Whew, today’s topic is going to be controversial, at least in the dividend growth communities. I’m all about stirring the pot if it makes us all a little bit more informed. I will discuss dividend ETFs and if they will be suitable for your portfolio.
I always seem to be rude, so let me get this out of the way. Welcome back to the Investing for Dividends series (101, 102, 103, 104, 105), one of my longest-running series. Here, we talk about ways to maximize our dividend portfolios with long-term investing strategies. Now, let’s get into dividend ETFs.
What are ETFs? Electronic Traded Funds (ETFs) are a collection (or bundle) of stocks that companies group together to trade on a stock exchange. The entire collection trades as one security, just like one company, say McDonald’s, trades on the stock exchange.
Investing Insider vs. Outsider
The benefits of ETFs. There are two main benefits of ETFs; simplicity and diversity. By purchasing one ETF, you can diversify into potentially hundreds of companies. This technique makes it simple to invest because you do not have to research each underlying company individually.
Index funds are ETFs—they track an index such as the Dow Jones Industrial Average or the S&P 500. Other companies create their own index based on specific requirements and then have their ETF track the index they created. This allows ETFs to function without active management—making their fees extremely low.
However, creating an index to track passively has its issues. I will get more into the problems later, but let me give you an example for now. Say I create the hamburger index that includes all the companies that sell hamburgers. I can now make the Hamburger ETF that passively tracks my index.
My robots would make trades based on the index. It could be an awesome ETF when I have McDonald’s and Wendy’s as my star companies. But what if Josh’s Burgers became a listed company on the stock exchange. My ETF, by definition, would have to trade Josh’s Burgers’ stock—this is where issues will come in later.
Stocks vs. Cryptos
What are Dividend ETFs? Dividend ETFs are ETFs that want to capture the magic of dividend investing, lowering the barrier of entry. They also give the holders much more diversity, which is great during rough patches like the 2020 pandemic.
A quick refresher on dividend growth investing. DGI is a subset of income investing. The goal of dividend growth investing is to find companies with growing profits, growing stock prices, and that increase their dividend payment year over year.
You may even say that income is a secondary metric of the DGI community. DGI folks are more concerned with the total return—a combination of capital appreciation and reinvesting dividends.
McDonald’s is an excellent DGI stock as they have increased their dividend for 40 straight years. Here are a couple of great articles on McDonald’s growth over the years (CNBC and The Motley Fool). DGI investing is straightforward because of the power of compounding.
So the question becomes, will you capture the power of DGI through investing in dividend ETFs? And, of course, the answer is yes and no. The answer lies in the example I gave above; you will get the good stocks and the bad with a random index.
How We Plan to Retire on Dividends
Part of a good DGI strategy is knowing when your favorite stocks are selling at a discount and doubling down on them. For example, during the OPEC nightmare in April 2020, one of my favorite oil DGI stocks, Exxon Mobil (XOM), was down to $37 from a high of $90 a few years earlier.
If you had added a little more cash to your XOM position, you would have reaped the benefits of capital appreciation and an increase in income. Following your stocks closely is a principle of the DGI community.
If you had invested in dividend ETFs, you could have bought at reasonable prices in March 2020, but the returns wouldn’t have been the same. To summarize, due to how dividend ETFs pick their indexes, they will have to allocate funds to crappy stocks.
For me, I invest in Closed-End funds when investing for income. I have a DGI portfolio (Charles Schwab), and I also have a portfolio of dividend ETFs (Wells Fargo). When it comes to pure income investing, I find that closed-end funds suit my taste the best.
Who benefits the most from DGI? I would say investors in their 30s, 40s, and 50s will benefit the most from DGI. These cohorts have the most time to let the power of compounding work its magic.
The Velocity of Money and How it can Make You Rich
Who benefits the most from Dividend ETFs? I would say that investors in their 50s and 60s would benefit the most from dividend ETFs. They may not have the time to track 10-20 companies. ETFs will give them some income and some growth, which is all we can really ask for nowadays.
Who benefits the most from Closed-End Funds? Anyone looking to replace their earned income with dividend income should have a small or medium-sized allotment of closed-end funds. CEFs are actively managed, meaning they do not have to keep loser stocks around. Their only purpose is to get you income, sometimes at 9-10%. CEFs, however, have little to no growth prospects.
Why I invest in Dividend ETFs. I still love dividend ETFs. As I said, they do give you some solid income (3-4%) and some growth (appx 3-4% capital appreciation). I have never been disappointed by my dividend ETFs because I know what to expect. Some dividend ETFs even have dividend growth streaks.
Dividends vs. Royalties part I
One of the fantastic things about DGI is watching your stocks give you a pay raise. It is truly a great feeling to watch as your companies increase their dividend for the upcoming years. Yesterday, one of my favorite DGI stocks, Altria (MO), increased its dividend. I love this aspect of DGI, and I miss that feeling with my dividend ETFs.
My favorite Dividend ETFs. My two favorite dividend ETFs are Wisdom High Dividend ETF Fund (DHS) and Invesco S&P 500 Dividend ETF (SPHD). As you can see below, they both have some excellent appreciation and yield roughly 4%. They also both pay monthly, which is terrific as well. On the far right, you can see their annual dividend payout.
Are Dividend ETFs a good fit for your portfolio? I think everyone has room for a monthly dividend payer or two. If you are not a DGI purist, which only believes in blue-chip stocks, then dividend ETFs can be a fantastic fit; I have no complaints.
Is Saving Money Bad?
However, I caution against filling up your portfolio with only dividend ETFs. Learning about your companies is vital to the long-term sustainability of your dividend portfolio. There is room for all flavors of dividends, such as preferred shares, dividend ETFs, closed-end funds, bond funds, index funds, and REITs.
As I said in “Let Dividends be Your Lighthouse through Retirement,” we need to plan for our golden years as soon as we are born. There is no room to “play around.” Dividend investing is best when we begin the journey as early as possible.
Having an excellent portfolio of blue chips and some dividend ETFs is a good way to hedge yourself against a company going bust in the future. There are some very good dividend ETFs that should meet your income and appreciation needs.
Ensure you do your due diligence and pick the winners. I keep 3-5 dividend ETFs in my portfolio at all times, so I am a fan. You will have to see how you can fit them into your portfolio. I hope this helps you out a little. Please grab the Free PDF ebook on the way out. Enjoy and Happy Investing.
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