The iShares S&P 500 ETF (ASX: IVV) is one of the largest exchange-traded funds (ETFs) on the ASX and has built a reputation for delivering capital gains, but not so much for passive income.
How well has it performed? In the five years to December 2024, it has delivered an average return of 17.2% per year. Of course, with returns that good, we shouldn't expect the next five years to be as rewarding – past performance is not necessarily a reliable indicator of future performance.
This fund owns 500 of the largest and most profitable businesses in the US, including many of the world's biggest businesses. That includes names like Alphabet, Microsoft, Meta Platform, and Apple – these are some of the main companies that have driven the overall IVV ETF return. Another benefit of this ETF is that it has very low management fees of just 0.04% per annum, so nearly all the returns stay in the hands of investors.
Those businesses at the top of the holdings are not known for providing much passive income because each has a low dividend yield. However, that doesn't mean we can't create the passive income ourselves. Cash flow can be created by the sale of IVV ETF units.
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Access a portion of the IVV ETF capital gains
According to Blackrock, the IVV ETF had a 12-month trailing dividend yield at 31 December 2024 of 1.28%. While that's better than nothing, it's not exactly mind-blowing.
How about if we could unlock a much better passive income yield from the fund? Income-hunters may want to have a yield of say 5%, considering that's similar to what term deposits are currently offering.
Aussies could utilise some of the fund's capital gains and sell IVV ETF units annually to create the desired cash flow.
Let's run through an example. Imagine an Aussie had $30,000 invested in IVV ETF units. If the iShares S&P 500 ETF achieved a 10% return, it'd become worth $33,000. Then, the investor could decide to sell 5% of the fund value at the start of the year – $1,500. The income-focused investor would have $1,500 of cash flow and an ending portfolio value of $31,500.
The Australian taxation system (currently) allows investors to benefit from a capital gains discount, reducing how much tax is owed on the sale. I would also suggest turning on the distribution reinvestment plan (DRP) to ensure the fund value grows to its maximum potential.
Of course, the IVV ETF won't achieve a 10% return year after year like clockwork. There will be some good years and some weak ones, perhaps even going through a significant setback as we saw in 2020 and 2022 due to COVID-19 and inflation fears, respectively.
For the sake of simplicity, let's say it returns 10% again. If the iShares S&P 500 ETF rose another 10%, it'd be worth $34,650. If the investor sold 5% of the starting value ($31,500), the passive income cash flow would be $1,575, and the investor would end that year with a portfolio balance of $33,075.
Foolish takeaway
Life doesn't always work out as smoothly as a spreadsheet. But, if the IVV ETF's return was stronger than an average of 5% per year, then it could deliver growth of the payments and capital value.
I'd be cautious about selling more than 5% each year because future performance may not be as good as the past. I think it's wise to keep some of the past growth saved for a rainy day.
With the IVV ETF invested in numerous impressive businesses with global growth aspirations, I think the fund could be one of the most useful options to utilise this strategy that I've summarised today.
