Income stocks that pay a steady dividend can offer investors a sense of security no matter what the broader market is doing. Even better, income investors today can target yields from several types of dividend ETFs beyond straight-up income stocks.
XAn exchange traded fund is a basket of stocks, bonds or commodities that trade like individual stocks. Since equity ETFs comprise multiple stocks, they often carry lower risk than owning a few individual securities.
ETFs have also quickly gained popularity because investors can buy or sell them throughout the day, unlike mutual funds. They also tend to cost less and are more tax efficient than their mutual fund counterparts.
Investors today face a plethora of choices when hunting dividends. Dividend ETFs range from high-yield stock and bond funds, to bond ETFs with set maturities. Industry tracker ETF Database, for instance, shows more than 200 dividend ETF offerings made up of equities, preferred stocks, bonds and even real estate.
High Dividend Yield Stock ETFs
If you're looking for dividends, why not go for the biggest dividends? That's what these dividend ETFs try to do. But keep in mind that just because a company pays big dividends doesn't mean it's a fast grower in terms of earnings or stock price performance.
A popular choice among investors in this category is Vanguard High Dividend Yield (VYM). The $28.7 billion fund, which tracks the FTSE High Dividend Yield Index, offers a 12-month yield of 3.06%. That's well above the S&P 500's average 1.84% payout. It's also one of the cheapest high dividend ETF options available, with a 0.06% expense ratio.
As of Oct. 31, top 10 holdings included Dow Jones Industrial Average stocks JPMorgan (JPM), Johnson & Johnson (JNJ), Procter & Gamble (PG), Exxon Mobil (XOM) and Intel (INTC). The top 10 stocks accounted for nearly 27% of the 405 -stock portfolio.
High Yield Bond ETFs
While bond ETFs may sound like a safe haven, high-yield bond funds are actually better suited for investors who know how to handle exposure to high risk. These dividend ETFs invest in riskier assets such as junk bonds and senior loans, which may pay bigger yields than other bond ETFs. But they carry higher exposure to default risk, or the inability to pay back debt. The underlying bonds tend to carry credit ratings that are below investment grade. In addition, as interest rates rise, junk bond demand often falls.
IShares iBoxx $ High Yield Corporate Bond ETF (HYG) is up 7% this year (through Dec. 2). The $19 billion fund, though, boasts a 12-month yield of 5.19%. SPDR Bloomberg Barclays High Yield Bond ETF (JNK), with $10.1 billion in assets, is also up 7%. Its annualized dividend yield is 5.55%.
Dividend Growth ETFs
Dividend growth ETFs seek companies with steady profit and sales growth, which could lead to increased dividends over time. Vanguard Dividend Appreciation ETF (VIG), with $40.9 billion in assets, tracks the Nasdaq U.S. Dividend Achievers Select Index, comprised of profitable U.S. companies with a track record of boosting their dividends for at least the past 10 consecutive years.
Top five holdings as of Oct. 31 were Microsoft (MSFT), Procter & Gamble, Walmart (WMT), Visa (V) and Comcast (CMCSA). The five blue chips made up about 21% of the 182-stock portfolio. Procter & Gamble and Walmart are S&P 500 Dividend Aristocrats, companies that have increased their dividends each year for at least the past 25 consecutive years. Microsoft has boosted its payouts every year since it paid its first dividend in 2004.
Strategic Bond ETFs
Strategic bond funds typically hold a diverse portfolio of bonds. These dividend ETFs can own bonds that invest in different types of debt such as Treasuries, high-grade and high-yield corporates, foreign bonds and municipal bonds with different maturities. There are many strategies investors can choose from with various risk/reward profiles.
A more recent type of bond fund is the strategic beta bond ETF, which uses lower-cost indexes that weight holdings in nontraditional ways. WisdomTree Yield Enhanced U.S. Aggregate Bond ETF (AGGY), for instance, tracks an index that parses the Barclays U.S. Aggregate Bond Index based on sector, maturity and credit quality. The ETF overweights those with the highest yields. AGGY, launched in July 2015, offers a 12-month yield of 3.06%.
Another strategic beta bond offering, iShares Edge Investment Grade Enhanced Bond (IGEB), launched in July 2017. The $92.2 million fund combines quality and value, according to Morningstar Inc., and reduces risk by filtering out the 20% of bond issuers with the highest default probability.
Target-Maturity ETFs
Another type of dividend ETF is the so-called target-maturity or defined-maturity bond ETF. A straight-up bond fund continually buys and sells bonds, so the bond fund gives up a feature in individual bonds that investors find attractive: when they mature, investors get their principal investment back plus any interest they've collected along the way. The target-maturity bond ETF holds fixed-income investments that have similar maturities. For instance, a fund may own short-term corporate bonds that all mature in 2019, or those that mature in 2022.
When the bonds mature, the ETF closes and the cash goes back to the investors. Guggenheim's BulletShares and iShares iBonds Term offer about 40 target-maturity bond ETFs. The maturities cover 2018 to 2026 and range from corporate to municipal to high yield.
Holding hundreds of bonds with the same maturity year helps spread risk in case of downgrades or defaults. They can also help protect investors from rising interest rates. As with individual bonds, investors might have to accept a lower price if they sell before maturity when prices are down due to downgrades or rising rates. But if they hold to maturity, they get the par value of the bond back.
Follow Nancy Gondo on Twitter at @IBD_NGondo
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