Why I Questioned JEPQ’s High Returns and What You Should Know About Dividend Funds

The JPMorgan Nasdaq Equity Premium ETF (NASDAQ:JEPQ) is a case study in higher yields not always being better for investors. On the surface, JEPQ’s 9.96% SEC yield looks like a compelling opportunity for investors. If you invest $100,000 into the fund, you will receive $9,960 in annual cash flow. Most dividend stocks and funds can’t keep up with that type of yield. 

However, you sacrifice a lot to get that yield, and the real yield is very different from the yield that JEPQ advertises. The challenges surrounding JEPQ’s high yield and the abundance of additional options make it a concerning ETF for long-term investors. These are some of the red flags to keep in mind.

The Cash Flow Doesn’t Get Any Special Treatment

JEPQ aims to deliver monthly income to its investors and exposure to the Nasdaq 100 with less volatility. While volatility can be scary during the bad times, investors need volatility to realize the highest gains. It’s understandable that retirees want to avoid volatility and aim for steady cash flow instead, but JEPQ isn’t the best way to do that.

The ETF’s 9.96% SEC yield sounds like a steal, but all of that cash flow comes from short-term options trading. All of the income from these trades is treated as ordinary income, and that will push up your tax bill. It can also push your Social Security checks to a higher tax bracket, which can reduce your benefits.

ETFs that mirror benchmarks like the S&P 500 and Nasdaq Composite have a history of annualized double-digit returns. However, those come as unrealized capital gains, which aren’t taxed until you sell your shares. Even when you sell those shares, you get a more favorable long-term gains tax rate. That perk doesn’t exist for JEPQ cash distributions.

Returns Have Lagged The Stock Market

The Nasdaq Composite is up by 25% over the past year, while JEPQ has only gained 6% over the past year. That 6% gain does not include the 11.1% trailing 12-month yield.  Investors are looking at a 17% return from JEPQ over the past year, but the real return is a bit lower since the proceeds from the 11.1% trailing 12-month yield are all treated as ordinary income.

Ultimately, investors care about how much they can gain from an ETF based on their risk tolerance. A fund that lags the Nasdaq Composite and S&P 500 while having an inefficient tax setup may not be what investors need. 

The Expense Ratio Is Higher Than Passively Managed Funds

A 0.35% expense ratio isn’t bad, but when you can find better funds with expense ratios below 0.10%, it becomes a red flag to consider. A 0.35% expense ratio means you have to give up $35 of every $10,000 to the financial firm. That can add up, especially as the portfolio grows and you factor in all of the extra taxes that you have to pay.

Investors can more easily deal with a 0.35% expense ratio if the fund is exceptional. For instance. the iShares Semiconductor ETF (NASDAQ:SOXX | SOXX Price Prediction) has a 0.34% expense ratio, but it has also delivered an annualized 20.1% return over the past five years and an annualized 25.7% return over the past decade. Those returns make it easier to justify a 0.34% expense ratio compared to JEPQ’s 0.35% expense ratio.