield has dropped to 1.1%, its lowest since the early 2000s, and even the so-called Dividend Aristocrats -- companies that have raised their payouts for at least 25 consecutive years -- yield only 2.5%.

That's where target-income funds come in. The products are designed to provide investors with above-average income, often by using stock options strategies to boost payouts, usually by writing "covered calls." A call option gives the holder the right to buy a stock for a fixed price by a predetermined expiration date, while the person who "writes," or sells, the option has to deliver shares to the buyer if the stock rises above the "strike price" specified in the options contract.

Selling a call option on a stock you don't own -- a "naked" call, in options market parlance -- against a stock you don't own offers very little reward with lots of risk. But if the options seller owns the stock, they are "covered," and the worst that can happen is that they sacrifice some upside for an upfront payment.

Such a strategy has the ability to turn just about anything -- stocks, gold, even Bitcoin -- into a yielding asset. What makes the target-income funds different is that, as their name suggests, they aim to provide the same percentage of income each month. Vest Financial, via First Trust, launched the FT Vest S&P 500 Dividend Aristocrats Target Income exchange-traded fund (ticker: KNG) in 2018. The fund owns the 69 Dividend Aristocrats, including Caterpillar and Coca-Cola, and then writes options against them to bring the yield up to 9%, while sacrificing about a fifth of the upside in the group.

Vest offers other target-income strategies including the FT Vest Rising Dividend Achievers Target Income ETF (RDVI), which tracks a group of Nasdaq-listed stocks that have increased dividends over one, three, and five years and yields 8.5%; the FT Vest Gold Strategy Target Income ETF (IGLD), which yields 7%; and the recently launched FT Vest Bitcoin Strategy & Target Income ETF $(DFII)$, which targets an annual yield of 15%.

Vest isn't the only company in the target-income fund game. Other ETFs include Simplify Barrier Income $(SBAR)$, which launched this year and targets a 15% yield by selling put options on stock indexes. Defiance S&P 500 Income Target $(SPYT)$, which launched in 2024, targets a 20% yield by holding index ETFs and selling call spreads on the index. (A call spread involves selling one call option and buying a different call option simultaneously.)

Target-income ETFs aren't risk-free. They run complicated strategies, and investors have to rely on active managers more than with plain-vanilla index ETFs or even actively managed stock portfolios. They're also far more expensive -- the Vest S&P 500 Dividend Aristocrats ETF has a 0.75% expense ratio, far higher than the SPDR S&P 500 ETF's $(SPY.NZ)$ 0.09%. There is a lot of trading activity in target-income funds, which can also make them less tax-efficient.

Investors have to sacrifice upside, too -- there's no such thing as a free lunch, after all, even in the options market. The FT Vest Dividend Aristocrats ETF has returned 9.1% annualized over the past five years, lagging behind the ProShares S&P 500 Dividend Aristocrats ETF's $(NOBL)$ 9.8% annualized return over the same period, while the Defiance Target Income ETF has returned 13.6% over the past year, trailing the SPDR S&P 500 ETF's 18.1% return.

That's a bit of a sacrifice, but for investors who want to shift some of their return to income from capital appreciation, it may be worth it.

Write to Al Root at allen.root@dowjones.com

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August 01, 2025 21:31 ET (01:31 GMT)

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