Dividend ETFs: The 5 Best Ways to Collect Income
Even dividend stocks can crack, so don’t bet the farm on just one or two. Buy a basket or two instead via these five ETFs.
It’s a strange time to be an income investor. Most government bonds in the developed world actually sport negative yields. And even those in positive territory — like U.S. Treasuries — don’t yield enough to make them worth considering.
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But more fundamentally, bonds — even in a normal rate environment — aren’t really your best option as a long-term income vehicle.
Bonds are tax-inefficient, as all of your income returns are taxed as current income at your marginal tax rate. And unless you’re buying TIPS, there isn’t an inflation adjustment. Your income from the investment doesn’t grow, whether you own it for 10 months or 10 years.
A better option for long-term investors would be a good portfolio of dividend stocks. Yes, stock dividends are less secure than bond interest. The bondholders always get paid first, and a company can cut its dividend at the whim of the board of directors if cash is a little tight. But you can mitigate this risk by diversifying across sectors and by keeping your exposure to any single stock modest.
Dividends are generally taxed at a more favorable rate than bond interest, plus — and this is the biggest selling point — healthy companies tend to raise their dividends over time. This keeps your income stream a step ahead of inflation.
Of course, the easiest way to get exposure to a diversified portfolio of dividend stocks is to buy a dividend ETF or a handful of dividend ETFs. Today, I’m going to give you five solid names to consider.
All have a slightly different approach to dividend investing, so buying a basket of these dividend ETFs is a smart move.
iShares Select Dividend ETF
I’ll start with the granddaddy of them all, the iShares Select Dividend ETF (DVY).
DVY was the first of the dividend ETFs, and it’s still a solid option. The ETF had a serious rough patch in 2008 because it was overweighted to financials at the time. But the managers have adjusted the strategy over the years and made improvements.
DVY’s underlying index screens dividend stocks for positive dividend-per-share growth, a payout ratio of 60% or less, and a track record of at least five years of dividend payment. Then it selects the 100 highest-yielding stocks. The result is an ETF loaded with high-yielding, reliable dividend stocks.
This iShares fund is currently weighted heavily in utilities and financials (30% and 14% of the portfolio, respectively). Should the S&P 500 enjoy a robust bull market, this portfolio likely will not outperform. But it should keep paying a respectable stream of dividends every quarter.
The current dividend yield is 3.2%, putting it about on par with a corporate bond. And at 0.39%, the expense ratio isn’t exceptionally low by modern ETF standards, but it’s not prohibitively high either.
Vanguard Dividend Appreciation ETF
One of my favorite dividend ETFs — and one that I’ve held personally for years — is the DVY is the Vanguard Dividend Appreciation ETF (VIG).
Despite being labeled as a “dividend ETF,” VIG is not designed to throw off a lot of income. In fact, VIG’s dividend yield is only 2%, about the same as the S&P 500.
But that’s the thing. You don’t buy VIG or its constituent holdings for their dividends today; you buy them for their dividends tomorrow. This Vanguard ETF (and several competing ETFs) are based on various flavors of the Dividend Achievers Select Index. And the biggest factor here isn’t yield but rather consistency. The index requires a stock to have at least 10 consecutive years of rising dividends.
As simple as this criteria is, it’s remarkably powerful. There is no better signal of a company’s financial strength than a long history of raising its dividend. CEOs have a tendency to throw money around on empire building projects … or to simply stockpile it for a rainy day. So, a willingness by management to part with the cash by distributing it to shareholders via a dividend is a signal that they see a lot more of it coming.
I’ve used a basic rule of thumb since the last crisis: If a company was able to maintain or raise its dividend during the 2008-09 meltdown, chances are good that it won’t slash its dividend any time soon — or ever — because that stock survived the end of the world as we knew it. Well, any stock making the cut for VIG is a stock that managed to raise its dividend in 2008 and 2009. That tells you something about the quality of the stocks in the portfolio.
There are downsides to the 10-year screening criteria. You’re automatically stuck with older companies. A younger company with great dividend-raising prospects obviously wouldn’t make the cut. And as with any investment strategy that depends on historical data, there is no guarantee that a 10-year streak of raising dividends in the past will mean another good 10 years of increased payouts going forward.
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As they say, past performance is no guarantee of future results. But if you’re looking for a good, quality basket of stocks, VIG is a solid option.And it’s also about as cheap as you can get.
SPDR S&P Dividend
If a 10-year dividend track record is good, then a 25-year track record must be better, right?
Well, maybe. That’s Standard & Poor’s view, at any rate. S&P has a dividend growth strategy called the Dividend Aristocrats, which screens the companies within the S&P 500 for those that have hiked their dividends every year for at least the past 25 years straight. The SPDR S&P Dividend (ETF) (SDY) then takes that scrubbed list and builds a portfolio of the 50 with the highest dividend yields.
This will give you a portfolio with a slightly different complexion than VIG. To start, since you’re limited to S&P 500 companies, it’s going to be biased toward larger stocks. And that additional 15 years of dividends will generally mean you’re dealing with an older company. (A longer history of dividend payments does not necessarily mean an older company. But in practice, that is usually the case.)
The bottom line is SDY gives you a collection of older, slightly stodgier stocks. That’s not bad, mind you. If you’re a conservative investor, that might actually be a very good thing. And hey, “old and stodgy” describes most of Warren Buffett’s portfolio. But it’s definitely something to consider. I tend to prefer VIG’s shorter 10-year criteria, but I also have a personal investment time horizon of more than 20 years.
Global X SuperDividend U.S. ETF
A newest addition to the mix is the Global X SuperDividend U.S. ETF (DIV). Global X takes a slightly different approach in their portfolio, specifically targeting low-volatility stocks as part of their screening criteria.
They start with an initial universe of U.S. equities with betas less than 0.85 relative to the S&P 500 that also meet their minimum market capitalization and liquidity. The remaining stocks are then ranked by dividend yield, and the top 50 make the cut for inclusion in the ETF. These 50 stocks are equally weighted to reduce the risk of overweighting you see in traditional cap-weighted indexes, and the components are rebalanced annually.
DIV has a portfolio that looks a lot different from its fellow dividend ETFs. Sure, it has a 25% allocation to utilities. But it has 21% of its portfolio in mortgage real estate investment trusts (REITs) and 11% in master limited partnerships (MLPs) — two sectors generally excluded from other dividend ETFs. Personally, I’ve been bullish on both of these sectors for the past year, so I’m delighted to see them included here. But I also recognize fully that both of these sectors can be somewhat controversial, as both have come under fire for being financially engineered and overly leveraged.
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Still, if you’re looking for a different dividend ETF that might zig while its peers zag, this is one to consider. DIV pays a massive 6.3% dividend and has expenses on par with its peers.
Cambria Shareholder Yield ETF
I’ll leave you with one final dividend ETF, but one that is something of a hybrid: the Cambria Shareholder Yield ETF (SYLD), run by one of my very favorite quant analysts, Meb Faber.
The Cambria fund is not a pure “dividend ETF,” per se. Rather than measuring dividend yield exclusively, it ranks stocks with a combined score based on dividend yield, buyback yield and debt reduction. The thinking here is pretty straightforward. While dividends are an important way for management to take care of their shareholders, they’re certainly not the only way. Well-timed buybacks and debt reduction can also be shareholder-friendly ways to utilize cash.
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Because SYLD spreads its net a little wider, I’d consider it a good addition to any allocation of dividend ETFs. SYLD tends to be much less heavily exposed to the utility and consumer staples sectors that tend to dominate other dividend ETFs.
This article is by Charles Sizemore of InvestorPlace. He is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he was long DVY, VIG and SYLD..