You’re interested in building an income stream from dividends, but you don’t want to own and manage 20 or more dividend stocks. Here’s some good news: You can build a diversified portfolio of dividend-payers without picking a single stock. You’d use exchange-traded funds (ETFs) to do it.
Ready to learn more? Let’s dive into how and when ETFs pay dividends, which ETFs pay the highest dividends and the pros and cons of dividend ETFs vs. dividend stocks.
How And When Do ETFs Pay Dividends?
An ETF owns and manages a portfolio of assets. If those assets pay dividends or interest, the ETF distributes those payments to the ETF shareholders. Those distributions can take the form of reinvestments or cash.
ETFs that position themselves as dividend funds generally opt for cash distributions over reinvestments. This aligns with their mission to provide cash income for their shareholders.
ETF Ex-Dates, Record Dates And Payment Dates
As with a dividend stock, a dividend-paying ETF structures shareholder payments around an ex-dividend date or ex-date, a record date and a payment date.
- The ex-date is a deadline. If you want to receive a dividend for an ETF you don’t yet own, you must buy it before the ex-date. Transact on or after the ex-date and you won’t make it onto the registered shareholders list in time to be eligible for the dividend.
- The record date is usually one business day after the ex-date. Only registered shareholders as of the record date are entitled to the dividend.
- The payment date is when the fund sends out its dividends.
These dates won’t align with when the ETF collects dividends from the stocks in its portfolio. Consider a dividend ETF that owns 50 dividend stocks. Each of those stocks has its own dividend cycle and calendar of dividend dates. It would be inefficient to distribute those funds to ETF shareholders immediately. So, the ETF sets its own dividend schedule.
That could mean the ETF is collecting dividends monthly, reinvesting them in the fund temporarily, and then sending out aggregate payments to the ETF shareholders quarterly.
The ETF’s prospectus will specify which months it pays dividends. You can also look up a fund’s dividend history on various financial websites. For specific, upcoming dividend dates, follow the fund’s news releases and shareholder communications, which can typically be found on the ETF’s website.
With inflation at a 40-year high running at more than 7%, dividend stocks offer one of the best ways to beat inflation and generate a dependable income stream. Download “Five Dividend Stocks To Beat Inflation,” a special report from Forbes’ dividend expert, John Dobosz.
Highest Dividend ETFs
If you go hunting for a list of the highest dividend ETFs, you’ll likely see funds with yields that stretch into the double-digits. You should know that very high yields are often associated with riskier assets or complex trading strategies.
These approaches may have a small role to play in your portfolio, but they’re not what you’d consider core assets. You’ll be disappointed if you invest heavily in a high-yield fund that ends up being too volatile for your comfort level.
Some of the riskier elements to watch for in high-yield dividend ETFs include leverage, derivatives and emerging markets:
Some funds use leverage, or borrowed money, to amplify income and returns. The flip side, though, is that leverage also amplifies losses.
Gabelli Dividend & Income (GDV) is a dividend fund that uses leverage. The fund yields about 6%.
Derivatives are tradable financial contracts. The contracts often involve the right to purchase another asset in the future at a specific price. The value of the derivative depends on the value of the underlying asset relative to the contract terms.
Here’s a simplified example. Say you own a baseball card worth $5. Your neighbor believes that card will appreciate so she offers to give you $2 today for the option to buy the card from you in 60 days for $6. You agree.
The agreement is the derivative and it only has value if the baseball card is worth more than $8 in 60 days. At $8, your neighbor simply breaks even–$2 for the contact and $6 to buy the card. At $9, though, your neighbor could:
- Act on the contract and buy the card for $6. Then, she could sell the card for $9 and come away with $1 in profit.
- Or, she could sell the contract to a third-party for $2.50. That third-party would buy the contract and the card for $8.50 total. In this scenario, your neighbor and the third-party each notch a gain of $0.50. You, unfortunately, sold an asset worth $9 for $6, plus $2 on the contract.
The takeaway? Derivatives tend to be speculative and complicated. Funds can use them profitably, but there is a higher degree of risk.
JPMorgan Equity Premium Income ETF (JEPI) combines equity positions and derivatives to generate income and lower volatility. This fund yields more than v10%.
Emerging markets are developing economies that are getting more sophisticated in terms of production, investment and regulation. Examples, according to investment research company MSCI, include Brazil, Greece and China, among others.
These economies can experience rapid economic growth, but it’s accompanied by volatility. As such, many advisors recommend capping your emerging markets exposure to 5% or 10% of your portfolio.
iShares Emerging Markets Dividend Fund (DVYE) invests in 100 dividend-paying stocks in Brazil, China, Taiwan, India and other emerging markets. Over the last 12 months, the fund has yielded 9.5%. Notably, the share price has also dipped 36%.
Conventional High-Yield Dividend ETFs
There are high-yielding dividend ETFs that use more conventional trading strategies. Many of these provide a nice balance between risk and return. The table below highlights six dividend ETFs with varying exposures that might fit into your portfolio.
Dividend ETFs Vs. Stock Dividends
If you’ve been researching stocks that pay dividends, you might know that some very large companies pay dividend yields of 5% or more. Verizon (VZ) and chemical company Dow (DOW) are examples. In that context, you might wonder why you’d invest in dividend ETFs over dividend stocks.
There isn’t a universal answer. Whether ETFs or stocks are the better fit for you depends on your investment goals and how much time you want to spend managing your portfolio. ETFs are easier to manage, but stocks give you more precise control.
Here’s a closer review of the pros and cons of dividend ETFs relative to stocks.
Pros Of ETFs Over Stocks
Dividend ETFs are diversified. With ETFs, you can build a diversified portfolio from just one position. If you invest in stocks, you’d need 20 or more positions to achieve proper diversification.
Dividend ETFs are easier to manage than dividend stocks. Three or four ETFs are easier to maintain than 20 or 25 stocks. Monitoring and rebalancing your portfolio is simpler with fewer positions. Rebalancing involves making trades to restore your target asset allocation.
You may spend less on trading fees with ETFs. If you pay trading fees, investing in a small, stable set of ETFs will cost you less than a larger stock portfolio.
ETFs can provide safer exposure to companies or industries you don’t know very well. Say you are interested in investing in large, international dividend stocks. Unless you have specialized knowledge in this area, an ETF is usually safer than individual stocks. With an ETF, you have diversification and, usually, a defined, proven investment strategy on your side.
Cons Of ETFs Over Stocks
ETFs charge you fees. As an ETF shareholder, you pay your share of the fund’s expenses. Those expenses do reduce your net investment returns. The cumulative effect over time can be significant.
You can manage these expenses somewhat by choosing funds with low expense ratios. A low expense ratio on a U.S. large-cap index fund is something below 0.10%. You may have to accept higher expense ratios, up to 0.50%, for international equities and other specialized exposures.
You have less control over ETFs vs. stocks. You have no say in how your ETF manages its portfolio, other than approving of (or not) the fund’s investment approach. If you are particular about your exposures, build your portfolio from individual stocks.
ETFs don’t break out the way the stocks can. Individual stocks can beat the market, but dividend ETFs generally will not. The opposite is also true, however. Individual stocks may nosedive, while mainstream ETFs are less volatile.
Are Dividend ETFs Right For You?
Dividend ETFs may be a great option if you’re looking to build an income stream over time–but you don’t want the job of picking stocks. Lean into diversified funds with low expense ratios and reinvest those dividends if you can. You will pay taxes on the earnings, but reinvesting builds your share count and income potential faster.
If you enjoy researching stocks and managing your portfolio hands-on, then individual stocks may suit you better.
You can also take the middle ground. Invest in a few individual stocks alongside ETFs for diversity. This is a smart strategy. It allows you to build your investing confidence and your wealth at the same time. As you gain knowledge and experience, you can adjust your investing approach accordingly.
Source: Fox Business
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