In low-interest-rate environments, high-yield assets become attractive to income seekers. Dividend ETFs (exchange traded funds) are a common choice for high-income investors. They hold a basket of dividend-paying REITs, preferred stocks, or common stocks.
Investors have three ways to buy dividend investments for passive income. You can buy individual stocks, buy dividend mutual funds, or invest in ETFs. All three of these decisions are justified, but dividend ETFs are different for a number of reasons. In this post, we’re going to examine the pros and cons of dividend ETFs and highlight a few that are worth a second look.
Dividend stocks have proven better than the stock market overall, but it’s not always easy for investors to pick individual stocks. This is where a dividend ETF can help. It’s important to know, however, that not all dividend ETFs are created equal, just as not all dividend investors have the same goals. Some invest in dividend stocks or ETFs for growth, while others invest in income. Both
Benefits of dividend ETFs
- Diversification. A dividend ETF is more diversified than a single stock. Although ETF stock prices can fluctuate just like stocks, your investment will be based on the aggregate performance of the ETF, not just a stock. It may well be that you are minimizing the disadvantage but also minimizing the advantage. A stock can go to zero, this scenario is unlikely with a diversified ETF.
- Higher earnings potential. Some ETFs may have higher highs as the company uses covered calls to get more income from their holdings.
- Free ETF fees. Some discount brokers do not offer fee transactions for ETF trades.
Disadvantages for dividend ETFs
- No discounted DRIPs. Some individual dividend stocks offer dividend reinvestment plans (DRIP). These programs offer investors the opportunity to build a stock position over time by using the dividends paid to buy back new stocks at a discount. Dividend ETFs only offer synthetic DRIPs through the discount broker.
- Mixed yield. Due to the nature of the ETF, investors receive a mixed return from the basket of stocks, bonds, or other investment vehicles.
- Distribution of income. Individual dividend stocks support tax credit by paying a dividend, but the ETF bundle can do many trades to provide investors with income that results in a distribution with different tax treatment. See the difference between dividends and payouts. Choosing the right investment account is important for tax tracking.
Should you buy them?
Yes, dividend ETFs have a place in an income generating portfolio. When looking for income, the benefits outweigh the disadvantages. For a growth portfolio, however, an index ETF is probably better.
Here is a list of dividend ETFs to get you started. See if these are suitable for your portfolio.
- S & P / TSX Canadian Dividend Aristocrats Index Fund (CDZ)
- BMO Canadian Dividend (ZDV)
- iShares Dow Jones Select Dividend Index (DVY)
- SPDR S&P dividend (SDY)
- WisdomTree LargeCap Dividend – (DLN)
- Vanguard Dividend Appreciation – (VIG)
Read the guide to Canadian Dividend ETFs for an overview of the top 10 positions.