Dividend ETFs: Income Option For Troubled Times

John D. Rockefeller once had this to say about happiness. “Do you know the only thing that gives me pleasure? It’s to see my dividends come in.”

Old man Rockefeller had it right. At a time when investors crave regular income, dividend ETFs are in demand, and when they  “come in”, they’re making a lot of otherwise cranky investors fairly happy.

The stock market offers a good deal of uncertainty these days, and getting paid in cold, hard cash can ease the pain of even the most volatile markets. Much like the lesson Baby Boomers and their families are learning from the Great Depression, especially in terms of budgeting and spending, investors are learning another great lesson from the Depression Generation – that dividend stocks can be manna from heaven when Modern Portfolio Theory starts proving to be a bust.

Dividends Work – Here Are Some Good Reasons Why

Clearly, dividend investors know what they’re doing. Category returns hold up extremely well:

  • From 1926 through 2010, reinvestment of dividends accounted for 97% of the stock market’s total return after inflation.
  • Weighting by dividends can raise a portfolio’s dividend yield. Research shows that portfolios comprised of the highest dividend-yielding stocks within the S&P 500 Index have historically outperformed the S&P 500 Index as a whole.
  • Cash dividends provide an objective measure of a company’s value and profitability — one that cannot be manipulated.
  • Potential bear market protection — as stock prices fall, investors can buy more shares with reinvested dividends.

Source: WisdomTree.com

Key Types of Dividend ETFs

Increasingly, dividend-oriented investors are turning to exchange-traded funds to get their income fix.

We’ll list some of the most promising dividend ETFs below, but first know the facts – not all dividend ETFs are created equal. Primarily, they break out in three categories:

  • High dividend yield funds – The most common brand of dividend ETFs, high dividend yield funds aim for all the current income they can get. Capital gains – what most equity funds strive to accumulate  – isn’t a priority with high dividend yield funds. It’s all about income. A good benchmark fund in this category is the iShares Dow Jones U.S. Select Dividend ETF (DVY), which holds the top dividend-paying funds in the U.S, as measured by fund managers on a year-to-year basis. Getting into this select club isn’t easy for dividend-paying companies. Each must provide a five-year track record of dividend payments, and must have a dividend payout ratio of 60% of earnings or less.
  • High dividend growth – The second member of the dividend ETF class is the “growth rate” dividend fund. Essentially, fund managers make this one fairly simple. Managers in an ETF like the Powershares Dividend Achievers ETF (Stock Quote: PFM) want to see companies that have raised their dividend rates for 10 or more years, on a consecutive basis. Those are the types of companies that dividend investors love – stable, growing, and capable of keeping right on paying those dividends for years to come.
  • Dividend weighting – Again, the science behind the third class of dividend ETFs isn’t complicated. While most ETFs are weighted by key barometers like market capitalization, dividend weighted ETFs are measured by more fundamental criteria – like earnings and dividends. The WisdomTree Total Dividend Fund (Stock Quote: DTD) may well be the prototypical dividend weighted ETFs, and it’s one of the highest dividend paying funds.

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Dividend ETFs Worth Considering

What dividend ETFs should be at the top of your tire-kicking list? There are plenty to choose from – but these might be among your first choices:

Vanguard Dividend Appreciation (Stock Quote: VIG) – Like the Powershares Dividend Achievers ETF, the Vanguard Dividend Fund is strict about including companies with one key characteristic – they have hiked their dividends for 10 consecutive years. With $8.2 billion in assets, Vanguard may classify this fund in the “Large Blend” category, but the only blend investors should care about is the one that mixes fund assets with companies with a great track record of paying out dividends.

iShares Dow Jones U.S. Select ETF (Stock Quote: DVY) – With an 8.05% year-to-date return so far in 2011, and a 6,70% average return over the past three years, the iShares U.S. Select Fund attracts no shortage of investors – it has about $6.4 billion in assets. The fund is one that Warren Buffet would love – it covers companies that it strongly believes will ride out the tough economic times and grow substantially over time. But for the present day, this ETF loves its dividends, and loads up on companies that pay them. Big name U.S. brands like Lorillard and Kimberly Clark are big components of the fund.

SPDR S&P International Dividend ETF (Stock Quote: DWX)  – This high-flying ETF falls into the foreign large cap dividend category, and is having a stellar 2011, with 8.90% year-to-date returns. The SPDR Fund is a big one – it holds about 100 global companies that specialize in providing great dividend yields. But the real story with the SPDR S&P International Fund is in its dividend yield – at an ample 4.19%, it’s one of best ETFs in its class.

There are plenty of other great dividend yield ETFs to check out – PowerShares International Dividend Achievers (Stock Quote: PID), with a nice mix of emerging market stocks, and iShares High Dividend Equity ETF (Stock Quote: HDV, with a good assortment of dividend-paying health care and consumer goods stocks, come immediately to mind.

So go ahead and do your homework, and know that by focusing on dividend paying ETFs, you’re helping to bullet-proof your investment portfolio – at a time when it needs it most.

John Rockefeller recognized that, and happily so.

By Brian O’Connell