Dividend investing has become an obsession. Books have been written about. YouTube channels have been dedicated to it. Some have an almost cult-like attachment to the Dividend Aristocrats.
Many investors flock to dividend ETFs because of their higher yields. In contrast, I like dividend ETFs for their lower valuation metrics. Given the high valuations in the S&P 500, an argument can be made to add a dividend ETF or mutual fund as a way to bring down the P/E ratio of a portfolio.
In that light, we’ll look at 5 excellent dividend ETFs to consider. We dive into each to understand how the portfolio is constructed and how each has performed over the past decade. We also look at three dividend ETFs we should avoid.
- What is a Dividend ETF
- How to Compare Dividend ETFs
- 5 Best Dividend ETFs
- 3 Dividend ETFs to Avoid
- Final Thoughts
What is a Dividend ETF
Virtually all stock ETFs generate dividends. Even an S&P 500 index fund has a yield (about 1.2% for those keeping score at home). The payment of a dividend, by itself, does not qualify a fund as a dividend ETF. Rather, a dividend ETF is a fund that invests in companies that pay a higher than average dividend yield.
Such a broad definition leaves room for a wide variety of investment strategies. Some funds focus on companies with high yields, while others focus on companies that are growing their dividends at a high rate. Still other ETFs limit their portfolios to companies that have increased their dividends each year for a set number of years (typically 5 to 20).
While each of these funds are rightly described as dividend funds, they couldn’t be more different.
How to Compare Dividend ETFs
To compare one dividend ETF with another, here are the factors I consider:
Dividend Yield: As I’ve stated repeatedly on my YouTube channel, total return should be an investor’s north star. That said, in evaluating a dividend ETF, the yield is an important factor. Here I’m more concerned with yields that are too high than too low. I’ve yet to find a dividend fund with yields 3x or more the market’s average that have performed well over long periods of time.
Dividend Growth: Beyond yield, look at how quickly the companies in a fund grow their dividends. Such companies often offer the best combination of returns–a dividend along with excellent growth prospects.
Dividend Stability: A high yield doesn’t help an investor if the company paying it is on shaky ground. Here I want to understand what percentage of a companies profits go to paying the dividend (i.e., Payout Ratio). A red flag would be a company who is borrowing money to meet the dividend expected by investors.
Fundamental Factors: One of the benefits of a dividend ETF is that a value approach to investing. Many dividend ETFs have P/E and P/B ratios well below the market average.
Expense Ratio: As with any investment, we need to understand the costs. An expense ratio above about 15 basis points requires scrutiny.
5 Best Dividend ETFs
1. Schwab US Dividend Equity ETF (SCHD)
The Schwab U.S. Dividend Equity ETF (SCHD) easily takes the #1 spot on my list. It has a yield about 2x the market’s average. It requires companies to have 10 consecutive years of dividend payments to make the cut. And most importantly, it has relatively low valuations. It’s P/E ratio is about 19. While that’s still high based on historical standards, it’s well below the valuations of the S&P 500 (currently more than 30).
The fund tracks the Dow Jones U.S. Dividend 100 index. The index screens companies based on the following criteria:
- Minimum 10 consecutive years of dividend payments
- Minimum float-adjusted market capitalization of US $500 million
- Minimum three-month ADVT of US $2 million
What makes SCHD a winner, however, is the fundamental analysis used in stock selection. Factors include return on equity, free cash flow to debt and the five-year dividend growth rate. The result is a fund that has performed well over the years.
Tracking Index: Dow Jones U.S. Dividend 100 Index
TTM Yield: 2.82%
Dividend History: 10 consecutive years of dividends
Expense Ratio: 0.060%
AUM: $27.8 billion
2. Vanguard Dividend Appreciation ETF (VIG)
The Vanguard Dividend Appreciation ETF (VIG) tracks the S&P U.S. Dividend Growers Index. Unlike SCHD and the Dow Jones U.S. Dividend 100 Index, this index requires companies to have increased their dividend in each of the last 10 years. It then excludes the top 25% based on yield.
The result is a fund that’s closer to a blend fund than value. It valuation metrics are higher (it’s P/E ratio is about 25) and its dividend yield is lower. In addition, it has underperformed SCHD by about 1% over the past 10 years. Of course, who will win the next 10 years is anybody’s guess.
Still, it’s a sold choice for those who want a dividend focused ETF that slightly tilts toward growth.
3. Vanguard High Dividend Yield ETF (VYM)
The Vanguard High Dividend Yield ETF (VYM) tracks the FTSE High Dividend Yield Index. Good luck finding details on this index. The best I could find comes from Morningstar:
The fund tracks the FTSE High Dividend Yield Index, which captures the highest-yielding half of the universe of dividend-paying stocks in the large- to mid-cap U.S. equity market. The index starts with the FTSE USA Index and ranks its constituents by their projected 12-month yield. It then adds stocks by descending rank until 50% market-cap coverage of the universe of dividend payers is reached. As it aims for 50% market-cap coverage of this cohort, the fund tends to sweep in 400 to 450 stocks. Companies that have not paid dividends in the past 12 months or are not expected to pay one in the next 12 months are not eligible. REITs are also left out.
It’s noteworthy that the index doesn’t apply qualitative factors to its stock selection. Companies in the top 50% based on yield make the cut.
While the fund has trailed others on this list over the past decade, its portfolio could do well as we rotate from growth to value.
Tracking Index: FTSE High Dividend Yield Index
TTM Yield: 2.72%
Dividend History: 12 months
Expense Ratio: 0.060%
AUM: $38.0 billion
4. iShares Core Dividend Growth ETF
iShares Core Dividend Growth ETF (DGRO) tracks the Morningstar U.S. Dividend Growth Index. The index screens for companies that–
- pay qualified dividends
- have a minimum of five years of uninterrupted annual dividend growth.
- have a significant margin to continue growing dividends.
It excludes the top 10% of qualifying companies.
Tracking Index: Morningstar US Dividend Growth Index
TTM Yield: 2.00%
Dividend History: 5 years of uninterrupted dividend growth
Expense Ratio: 0.080%
AUM: $20.1 billion
5. SPDR S&P Dividend ETF
SPDR S&P Dividend ETF (SDY) tracks the S&P High Yield Dividend Aristocrats Index. While the Dividend Aristicrats include companies that have increased their dividends for the last 25 years, this index limits the screen to 20 years. With this adjustment, it adds about 50 companies to its portfolio.
SDY has been the worst performing ETF in our list over the past 10 years. Its dividend has also been inconsistent. It dropped significantly in 2016 and again in 2018. Keep in mind that companies get cut from the index if their dividend payments can’t keep up, while new companies join who meet the criteria. One does wonder, however, if the fund is poised for a turn around as interest rates rise.
Time will tell.
Tracking Index: S&P High Yield Dividend Aristocrats Index
TTM Yield: 2.60%
Dividend History: 20 consecutive year history of increasing dividends
Expense Ratio: 0.35%
AUM: $19.0 billion
3 Dividend ETFs to Avoid
Just because an ETF pays a high dividend doesn’t mean it’s a good investment. In fact, a yield significantly above the market’s average should serve as a warning to stay away. Here are three dividend ETFs I wouldn’t recommend.
1. SuperDividend ETF (SDIV)
The SuperDividend ETF (SDIV) invests in the 100 companies that pay the highest dividend yield. The result is a portfolio consisting of 30% U.S. companies and 70% international companies. While its current yield is above 7%, its annual returns over the past decade barely exceed 3%.
Beyond performance, the fund has a turnover ratio of more than 124% according to Stock Rover. This increases costs. And its standard deviation is near 30 according to Morningstar.
In short, to sacrifices total return for yield, has high turnover and is volatile, resulting in a very poor investment.
Tracking Index: Solactive Global SuperDividend Index
TTM Yield: 7.19%
Dividend History: Top 100 global dividend yield companies
Excluded: Companies excluded based on certain qualitative screens
Expense Ratio: 0.590%
AUM: $948.9 million
2. SuperDividend U.S. ETF
The SuperDividend® U.S. ETF (DIV) is the U.S. only version of the above fund. While its yield is lower, it still comes in above 5.5%. And like SDIV, its total returns were just about 3% over the past decade. Not only does the fund suffer from poor returns, its volatility is significantly higher than an S&P 500 fund.
As with SDIV, DIV has a turnover percentage of near 100% and a standard deviation of 28. In short, investors are paying 45 basis points for an underperforming fund that comes with more risk.
Tracking Index: Indxx SuperDividend U.S. Low Volatility Index
TTM Yield: 5.61%
Dividend History: 12 month
Excluded: Dividend yields below 1% or above 20%
Expense Ratio: 0.450%
AUM: $655.8 million
3. Invesco High Yield Equity Dividend Achiever ETF
The Invesco High Yield Equity Dividend Achiever ETF (PEY) tracks the NASDAQ US Dividend Achievers 50 Index. The index in turn is comprised of the top 50 securities by dividend yield from the NASDAQ US Broad Dividend Achievers Index. The result is a focused fund that has significantly underperformed the S&P 500 while exposing investors to greater risk.
Tracking Index: NASDAQ US Dividend Achievers 50 Index
TTM Yield: 3.77%
Expense Ratio: 0.520%
AUM: $936.7 million
Dividend investing can be a part of a reasonable investment plan. Dividend ETFs give investors exposure to value funds. Taken to extremes, however, a dividend focused investment strategy can result in lower total returns. As a result, care must be taken not to reach for yield, even in retirement.