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Wed. Dec. 5, 2007

Dividend Investing With ETFs *

This article appeared in the Carnival of Personal Finance #130.

Dividend investing is not necessarily limited to individual stocks. I have found that exchange traded funds (ETFs) offer a viable option when looking for income producing investments. As noted in my The Process… article, 16.5% of my after-tax portfolio is allocated to dividend/income ETFs. The goal of this portion of my investments is to provide growing dividend income with lower risk than owning individual stocks.

I am currently invested in the following ETFs:

  1. SPDR S&P Dividend ETF (SDY) – The Fund seeks to replicate as closely as possible, before expenses, the price and yield of the S&P High Yield Dividend Aristocrats Index. The Fund uses a passive management strategy designed to track the price and yield performance of the Dividend Index.
  2. Vanguard Financials ETF (VFH) – Vanguard® Financials ETF seeks to track the performance of a benchmark index that measures the investment return of financial stocks.
  3. Vanguard Dividend Appreciation ETF (VIG) – Vanguard® Dividend Appreciation ETF seeks to track the performance of a benchmark index that measures the investment return of common stocks of companies that have a record of increasing dividends over time.
  4. Vanguard REIT ETF (VNQ) – Vanguard® REIT ETF seeks to provide a high level of income and moderate long-term capital appreciation by tracking the performance of a benchmark index that measures the performance of publicly traded equity REITs.
  5. Vanguard High Dividend Yield ETF (VYM) – Vanguard® High Dividend Yield ETF seeks to track the performance of a benchmark index that measures the investment return of common stocks of companies that are characterized by high dividend yields.

Each of these ETFs are relatively new and therefore do not have a long history to evaluate their dividend track record. Based on the limited data available, these ETFs have the potential to perform to the level I look for when purchasing a dividend stock.

Why would I choose an ETF instead of a mutual fund? ETFs are easily bought and sold through a broker. ETFs held long-term are tax-efficient because of the way they are created and redeemed. A custodial bank holds a basket of stocks in the ETF’s account for a fund manager to monitor. Shares are sold representing ownership in the basket of stocks. Generally, there isn’t much activity in these accounts that would generate taxable capital gains, which are normally distributed. This allows an investor to defer capital gains to when the ETF is sold.

Do you utilize ETFs in your investing strategy?

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6 Responses to “Dividend Investing With ETFs *”

  1. RTR says:

    Thanks for sharing!

  2. Joe says:

    One ETF I was looking into for it’s dividend yields was PFF which invests in Preferred Stocks, and currently pays over 11%, but then I went into a different direction – how to get dividends with preservation of capital:

    There is a very conservative options strategy called a “collar strategy” where you hold a stock (or an index) and sell covered calls against it, and use the money from the calls to buy “insurance” using puts. I’ve been doing a lot of research into using this strategy. It looks like a very good conservative strategy. While you can “roll this yourself”, it’s a lot of work. I have found 2 ways to have somebody else implement this for me. One is a service: http://www.swaninvesting.com/ and requires a large investment ($400K), and the other is a closed-end fund (traded on the NYSE): Eaton Vance Risk Managed Diversified (symbol: ETJ). Currently ETJ pays almost 10% dividends, which can be reinvested, but because it is a closed-end fund, it can trade either below, at, or above it’s Net Asset Value.

  3. Gina says:

    I’m new to dividend investing and would like to know whether ETF’s work as well as stocks when it comes to the increase in dividends. Do ETF’s generally increase their dividends like most stocks do?

  4. Gina: ETF can work like a dividend stock. However, my experience with them has shown they are more volatile with dividends moving up and down each quarter (more down than up lately). Currently, I prefer selecting good individual dividend stocks where the dividends are more stable and more likely to increase.

    Best Wishes,
    D4L

  5. Jason says:

    D4L,

    Love the website, keep it up.

    Can you help me understand how the distributions of dividends work within an ETF structure? Does it work the same as a single stock where you see the dividend show up in your account?

    Apologies if the question is vague. If there are resources you can point me to to help that would be much appreciated.

    Best,
    Jason

  6. Jason: An ETF works just like an individual stock. The dividends show up in your brokerage account.

    Best Wishes,
    D4L