The Best Dividend ETFs for Building Income
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The Best Dividend ETFs for Building Income

In our journey through investment strategies, we’ve explored the critical role of bond ETFs. These instruments are pivotal in any diversified portfolio, particularly in volatile economic climates. Bond ETFs strike a delicate balance between stability and income generation, which is vital for a well-rounded investment approach.

The concept of diversification is often hailed as the only “free lunch” in the investment world. It involves spreading investments across various asset classes – a mix of individual stocks, bonds, cash, and ETFs. This strategy is instrumental in mitigating risk while simultaneously optimizing long-term income. Diversification is more than a mere investment tactic; it’s a fundamental principle that underpins successful long-term portfolio management.

Today, we shift our focus to dividend ETFs that excel in delivering income appreciation. Our selection encompasses ETFs tailored to diverse investor needs, ranging from those seeking steady income to others eyeing income and growth.

Categories of ETFs:

  • Dividend ETFs: Ideal for investors seeking steady income streams. (Focus of this article)
  • Growth ETFs: Targeted towards those aiming for capital appreciation.
  • Sector-specific ETFs: Perfect for investors looking to capitalize on particular industry trends.
  • Specialty ETFs: These offer unique investment opportunities outside the traditional market categories.

The Best Dividend ETFs

StrategyETFTickerExpense RatioYield
International High-YieldVanguard International High Dividend Yield ETF(VYMI)0.22%4.45%
High-YieldSPDR S&P 500 High Dividend ETF(SPYD)0.07%4.66%
High-Yield Dividend GrowthSchwab U.S. Dividend ETF (SCHD)0.06%3.59%
High-Yield DividendVanguard High Dividend ETF(VYM)0.06%3.25%
20+ Years Dividend IncreasesSPDR S&P Dividend ETF(SDY)0.35%2.6%
10+ Years Dividend IncreasesiShares Core Dividend Growth ETF(DGRO)0.08%2.61%
25+ Years Dividend IncreasesProShares S&P 500 Dividend Aristocrats ETF (NOBL)(NOBL)0.35%2.29%
10+ Years Dividend IncreasesVanguard Dividend Appreciation ETF(VIG)0.06%1.85%

In-Depth Examination of each Individual ETF:

Vanguard International High Dividend Yield ETF (VYMI):

  • Strategy & Composition: This fund aims for a balance between high yield and managed risk. It tracks the FTSE All-World ex U.S. High Dividend Yield Index, focusing on large and mid-cap stocks. The strategy is to select stocks with high expected dividend yields, prioritizing larger, more stable companies for downside protection.
  • Performance & Risk Profile: This ETF offers an attractive yield with a reasonable level of risk, leveraging the stability of large firms. The portfolio’s average return on invested capital often surpasses its benchmark index.
  • Market Cap & Diversification: The ETF is weighted towards financials and energy sectors, with significant exposure to mature non-US markets and emerging markets. It’s highly diversified, with over 1,300 holdings, ensuring a broad spread of risk.

SPDR S&P 500 High Dividend ETF (SPYD):

  • Focus & Index Tracking: SPYD measures the performance of 80 high dividend-yielding companies within the S&P 500. The index covers a broad range of large-capitalization U.S. equities, including common stocks and REITs.
  • Valuation & Quality: The ETF is characterized by slower-growing U.S. companies with an attractive PE ratio and strong financials. It shows good sector diversification, with a heavier tilt towards REITs, energy, and utilities.
  • Portfolio Makeup: This ETF holds 79 companies, with the largest names predominantly in the energy sector. It’s designed to offer an attractive combination of income and stability.

Schwab U.S. Dividend ETF (SCHD) – A High-Yield Focused ETF:

  • Strategy & Index Alignment: SCHD constructs a portfolio of disciplined dividend stocks with strong fundamentals, mirroring the Dow Jones U.S. Dividend 100 Index. The fund emphasizes value stocks and includes safeguards to diversify risk and reduce turnover.
  • Fundamentals & Performance: This ETF stands out for its focus on fundamentals, targeting stocks on firm financial footing, which promotes a durable yield. The portfolio often outperforms its category benchmark in terms of profitability and risk-adjusted returns.
  • Concentration & Diversification: While the portfolio is somewhat concentrated with 100 companies, measures are in place to ensure diversification, limiting individual stock and sector weights.

Vanguard High Dividend ETF (VYM):

  • Approach & Index Tracking: This fund seeks a balance between high yield and risk management, fully replicating the FTSE High Dividend Yield Index. It focuses on stocks with a strong dividend payment history, excluding REITs and companies with uncertain dividend futures.
  • Turnover & Risk Profile: VYM typically features lower turnover and firm-specific risk compared to its peers. Its market-cap-weighted approach leans towards mature industry leaders, providing a relatively stable investment option.
  • Diversification & Holdings: The ETF is well-diversified across various sectors, with a slight overweight in consumer defensives. It holds a large number of companies, further spreading risk and enhancing its appeal for long-term, risk-averse investors.

iShares Core Dividend Growth ETF (DGRO):

  • Investment Strategy: DGRO seeks to track the investment results of an index composed of U.S. equities with a history of consistently growing dividends. It targets dividend companies with a focus on sustainable growth.
  • Risk Management: The fund starts with a broad list of dividend-paying companies, then applies filters such as payout ratios of 75% or less, avoiding the top 10% yields to reduce the risk of future cuts.
  • Portfolio Composition: DGRO offers a reasonable valuation compared to the broader market. It boasts a high percentage of wide-moat companies, indicating quality and stability. The ETF is well-diversified across sectors, with a significant tech representation.

SPDR S&P Dividend ETF (SDY):

  • Focus on Dividend Stability: SDY invests in the market’s most disciplined dividend stocks. The fund has a quality tilt and seeks to securely pursue yield over the long term.
  • Dividend Growth Requirement: The index strategy requires each stock to have increased its annual dividend for at least 20 years. This stringent criterion ensures a portfolio of fundamentally sound companies.
  • Sector Biases and Performance: SDY’s yield weighting results in a large-value category, but with significant sector tilts, most notably toward utilities. The fund’s stringent dividend growth requirement leads to a diversified portfolio, albeit with a different composition than its benchmark.

ProShares S&P 500 Dividend Aristocrats ETF (NOBL):

  • Strategy for Consistent Dividend Growth: NOBL focuses on S&P 500 companies with at least 25 consecutive years of dividend growth. The fund is equally weighted and rebalanced quarterly.
  • Portfolio Characteristics: Known for its high valuations, NOBL targets premium companies commanding a growth premium. It has a substantial allocation in consumer staples, basic materials, and industrials, with a lower representation in tech.
  • Risk and Return Profile: The fund’s balanced approach towards long-established dividend-paying companies offers a mix of stability and moderate growth potential, appealing to conservative investors focused on income consistency.

Vanguard Dividend Appreciation ETF (VIG):

  • High-Quality Dividend Growers: VIG focuses on companies with a solid record of growing dividends. It uses a market-cap-weighted approach for stable companies that have increased dividends for at least 10 consecutive years.
  • Sector Allocation and Performance: As of its recent analysis, the fund was overweight in industrials and consumer staples, and underweight in technology and energy. This sector orientation, combined with stringent selection criteria, balances income, capital appreciation, and risk.
  • Investment Outlook: VIG is particularly noted for its strong diversification across almost 300 companies, with significant exposure to very stable companies like Microsoft, Johnson & Johnson, Procter & Gamble, and others. It is an attractive choice for investors seeking dependable dividend growth and lower market declines during downturns.

Historical Performance Analysis

In this section, we will examine the historical performance of each ETF, providing insights into their past achievements and trends. This analysis is crucial in understanding how these ETFs have fared over time, helping investors gauge their potential future performance.

Vanguard International High Dividend Yield ETF (VYMI):

  • Performance Since 2017: Despite its global high-yield focus, VYMI has not matched the performance of the tech-heavy S&P 500 in the last six years. It experienced similar annual volatility to the S&P 500 but suffered a higher peak decline during the pandemic.
  • Returns & Dividend Growth: The ETF has shown variable dividend income growth, with significant cuts during the pandemic. Its inflation-adjusted returns stand at 21%, compared to 89% for the S&P 500.

SPDR S&P 500 High Dividend ETF (SPYD):

  • Performance Since 2017: SPYD exhibits slightly higher annual volatility compared to the S&P 500. It experienced a higher peak decline during the pandemic but has shown a strong recovery in dividends in 2022.
  • Overall Returns: The ETF has provided 67% inflation-adjusted returns versus 89% for the S&P 500.

Schwab U.S. Dividend ETF (SCHD):

  • Performance Since 2011: SCHD has matched the S&P 500’s performance over time with slightly lower volatility. It boasts stable dividend growth since 2012 and has experienced less decline during market downturns, including the 2022 bear market.
  • Returns Comparison: The ETF has delivered 334% inflation-adjusted returns, closely aligning with the S&P 500’s 326%.

Vanguard High Dividend ETF (VYM):

  • Performance Since 2008: VYM has generally kept pace with the S&P 500, offering a 1% higher yield. Its 10-year return average of 12.1% is expected to beat the S&P 500’s 10.6% over time.
  • Market Downturns: The ETF demonstrated relatively good resilience during the pandemic, with more stable dividend growth over time.

SPDR S&P Dividend ETF (SDY):

  • Performance Since 2005: SDY has matched the S&P 500’s performance for much of its history, with similar volatility. It offers a 0.8% higher yield and has shown resilience in market downturns.
  • Returns and Income Variability: The ETF has achieved >300% inflation-adjusted returns and has experienced variable income over time.

iShares Core Dividend Growth ETF (DGRO):

  • Performance Since 2014: DGRO has slightly outperformed the S&P 500 for much of its history with lower volatility. It offers a 0.5% higher yield and has shown good resilience during market downturns.
  • Overall Performance: The ETF has delivered inflation-adjusted returns nearly matching the S&P 500’s performance.

ProShares S&P 500 Dividend Aristocrats ETF (NOBL):

  • Performance Since 2013: NOBL has kept up with the S&P 500 throughout most of its history, offering a 0.7% higher yield. It has shown good resilience during market downturns.
  • Returns Overview: The ETF has yielded 107% inflation-adjusted returns compared to 128% for the S&P 500.

Vanguard Dividend Appreciation ETF (VIG):

  • Performance Since 2006: VIG has closely matched the S&P 500’s performance over time with lower volatility. It offers a slightly higher yield and has demonstrated strong resilience in market downturns, including the Great Recession.
  • Dividend Stability: VIG stands out for its stable dividend growth, having never cut its dividend, even during the Great Recession.

The Trade-offs of Investing in ETFs

In this section, we address the limitations and potential drawbacks of investing in ETFs. While ETFs offer numerous benefits, including diversification and ease of management, it’s crucial to understand their inherent limitations to make informed investment decisions.

Limited Fundamentals Due to Diversification:

  • Diluted Impact of High Performers: One of the intrinsic limitations of ETFs is that their performance is often an average of all included stocks. This means the impact of individual high performers might be diluted within the broader fund.
  • Comparison with Individual Stock Portfolios: In contrast to individual stock portfolios, which can be meticulously crafted for specific goals and risk tolerances, ETFs offer a one-size-fits-all solution. This can lead to suboptimal performance in certain market conditions.

Overpaying for Some Components:

  • Market Valuation Variances: Given the diverse nature of ETFs, investors might end up overpaying for some components. The stock market is dynamic, with companies being constantly overvalued and undervalued. ETFs, by their nature, cannot adjust quickly to these fluctuations, which can lead to inefficiencies.
  • The Issue with Automatic Rebalancing: Unlike individual stocks, where investors can choose when to buy or sell based on valuation, ETFs automatically rebalance, potentially leading to buying high and selling low.

Dividend Stability and Variability:

  • Dividend Stocks vs. ETFs: While individual stocks, like 25+ years dividend streaks, might offer consistent dividends over decades, ETFs can exhibit more variability in their annual payouts.
  • Impact of ETF Construction: The construction of an ETF, such as NOBL’s focus on 25+ years dividend aristocrats, can lead to variability in annual income. For example, despite VIG’s stable dividend growth, its quarterly dividends can still be variable.

Augmenting ETFs with Individual Stocks

Combining ETFs and Stocks for Maximum Income Stability:

  • The Role of Individual Stocks: To counteract the limitations of ETFs, particularly in terms of dividend stability and tailored risk management, investors might consider augmenting their ETF holdings with individual stocks.
  • Diversified Approach for Risk Management: This strategy involves creating a diversified portfolio that includes several ETFs across different asset classes, complemented by individual stocks chosen for their specific attributes, such as high dividend yield or growth potential, as in the Road To $1 Million Portfolio.

Conclusion:

In this concluding section, we synthesize the insights gathered from our comprehensive analysis of various dividend ETFs and offer final recommendations. Our goal is to guide investors in selecting ETFs that align with their investment goals and risk tolerance, ultimately contributing to a robust, diversified portfolio.

The Role of ETFs in Diversification:

  • Ease of Diversification: ETFs offer a straightforward way to achieve diversification across various sectors, investment styles, and geographic regions. This is especially beneficial for investors looking to spread risk without the complexity of selecting individual stocks.
  • Low-Cost Exposure to Different Markets: Many ETFs provide exposure to a wide range of markets and investment themes at a lower cost compared to actively managed funds, making them an ideal choice for cost-conscious investors.

Tailoring ETF Selection to Individual Needs:

  • For Dividend Growth Investors: Investors focused on dividend growth might consider ETFs that have consistently demonstrated strong performance in both dividend yield and growth, such as SCHD and VYM.
  • Seeking Stability and Performance: ETFs like VIG offer a blend of stability and performance, with a track record of lower declines in market downturns and consistent dividend growth.
  • Exploring Broad Market Exposure: For those seeking broad market exposure, ETFs like DGRO provide a mix of yield, growth, and diversification.

Recommendations Based on Analysis:

  • SCHD: With a 3% yield and a strong growth profile, SCHD is recommended for its historical market-beating performance and stable income growth.
  • VYM: Offering nearly a 3% yield and a robust growth profile, VYM is known for its stable income growth over time and one of the longest track records in the industry.
  • VIG: As an ETF with the widest moat collection of blue-chips, VIG is close to a perfect dividend ETF, never having suffered a down year in dividends, even during the Great Recession.
  • DGRO: This ETF offers a wide moat collection of US companies focused on sustainable growth and with a history of dividend increases. With a solid eight years of performance, low volatility, and dependable income growth, this ETF represents the right choice for anyone looking to achieve long-term stable income growth.

Building a Diversified and Risk-Managed Portfolio:

  • Incorporating ETFs into Portfolio Strategy: A balanced investment strategy can include a mix of 33% to 50% in ETFs, serving as the core of a diversified portfolio.
  • Ensuring Flexibility and Adaptability: The selected ETFs should offer the flexibility to adapt to changing market conditions and align with the evolving financial goals and risk profiles of investors.
  • Long-Term Perspective: Regardless of market fluctuations, these ETF recommendations are positioned to provide stability and growth over the long term, helping investors build a resilient and productive portfolio.

Road To $1 Million

Start Date: 04/17/2023

As of 04/19/2024:

  • Portfolio Value: $26,682
  • Left to reach $1M: $973,318

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