Dividend ETF: What it Means, How it Works

What Is a Dividend ETF?

A dividend ETF is an exchange-traded fund (ETF) designed to invest in a basket of dividend-paying stocks. The fund manager will choose a portfolio of stocks, based on a dividend index, that pays out dividends to investors, thereby working as an income-investing strategy for individuals that purchase the ETF.

Understanding a Dividend ETF

Dividend ETFs are established in order to gain high yields when investing in high-dividend-paying common stocks, preferred stocks, or real estate investment trusts (REITs). Dividend ETFs may contain only U.S. domestic stocks, or they may be global dividend ETFs, which have an international focus.

Most indexes used to create the dividend ETFs hold stocks with above-market dividend yields and a higher than average level of liquidity. These will vary, however, based on the ETFs that a fund manager picks and their specific investment approach.

Dividend ETFs are passively managed, meaning they track a specific index, but the index is usually screened quantitatively to include companies with a strong history of dividend increases as well as the bigger blue-chip firms that are generally considered to carry less risk.

A dividend ETF’s expense ratio should be lower or equal to the least expensive, no-load mutual fund. No-load mutual funds, by definition, can be bought or redeemed after a certain length of time without a commission or sales charge. Dividend ETFs are generally recommended for the generally risk-averse stock investor who is income-seeking.

Dividend ETFs vs. Other ETFs

Generally, ETFs offer investors the option to diversify within a given index; meaning that they will gain broad exposure to many stocks within a given index. Investors can also sell short, buy on margin, and purchase as little as one share, as ETFs have no minimum deposit requirements. Furthermore, expense ratios are lower than those of the average mutual fund for most ETFs.

The main reason investors purchase ETFs is that they are easy to buy and sell like stocks, they offer diversification, broad market exposure, and they have low costs due to their low expense ratios. Investing in dividend ETFs offers one strategy, but there are a number of other types of ETFs investors might research and add to their overall investment portfolio.

An IPO ETF, for example, can be appealing for investors who want to gain exposure to IPOs during their initial introduction to the market. They can diversify their investment across a pool of IPOs from a variety of sectors and industries. The advantages in IPO ETF investments are rooted in the benefits from potential upside growth in the share price. Yet, initial IPO success doesn't spell long-term stability, as the value of holdings can decrease in value later.

Index ETFs track a benchmark index like the S&P 500 as closely as possible. Investors can buy and sell index ETFs throughout the day on a major exchange, and investors gain exposure to a variety of securities in one transaction. Depending on which index the ETF tracks, index ETFs can include both U.S. and foreign markets, specific sectors, or various asset classes, such as small-caps or blue-chips.

Finally, an ETF of ETFs tracks other ETFs instead of an underlying stock or index. An ETF of ETFs allows for more diversification than other ETFs. These are actively managed like managed funds, versus passively managed like other ETFs, so they can be designed to factor in variables such as risk levels or time horizons. This approach can provide investors with low fees, immediate diversification, and broad exposure to strategies across different asset classes.

Investing in Dividend ETFs

Investors can access ETFs through their brokers or simply purchase an ETF like a stock on their own through online brokerage services. Some of the most popular ETFs are as follows:

• Vanguard Dividend Appreciation ETF (VIG)
• Fidelity International High Dividend ETF (FIDI)
• iShare Core High Dividend ETF (HDV)
• SPDR S&P Global Dividend ETF (WDIV)
• Schwab U.S. Equity Dividend ETF (SCHD)