Why Dividend Investors Should Consider Dividend ETFs

Exchange-traded funds, commonly known as ETFs, have enjoyed a massive boom in the past few years. Assets have steadily migrated away from traditional mutual funds and into major ETFs, particularly index funds like SPDR S&P 500 ETF (SPY).

Investors have flocked to ETFs for a variety of reasons, and the ETF boom shows no signs of slowing any time soon. There is now an abundance of ETFs to choose from, across a variety of market sectors and asset classes.

ETFs that cater to a particular investing style are also available. For example, dividend investors will find many suitable ETFs. This article will discuss why dividend investors should consider ETFs, and a few top dividend-related ETFs.

Why Invest In ETFs?

Before the onset of the ETF wave, investors had two options to invest in equities. The most common way was through mutual funds, which pool assets and buy shares of multiple companies. The other way to invest in equities is by directly buying individual stocks, which carries its own unique risk factors. As a result, many investors are reluctant to invest in individual stocks, preferring the immediate diversification of mutual funds. But in the past decade, investors have steadily shifted towards ETFs, which offer all of the benefits of mutual funds, with significantly lower fees.

There are many reasons why investors are more heavily utilizing ETFs within their portfolios. ETFs provide instant diversification benefits. Whereas investors purchasing shares of individual stocks are exposed to specific company risks, ETFs allow the opportunity to buy tiny fractions of a basket of companies. Buying one index-related ETF, such as SPY, provides diversification immediately to the investor.

There are also benefits of buying ETFs in comparison to mutual funds. Traditional mutual funds often carry higher expense ratios than ETFs. Until recently, the difference was stark. This has caused a price war of sorts among asset managers. Many investment managers have cut fees on mutual funds, but even today, ETFs typically offer lower fees.

For example, SPY carries an annual expense ratio below 0.1% (.0945% currently), while many other investment managers charge much higher expense ratios for comparable index funds. In comparison, the Invesco S&P 500 Index Fund (SPAIX) has an annual expense ratio of 0.57% for the Class A shares. Such significantly higher fees can really add up over time.

Suppose an investor purchases $100,000 of SPY over 30 years, and earns an 8% average annual rate of return (or roughly 7.91% annual returns subtracting annual fees). In 30 years, the investor’s portfolio will be worth just over $980,000. Contrast this with an investor who invests $100,000 into the related Invesco S&P 500 mutual fund, earning an annual return of 7.43% per year after expenses are taken into account. This investor will end up with a portfolio worth approximately $853,000—roughly $127,000 less than the first investor.

Top Dividend ETFs

The benefits of investing in ETFs versus traditional mutual funds are clear. For investors who decide to invest in ETFs, there are a huge number of ETFs to choose from. Not only are there ETFs to cover every market sector, such as healthcare, technology, or utilities, but there are also various ETFs corresponding to specific investment styles. For instance, there are growth ETFs, value ETFs, or dividend ETFs.

Dividend investing has proven to be a successful strategy over time. At Sure Dividend, we are big proponents of investing in high-quality dividend growth stocks. Our favorite dividend growth stocks are the S&P 500 Dividend Aristocrats, a select group of 64 stocks with over 25 consecutive years of dividend increases. Fortunately, it is possible for investors to purchase ETFs that hold the S&P 500 Dividend Aristocrats for investors not wanting to buy individual stocks.

One main example is the ProShares S&P 500 Dividend Aristocrats ETF (NOBL). This is among the most well-known ETFs that tracks the S&P 500 Dividend Aristocrats. NOBL has net assets of approximately $5.5 billion, as of September 30, 2019. NOBL has a reasonable annual expense ratio of 0.35%. As mentioned, NOBL invests in the S&P 500 Dividend Aristocrats.

NOBL has a diversified list of holdings. The top fund sector is consumer staples, at 23.5% of assets. This is followed by industrials (22.1%); financials (11.9%); consumer discretionary (10.9%); health care (10.6%); and more. The top 5 individual stock holdings of the fund are Target NYSE:TGT, AT&T NYSE:T, Brown-Forman Corp. NYSE:BF.B, Sysco NYSE:SYY, and AbbVie Inc NYSE:ABBV. AT&T and AbbVie are two of our highest-ranked S&P 500 Dividend Aristocrats for 2020, due to their strong business models, competitive advantages, and high dividend yields above 5%, they are perfect as retirement stocks.

NOBL has performed very well, in relation to the broader market. For example, in the past 5 years through 9/30/19, NOBL produced total annual returns of 11.3%, compared with 10.8% annual returns for the S&P 500 Index. This has occurred during a rallying bull market, which may come as a surprise. Typically, investors might assume that an ETF of higher-yielding dividend stocks would underperform the broader market index but it’s not always the case. The graph below shows the valuation not adjusted for re-invested dividends which is where NOBL can outpace the index as it pays more.

NOBL vs Indexes

NOBL looks like an attractive dividend ETF for investors looking to purchase a dividend-growth ETF. The ETF has an average price-to-earnings ratio of 18.5, which is a reasonable average valuation that indicates fund holdings are not excessively overvalued right now. Furthermore, NOBL has a dividend yield of 2.5%, which is significantly higher than the broader market index. The S&P 500 Index has an average dividend yield below 2% right now. For similar performances, NOBL provides a higher dividend yield.

NOBL is the best ETF for investors looking to invest specifically in the S&P500 Dividend Aristocrats. But there are other suitable ETFs as well. The SPDR S&P Dividend ETF, which trades under the symbol SDY, was created by State Street Global Advisors, the same company that offers SPY. The Dividend ETF (SDY) has just under $20 billion in assets under management. It does not invest exclusively in Dividend Aristocrats; instead, it screens for companies that have consistently increased their dividend for at least 20 years in a row, weighting the stocks by dividend yield. The top holdings of SDY include AbbVie, AT&T, Amcor PLC, Exxon Mobil, and IBM. SDY has an annual expense ratio of 0.35%.

SDY vs Indexes

The Bottom Line

Investors have directed huge amounts of assets to ETFs in the past several years, due to their significantly lower fees than traditional mutual funds. Investors can generate excellent long-term returns over time by investing in high-quality dividend growth stocks such as the Dividend Aristocrats. For investors who prefer to invest in a basket of S&P 500 Dividend Aristocrats all at once, the two major dividend growth ETFs mentioned above (NOBL and SDY) are among the best ETFs in the market today.

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DISCLOSURE: Please note that I may have a position in one or many of the holdings listed. For a complete list of my holdings, please see my Dividend Portfolio.

DISCLAIMER: Please note that this blog post represents my opinion and not an advice/recommendation. I am not a financial adviser, I am not qualified to give financial advice. Before you buy any stocks/funds consult with a qualified financial planner. Make your investment decisions at your own risk – see my full disclaimer for more details.