With yields from government and corporate bonds at record lows, risk-averse investors are looking for ways to generate returns on their investment while guaranteeing security of capital.
Dividend ETFs can be an investment vehicle that offers investors extra cash flow on investments. Not only can shareholders gain from the increase in share price, but they can also get additional income from dividend payments.
This article explains what dividend ETFs are and how you can choose a suitable one for your portfolio.
A dividend ETF is a type of exchange-traded fund that has shares of dividend-paying companies in its holdings.
Companies that distribute earnings to shareholders through cash or stock payments are selected by a fund manager who lumps them into a single financial instrument in which investors can pool funds and invest.
Dividend ETFs usually track dividend stocks or indexes. For example, the ProShares S&P 500 Dividend Aristocrats Index
Depending on the theme or composition that the fund manager wishes to adopt, there are various types of dividend ETFs.
The dividend ETF may track stocks, indexes, regions, or sectors. Others may track styles, market capitalization, or dividend yields.
For any intended investment purpose or objective, there should be an ETF that can satisfy that need for the investor. Here are the different types of dividend ETFs which an investor can choose from.
This type of dividend ETF tracks companies that have increased their dividend payout on a regular basis.
Companies that grow their profits steadily and distribute them to shareholders are considered for this type of ETF. Examples of dividend growth ETFs include iShares Core Dividend Growth (DGRO) and Vanguard Dividend Appreciation ETF (VIG )
These are ETFs created for value stocks that pay dividends.
Value stocks are shares of companies that are trading below their intrinsic value. Dividend value ETFs usually target value stocks that are in stable industries but are priced below their intrinsic value.
Examples of dividend value ETFs are AAM S&P 500 High Dividend Value ETF (SPDV) and iShares Core S&P U.S. Value ETF (IUSV).
These are ETFs that focus on stocks with high dividend yields.
A caveat must be added at this point. The payout from this type of dividend may be large, but you may be swapping for low or minimal share price gain.
This implies that these types of ETFs do not increase in share price that much, but this is compensated with the high dividend yields. Also, when the price of the underlying securities drips, there is an increase in yield.
Examples of a high dividend yield ETF is the Vanguard High Dividend Yield ETF (VYM) and iShares Core High Dividend ETF (HDV)
Dividend aristocrats are a select group of S&P 500 stocks that have increased their dividends for at least 25 years straight.
These are attractive stocks to own because of their consistent dividend-paying incomes. They are usually regarded as the gold standard for dividend-paying stocks.
An example of a dividend aristocrat ETF is the SPDR S&P US Dividend Aristocrats ETF.
There are certain metrics that can guide you on your choice of dividend ETF. Let's have a look at some of them.
This metric indicates how much your investment would yield in dividend payments.
This is obtained by dividing the stock's annual dividend by the stock's price. Dividend yield is useful for knowing which stock would give you greater returns on your investment.
For example, ETF-A trades at $40 and pays an annual dividend of $1 per share.
On the other hand, ETF-B trades at $20 and pays the same dividend as stock A. using the dividend yield metric, it can be seen that ETF-B has a higher dividend (5%) than ETF- A (2.5%).
A company may pay dividends, but is this actually sustainable?
The dividend payout ratio helps you to calculate the sustainability of dividend payout by a company or in this case, a fund.
Funds with high dividend ratios may have trouble maintaining their dividend payment over a long period. This is because the company needs to reinvest its profits to grow its operations.
A company that pays less than 50% of its earnings as dividends is considered stable, while a company that pays higher than 50% may not be able to sustain its dividend payment.
When looking at ETFs, consider the dividend payout ratio of the underlying securities as this would affect the yield on the ETF.
Dividend ETFs are suitable for certain kinds of investors.
Those who are investing for the long term, risk-averse and conservative in their investment approach can consider dividend ETFs.
Also, investors that do not have the luxury of time, such as retirees or those close to retirement, can use dividend ETFs to shore up their cash flow. If you are an aggressive investor with a panache for risk and growth, then this investment vehicle is not for you.
Dividend ETFs are a good way to diversify your portfolio and earn extra income from dividend payments.
It is also a passive way of investing and does not require constant monitoring or active trading. When compounded, the dividends can be a fulcrum to increase your portfolio holdings in the long term.
Though there are different types of dividend ETFs, you have to first clarify what your investment goals are. After selecting the type of dividend ETF that suits your needs, you can use the metrics outlined above to make your selection.
Photo by Anna Nekrashevich from Pexels
March 23, 2023