High-dividend-paying ETFs are sought by investors who want income and long-term investment opportunities, but it is important to select wisely.
High-dividend-paying ETFs sound like those mythical creatures from a fantasy world where you have two private jets that will whisk you away to your tropical island paradise. Gentle waterfalls flow to crystal clear pools and you watch stellar sunsets every evening. The air is fresh and balmy and there are no mosquitoes. Then you wake up.
Tropical islands aside, there are benefits to holding high-dividend-paying ETFs in your diversified portfolio. Dividend ETFs tend to hold stocks that have historically paid dividends. However, as with all investments, just because an ETF has paid a dividend in the past, it doesn’t mean that it will always pay dividends.
Of course, ETFs are known for being diversified by nature. Many ETFs hold dozens of investments, and some even hold hundreds. These holdings are primarily spread across a sector, industry, or geographic location, leading to greater access to many companies. This level of diversification avoids putting too much emphasis on an individual investment. This way, no single company stock will make or break the ETF’s ability to produce income.
Understanding why passive investing and time commitments are key to profitable ETF investing
One significant benefit of some high-dividend-paying ETFs is that they practice passive investing. Traditional ETFs are known for passive investing, which is a process that aims to maximize returns by selling and buying investments minimally. Fewer instances of buying or selling lead to fewer fees and lower expenses. Due to minimal trading, an investor practicing a passive style is often attempting to hold investments over long periods.
It is also important to realize that high-dividend-paying ETFs can involve less of a time commitment because of their structure. Investing in individual stocks requires enough understanding and foresight on an investment before you make the purchase. Investors will look at the current trading statistics, past performances, and a slew of financial ratios before determining whether the investment would fit within a portfolio. ETF investors don’t put as much time into looking at all of the individual stocks that make up an ETF. Instead they look directly at the performance of the ETF.
Overall, passive investing is cheaper, less time-intensive, less complicated, and can lead to greater returns after taxes.
Should you consider investing in high dividend-paying ETFs?
Not all investment types fit every investor. Some investors have the time, understanding, and ability to focus solely on individual stock investments. As mentioned early, this is not the case for everyone, just as dividend ETFs are not everyone’s focus. For instance, a day trader interested primarily in short-term investments would not be an ideal candidate for investing in high-dividend-paying ETFs, because they are more geared towards long-term strategies.
Here are the types of investors who are more apt to invest in dividend ETFs:
Investors targeting long-term goals: Passively managed ETFs generally have lower fees and fewer tax implications, and lower fees over a long period can help compound your investment returns.
Older investors: The best dividend ETFs can provide income to investors. This is a benefit to older investors who need income and still want to maintain a diversified portfolio.
Investors who avoid risk: Dividend-focused ETFs will apply their own criteria for screening stocks for inclusion in the fund. These criteria may filter out weaker stocks or stocks that with at-risk or unreliable dividend payments. The fund’s description will often identify the criteria it uses specifically, or it can be found in the fund’s shareholder materials.
Are dividend ETFs part of your investing strategy? What has convinced you to include these investments in your diversified portfolio?
Nancy Zambell, Chief Analyst of the Financial Freedom Federation, has spent more than 30 years helping investors navigate the minefields of the financial industry. Nancy's book, Make Money Buying & Selling Stocks is an introduction for new investors and a reminder for experienced investors on how to profit in the stock market.Learn More