Dividend ETF: What It Is & How To Find One (2024)

What Is a Dividend ETF?

A dividend ETF is an exchange-traded fund that holds dividend-paying stocks. Investors may choose dividend ETFs for income purposes or as a more stable alternative to growth stock funds. Investors may also be attracted to them because they commonly have lower expenses and are typically more tax-efficient than dividend mutual funds.

Dividend ETFs can also be an easier and more convenient way of holding a basket of dividend stocks, rather than building your own portfolio of individual dividend-paying stocks.

How Dividend ETFs Work

By owning dividend-paying stocks, various dividend ETFs collect the dividends and distribute them to the ETF shareholders. A dividend ETF normally makes dividend payments to its own shareholders on a periodic basis, such as quarterly. A dividend ETF will set an ex-dividend date, a record date, and a payment date for its dividends payments. Investors may choose to receive the dividends as cash or reinvest them to buy more shares of the ETF.

Dividend ETF taxation generally works the same way as a dividend-paying stock. Investors holding a dividend ETF for more than 60 days before the dividend was issued would pay a qualified dividend tax, which may be 0%, 15% or 20%, depending on the investor's income tax rate.

Tip: Dividend ETFs are generally considered to be tax-efficient investments. Many ETFs seek to passively track the performance of a benchmark index, and the passive management style typically requires very little turnover. This results in less frequent realization of capital gains, which minimizes capital gains taxes for investors.

Dividend ETF Types: 5 Categories

There are many different types of dividend ETFs, which are categorized by the types of dividend stocks that they hold. Common dividend ETF categories include high dividend ETFs, dividend REIT ETFs, dividend growth ETFs, dividend aristocrat ETFs, and international high dividend ETFs.

1. High Dividend ETFs

High dividend ETFs will seek to provide a high level of dividend income for investors. They may passively track the performance, less fees, of a benchmark index, such as the S&P 500 High Dividend Index.

Examples of high dividend ETFs include:

• Vanguard High Dividend Yield Index (VYM)
• iShares Core High Dividend ETF (HDV)

Important: It's worth noting that higher yielding Dividend ETFs are not necessarily better investment choices.

2. Dividend REIT ETFs

Dividend REIT ETFs, or dividend real estate ETFs, invest in a basket of real estate investment trusts (REITs), which are known in the investment community for yields that are often higher than typical equity dividend stock.

Examples of REIT ETFs include:

• Vanguard Real Estate ETF (VNQ)
• Global X SuperDividend REIT ETF (SRET)

3. Dividend Growth ETFs

Dividend growth ETFs focus on stocks of companies with a history of consistently growing their dividends.

Examples of dividend growth ETFs include:

• Vanguard Dividend Appreciation ETF (VIG)
• WisdomTree U.S. Quality Dividend Growth Fund (DGRW)

4. Dividend Aristocrat ETFs

Dividend aristocrat ETFs invest in dividend growth stocks that are in the . These are stocks of companies that have increased their dividends every year consecutively for 25 years.

Examples include:

• ProShares S&P 500 Dividend Aristocrats ETF (NOBL)
• SPDR S&P Dividend ETF (SDY)

5. International High Dividend ETFs

International high dividend ETFs primarily hold non-U.S. stocks of companies that have paid consistently high dividend yields over time.

Examples of international high dividend ETFs include:

• iShares Select Dividend ETF (IDV)
• Vanguard International High Dividend Yield ETF (VYMI)

Note: The dividends paid by some international companies may not be considered qualified dividends, however, and may trigger higher taxes for investors.

Evaluating Dividend ETFs

When evaluating and choosing the best dividend ETFs for a particular strategy or portfolio, investors may look for certain objectives or measures, such as dividend yield, dividend growth, and dividend quality.

• Dividend yield: The dividend yield reflects what % return investors are set to receive on the current share price. If a company's stock price is $20/share, it pays $0.20/share in quarterly dividends, the dividend yield would be 4%.
• Dividend growth: Also called dividend growth rate (DGR), this is the percentage growth rate of a company's dividend.
• Dividend quality: This is measured by the degree of quality or creditworthiness of the companies represented in the ETF. For example, if an ETF holds small-cap stocks or emerging markets stocks with a history of volatile business results, dividend quality may be low.

Warning: Higher yielding dividend ETFs are not necessarily superior to lower yielding dividend ETFs. In fact, higher yields are usually representative of higher risk. For instance, if investors become worried about the prospects for a certain dividend-paying company or ETF, the share price may drop, which would result in an increasing dividend yield. Also, struggling companies may need to offer higher yields in order to attract capital from dividend-hungry investors. This is why investors are wise to dig deeper and assess dividend quality, not just the level of the dividend yield.

Pros & Cons of Dividend ETFs

Pros of Dividend ETFs

• Diversification: Dividend investors can buy a diversified basket of dividend stocks in just one dividend ETF, which may consist of dozens or hundreds of holdings.
• Convenience: Compared to individual dividend stocks, dividend ETFs can be much easier investments to manage. Instead of researching and analyzing multiple stocks to hold in a portfolio, an investor can simply find the best dividend ETF to suit their needs.
• Income: Dividend ETFs can be a smart way for an investor seeking income to create a revenue stream.
• Relative stability: Many dividend ETFs tend to be less volatile than broader market indexes, especially growth-oriented stocks.

Cons of Dividend ETFs

• Lack of control: As is the case with other fund types, investors have no control over security selection with dividend ETFs.
• Blended income: Dividend ETFs payout a dividend yield that is a blend of the underlying holdings. If some holdings in a dividend ETF reduce dividends, the overall average yield can decline.
• Price risk: Declines in price in some market environments may outweigh dividend yields and create a net negative return.

Bottom Line

Dividend ETFs can be a convenient means of gaining exposure to many dividend-paying stocks via a single fund. While dividend ETFs can provide more stable returns than growth stocks, there remains a risk of losing principal from these ETFs. Dividend investors should carefully select dividend ETFs that align with their investing goals and risk tolerance.