In low-rate environments, high-yielding assets become attractive for those seeking income. Dividend Exchange Traded Funds (ETFs) are a common choice for income investors. They hold a basket of dividend paying REITs, preferred stocks, or common stocks.
Investors have three options when buying dividend producing investments for the purpose of generating passive income. They can purchase individual stock, buy dividend mutual funds, or invest in ETFs. All three choices have merit, but dividend ETFs stand out for several different reasons. In this post we will explore the pros and cons of dividend ETFs, and highlight a few worth taking a second look at.
Dividend stocks have proven to outperform the stock market at an aggregate but it’s not always easy for investors to select individual stocks. This is where a dividend ETF can help. However, it’s important to know that not all dividend ETFs are equal just like not all dividend investor have the same goals. Some invest in dividend stocks or ETFs for growth and some do it for income. Both
Pros of Dividend ETFs
- Diversification. A dividend ETF is a more diversified than an individual stock. Although ETF share prices can fluctuate just like stock, your investment is based on the aggregated performance of the ETF and not just on one stock. It can be good since you minimize the downside but you also minimize the upside. A stock can go to zero, this scenario is unlikely with a diversified ETF.
- Higher Yield Potential. With some ETFs, the high can be higher due to the company using covered calls to generate more income from the holdings.
- Free ETF fees. Some discount brokers offer no fee transactions on ETF trades.
Cons for Dividend ETFs
- No discounted DRIPs. Some individual dividend stocks offer dividend reinvestment plans (DRIP). These programs are a way for investors to build a stock position over time, using the dividends paid out to repurchase new shares at a discount. Dividend ETFs only offer synthetic DRIPs through the discount broker.
- Blended Yield. Due to the nature of the ETF, investors end up with a blended yield of the basket of stocks, bonds or other investment vehicles.
- Income Distribution. Individual dividend stocks will support the tax credit by paying a dividend but the ETF bundle can do many trades to provide investors with income resulting in a distribution with various tax treatment. See the difference between dividends and distribution. For tax tracking, choosing the right investment account is important.
Should You Buy Them?
Yes, dividend ETFs should be a part of your diversified portfolio. If you are looking for income, then the pros outweigh the cons. Here is a list of dividend ETFs to get you started. Take a look and see if these are right 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)
Feel free to review the guide to Canadian Dividend ETFs with a review of the top 10 holdings.