Advisors Favoring Dividend ETFs May Not Like What Happens Next

Warning to investment advisors: you may not like what you’re about to read. 

Hopefully, that’s even more incentive to read it. Because it's better you do the investment “dirty work” than have your clients tell you that you haven’t. 

While the glory of dividend investing is a priority for many advisory clients, be aware that it shares some elements with chasing high-flying AI stocks. For example, both assume that any price is a good price to pay. 

At this stage of the market cycle, expecting too much from dividend ETFs is a potential trap. We'll show you how to size up the current situation and explain it to clients.

High Yield Dividend ETFs' Total Return Problem

Yield is nice, but at what price? Many of the more popular dividend ETFs suffer from twin maladies in early 2024: either their yields aren't high enough to help retired clients meet their withdrawal rates, or the ETFs show few signs of emerging from a multi-year funk versus growth and total return-oriented ETFs. 

With US Treasury Bill rates still ranging from 5.0%-5.5%, the entire Treasury yield curve comfortably above 4.0% and credit bonds (corporate, high yield and municipal) adding some fixed return over government bonds, investing for the dividend payment is an uphill climb. 

Sure, there are dividend ETFs with very high yields. For instance, the $740 million Global X Super Dividend ETF (SDIV) sure does live up to its name with a 12.2% yield. But when total return is the question, the answer has consistently been “not here.” SDIV’s 10-year annualized return is -3.8%. And while that may eventually reverse course, in which case SDIV would be a double-win situation (yield and total return), the risk to an advisor recommending high yielding equity ETFs is that the client loves the sticker price (dividend yield level), but then sees red ink and questions the decision. 

SDIV is an extreme case, given its global exposure and mandate of searching for very high yielders. But similar risks continue to be present in some of the most popular dividend ETFs, such as the $63 billion Vanguard High Dividend Yield Index Fund ETF (VYM) and the $53 billion Schwab US Dividend Equity ETF (SCHD). Each has a fairly long history, but other than the temporary yield spikes in 2020 (pandemic) and 2008 (global financial crisis), neither has seen a yield as high as 4%. VYM is at 3.0% currently, while SCHD checks in at 3.4%. 

High Dividend Yield and Quality: Competing Interests

VYM and SCHD have earned large followings with simple, solid dividend stock selection processes, but each has produced only single digit returns cumulatively since the start of 2022. And each has received a giant price return lift from Broadcom Inc., which has more than doubled in price over that time. 

AVGO was yielding close to 3% two years ago, but now spins off only a 1.5% annual dividend rate. That leaves advisors wondering if the “juice” of the tech stock boom over the past year is somewhat of a false signal that can't be sustained, unless another super-stock meeting the ETFs’ dividend stock selection criteria comes along.

Quality yield is easy to find. But quality yield at a dividend percentage level is a challenge for advisors. Clients want yield, but at what risk is the question, given the potential bubble-like nature of the parts of the stock market that have masked the weak returns of the broader dividend stock segment of the ETF business. 

Sometimes, simple approaches work. And as such, it makes sense for advisors to discuss with clients the risks of reaching for yield as well as investing in dividend stocks that don’t currently reach T-bill payout levels. They will need a strong stock market in 2024 and beyond to make up for the pedestrian yields many dividend ETFs provide right now.