Why Income Investors Should Consider Dividend ETFs

This is a guest contribution by Bob Ciura of Sure Dividend. Sure Dividend helps individual investors build high quality dividend growth portfolios for the long run.

We believe long-term income investors can generate superior returns by buying high-quality dividend growth stocks and holding them for the long run. Specifically, we favor the Dividend Aristocrats, a group of 64 stocks in the S&P 500 that have increased their dividends for at least 25 consecutive years.

While the Dividend Aristocrats have outperformed the S&P 500 Index in the past 10 years (with less volatility as well), there are certain drawbacks to owning individual securities. For investors who would prefer a one-stop shop for dividend growth investing, dividend exchange-traded funds can be very useful. There are a number of dividend ETFs that are attractive for income investors looking for instant diversification.

Benefits of Exchange-Traded Funds

Exchange-traded funds, otherwise known as ETFs, have enjoyed increasing popularity in the last 10 years, as a more cost-effective alternative to traditional mutual funds. Previously, investors looking for a basket of securities had to opt for mutual funds. While mutual funds provided diversification, they often carried excessive annual fees, sometimes above 1%-2% per year. In addition, many mutual funds also had front-end or back-end fees that investors had to pay when making their initial investment, or when selling their investment.

ETFs became highly popular with investors because they typically carry much lower fees, particularly as it pertains to index funds. For example, the SPDR S&P 500 ETF Trust (SPY) was the very first exchange-traded fund listed in the United States back in 1993. Since then, it has grown into a giant in the ETF industry, with nearly $240 billion in assets under management as of March 17. It is a very popular option for index investors, as it has an annual gross expense ratio of just 0.0945%. This compares very favorably to mutual funds that also track the S&P 500 Index, such as the Invesco S&P 500 Index Fund Class A Shares which have an annual expense ratio of 0.55%.

The other key advantage of ETFs versus mutual funds is liquidity. Mutual funds are priced and traded only once per day, after the market close, whereas ETFs are traded all day. This provides greater liquidity for ETF investors.

Taken together, it is easy to see why ETFs have exploded in popularity over the past few years. There is a wide variety of ETFs to choose from, not just those that track the major stock indexes, but also those that track various market sectors or asset classes. Income investors looking for dividend growth ETFs have a number of available options.

The Best Dividend ETFs Today

At Sure Dividend, we are proponents of investing in high-quality dividend growth stocks. Our belief is that by selectively purchasing individual stocks, investors can cherry-pick the best dividend growth stocks for their portfolios. But purchasing individual stocks requires a greater level of due diligence, as it exposes investors to company-specific risks. Investors buying individual stocks need to keep a close eye on the company’s quarterly earnings reports and financial press releases, to make sure its financial position and growth remain on track.

For investors who do not have the time or desire to perform this due diligence, ETFs are a suitable alternative as they provide instant diversification. Fortunately, there are many ETFs that cater to dividend growth investing. Our top dividend ETF is the ProShares S&P 500 Dividend Aristocrats ETF (NOBL), as it is the only ETF that specifically tracks the Dividend Aristocrats.

NOBL employs an equal-weighting strategy to invest in all the Dividend Aristocrats simultaneously. As of September 30, 2019, the fund held all 57 Dividend Aristocrats at the time—the number of Dividend Aristocrats has since risen to 64, so it is almost certain the fund will update its holdings to reflect the new list of Dividend Aristocrats. NOBL has a current dividend yield of 2.6%, which is slightly higher than the average yield of the S&P 500, and it has a reasonable expense ratio of 0.35%. Just a few of NOBL’s holdings include Walmart, Johnson & Johnson, and 3M.

For investors who prefer to invest in a broader basket of stocks, we prefer the Vanguard Dividend Appreciation ETF (VIG). This ETF does not solely invest in the Dividend Aristocrat; instead, it seeks to track the performance of the NASDAQ Dividend Achievers, a group of stocks that have increased their dividends for 10 years in a row or longer. The Dividend Achievers list includes approximately 260 stocks, so it is much more comprehensive than just the Dividend Aristocrats.

Vanguard ETFs are especially popular because of their very low expense ratios, and VIG does not disappoint in that regard. VIG has an annual expense ratio of just 0.06%. As of February 29, 2020, VIG had total assets of $48.4 billion and 182 stocks in its portfolio. The top holdings are Microsoft, Visa, Procter & Gamble, Walmart, and Johnson & Johnson. There is some overlap with NOBL, as VIG holds all the Dividend Aristocrats, but it also holds Dividend Achievers such as Microsoft and Visa which do not currently qualify as Dividend Aristocrats. Whereas the NOBL fund is equally-weighted, VIG is more concentrated. The top 10 holdings of VIG comprise 35.5% of fund assets.

VIG has a lower dividend yield than NOBL, currently at 2%, but it could generate stronger dividend growth in the years ahead due to its allocation towards more growth-oriented companies such as Microsoft and Visa.

Final Thoughts

There are many benefits to owning individual stocks. Investors can selectively choose the best dividend growth stocks for their portfolios, while avoiding annual fees entirely. But for investors who do not want to take company-specific risks and instead prefer instant diversification benefits, ETFs are a better option than traditional mutual funds because of their lower fees. Our favorite dividend related ETFs are NOBL, which specifically tracks the Dividend Aristocrats and has an above-average dividend yield, and VIG, which tracks the Dividend Achievers and has an extremely low expense ratio along with stronger dividend growth potential.

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