ETFs Made Easy: Dividend Fund Diversity

In hunting for yield, not all ‘dividend’ ETFs are created equal.

There are plenty of reasons investors like dividend-paying stocks.

At the core of it is simple history: While prices go up and down, there are stocks out there that pay a certain amount in dividends, year after year, often oblivious to whether the S&P 500 Index is up or down. There’s a certain solace in knowing that even if your portfolio is down 5 percent, you’ll still get a dividend check.

That perceived stability is one reason many investors in retirement look to dividend stocks as a source of spendable income. And, in fact, there is academic research backing up the idea that over the long term, dividends may be the most important part of your equity returns.

But when wading into the world of ETFs with the word “dividend” somewhere in their names, things can get a bit confusing.

First, let’s talk about how dividends end up in your pocket if you’re an ETF investor. Imagine you hold an ETF with 100 large-cap stocks in it. Over the course of the year, most of those stocks will likely be paying out dividends, which the ETF manager will collect.

Those dividends come in all the time, on different days, and that ETF manager will generally put that cash to work as it comes in, buying up more stock with those dividend proceeds. The issuers will keep track of the amount of dividends they’ve received, and every so often, they’ll send a distribution out to shareholders of the ETF.

Different funds will send out those distributions at different frequencies. The grand-daddy of dividend ETFs, the Vanguard Dividend Appreciation ETF (VIG | A-69), distributes accumulated dividends quarterly. The Global-X SuperDividend ETF (DIV | B-38) does so monthly. Other firms do it semiannually or even once a year.

But perhaps more important than how frequent the dividends are, is getting a sense of how big they’ll be. And here’s where things can get confusing.

Useful Metrics

Take DIV, the SuperDividend ETF, as an example. If you look on the overview page for the fund here at ETF.com, you’ll see a field called “Distribution Yield.” That’s a backward-looking measure of the last year’s worth of all distributions—dividends, capital gains, income—calculated with its current price.

DIV shows 5.47 percent there. It’s a useful statistic to understand how much you’ll need to worry from a tax perspective.

But what most people care about is what they can expect next quarter.

If you go to the “fit” tab on that same page, you’ll also see a field called “Dividend Yield.” For DIV, it’s 6.36 percent. That number is looking at the weighted average of the annual yield from the most recent dividend payments of all the individual stocks inside the portfolio.

It’s not a crystal ball—companies can and do change their dividends over time. But it’s a pretty shiny rearview mirror that should give you a good sense of what to expect.

Know The Strategy

It’s tempting to just look at the highest-yielding fund in the high-dividend yield segment—in this case, it is DIV—and say, “That’s the one for me.” But it’s important to recognize that different dividend strategies have very different goals.

DIV, for its part, is deliberately selecting a small, 50-stock portfolio of just high-yielding stocks. It’s not trying to represent the total market, and it includes big slugs of things like pipelines and real estate.

VIG, for its part, actually has the lowest dividend yield in the whole segment, but it’s not chasing yield specifically. Its methodology is looking for companies that have increased their dividends recently, with the idea being that they’re poised for growth.

In fact, every one of the 14 funds in the segment has a very different approach to using dividends to select and weight the portfolio.

Do Your Homework

So while the idea of dividend investing seems easy, it requires a really hard look at the competing funds to decide which one is right for you—more so than in many other segments.

In fact, one recently launched fund, the Reality Shares DIVS ETF (DIVY), doesn’t even invest in stocks at all! It uses derivatives to extract just the dividend-growth part of outperformance—a unique strategy Paul Britt explained in detail.

In other words, you absolutely cannot just look for the word “dividend” in a fund description and stop there. Dividend investing can make a lot of sense, but you can’t just take it at face value.

At the time this article was written, the author held no positions in the securities mentioned. You can reach Dave Nadig at [email protected], or on Twitter @DaveNadig.