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.
5 Dividend ETF Pros
- Liquidity. Dividend ETFs are highly liquid. They trade like stock, so investors can buy and sell them throughout the day. Unlike mutual funds, investors have the choice to sell ETFs short or exercise options.
- Diversification. A dividend ETF is a more diversified than an individual stock. Although ETF share prices can fluctuate just like stock, they are less risky. A stock can go to zero, this scenario is unlikely with a diversified ETF.
- Lower Expense Ratios. Dividend ETFs are passively managed and track a specific index. That means they have lower expense ratios when compared to actively managed dividend mutual funds.
- Tax Benefits. Dividend ETFs are superior to mutual funds when it comes to taxes. Mutual funds may hit investors with unexpected taxes, even if they haven’t sold. Dividend ETFs have lower turnover and a lower tax bill. Capital gains are realized upon sale of the ETF.
- No Minimums. Like regular ETFs, dividend ETFs have no minimums. This makes them ideal for small investors who want to diversify, but don’t have enough cash to reach a mutual fund minimum purchase amount.
3 Dividend ETF Cons
- No 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. Dividend ETFs do not have DRIPS.
- Trading Fees. Since ETFs trade like a stock, you pay commission for each buy and sell. This means that ETFs are not ideal for dollar-cost averaging. Mutual funds have the advantage over dividend stocks or ETFs in this area. But keep in mind that mutual funds have higher expense ratios than ETFs.
- Lower Yield. Dividend ETFs invest in a portfolio of high-yielding dividend stocks. Since a dividend ETF is a basket of securities, it’s yield is an average of all the holdings. That means that some individual dividend stocks can have higher yields than the aggregate ETF.
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)
– Market Vectors Uranium & Nuclear Energy (NLR)*
*NLR is not a “dividend” ETF, but it currently offers an attractive yield
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