There’s a disturbing pattern I’m seeing increasingly more on monetary social media.
A rising variety of Gen Z traders, satisfied they’re completely priced out of homeownership, are swinging for the fences with no matter capital they’ve. And it’s not simply sports activities betting, prediction markets, or cryptocurrency anymore.
Now it’s exchange-traded funds (ETFs) – extra particularly, ultra-high-yield, single-stock ETFs promoting double- and even triple-digit payouts. Yields of fifty% and even 100% are being marketed because the shortcut to monetary freedom.
However there is no such thing as a free lunch in markets. If one thing is paying that a lot earnings a yr, that cash is coming from someplace. And in lots of circumstances, chasing these yields can really destroy extra wealth than it creates.
Let’s stroll by way of a real-world instance to indicate you precisely why the whole return math doesn’t work.
Wanting on the worst offender
Most traders are acquainted with Technique Inc. (NASDAQ:MSTR).
Initially a software program firm, it has successfully grow to be a leveraged Bitcoin treasury car. It points debt and most well-liked shares to purchase extra Bitcoin, after which typically points extra fairness to repeat the cycle.
Extremely-high-yield ETFs typically cap upside and generate distributions that underperform the underlying inventory. We will debate the sustainability of that mannequin one other time. The problem right here is one thing else: there are actually ETFs constructed round MSTR that publicize ultra-high yields.
A outstanding instance is the YieldMax MSTR Choice Revenue Technique ETF (NYSEMKT: REVENGE).
MSTY doesn’t merely maintain shares of MSTR. As a substitute, it holds Treasury payments as collateral and runs a posh choices technique utilizing calls and places designed to approximate publicity to MSTR whereas producing massive choice premiums. The upside is closely capped.
On the time of writing, MSTY advertises a jaw-dropping 64.5% distribution yield. That quantity is calculated by taking the newest month-to-month distribution, annualizing it, and dividing it by the ETF’s web asset worth.
Should you’re new to investing, that quantity is intoxicating. Make investments $100,000, accumulate $64,530 a yr. Monetary freedom unlocked, proper?
The phantasm of excessive yield
Let’s have a look at the interval from February 22, 2024, to February 10, 2026. Should you purchased MSTY and reinvested each single distribution, assuming no taxes and ideal execution, you’ll have earned a cumulative return of 57.5%. That sounds strong.
However for those who merely held MSTR inventory over the identical interval, your cumulative return would have been 86.5%. In different phrases, you paid a 0.99% expense ratio for the privilege of receiving large “earnings” distributions that also left you worse off than proudly owning the inventory outright.
And it will get worse. 98.6% of MSTY’s distribution has been categorized as return of capital. It’s your individual cash being handed again to you. Return of capital lowers your value foundation and isn’t instantly taxable, however economically, you’re simply getting your principal returned.
So what are you actually doing? You’re paying a excessive annual price to obtain your individual a refund within the type of an attention-grabbing “yield,” doubtlessly triggering taxes on every distribution and underperforming the underlying inventory even for those who reinvest every thing.
That’s monetary engineering dressed up as passive earnings. The one particular person right here getting cash is the ETF issuer. Case closed.