What Are Dividend ETFs?

The answer to the question seems obvious. Dividend ETFs hold a basket of dividend-paying stocks. That said, there’s considerable variation between  different types of dividend ETFs. And, along with these differences, come considerations to make as an investor. 

In today’s Juice, we tie together a few recent installments on dividends and ETFs to illustrate the potential efficacy of dividend ETFs in your portfolio. They might be one of the better paths to using dividend income now and into retirement. 

Before we begin, it will help to check out some of these previous Juices. They cover meaningful background on what we will discuss today. 

How To Research An ETF?

Dividend Stocks In Retirement: The Biggest Lie?

What Are Dividend Growth Tech Stocks?

Types Of Dividend ETFs

We’ll provide examples throughout today’s Juice, including a couple from today’s Trackstar top five. 

Passive dividend ETFs. These ETFs track the performance of a broad, but dividend-specific stock market index. Not unlike how the S&P 500 Index ETF (SPY) mimics the returns of the S&P 500. Dividend ETFs just do it with indices made up of dividend stocks. 

For example, the dividend ETF investors search for most in our Trackstar database — the Schwab US Dividend Equity ETF (SCHD) — mimics the returns of the Dow Jones U.S. Dividend 100 Index. Therefore, SCHD owns and only owns the stocks that make up that index in the same concentrations. Some passive dividend ETFs get a little more specific, such as the #2 name in Trackstar — the Vanguard High Dividend Yield ETF (VYM) — which uses the FTSE High Dividend Yield Index as its benchmark. 

If you look at the holdings of these two ETFs, you’ll see some of the same names at the top of the list. Companies including Broadcom (AVGO), Home Depot (HD) and Merck & Co (MRK). These ETFs can help you diversify away from other funds often dominated by Apple (AAPL) and Microsoft (MSFT). In this recent Juice, we show you another way to get into ETFs where AAPL and MSFT are lower or not on the list of holdings. 

Active dividend ETFs. These dividend ETFs invest around themes or specific criteria. 

For example, the Amplify CWP Enhanced Dividend Income ETF (DIVO) takes an active approach, investing in, according to the fund, “high-quality dividend-oriented stocks, along with covered calls on individual stocks.” The Juice covers the use of covered calls in ETFs tomorrow. Not too long ago, we expanded on DIVO and similar ETFs. 

Reinvesting ETF Dividends

Just as you can with stocks, you can use a dividend growth investing strategy with ETFs. If an ETF you own pays a dividend, you can direct your brokerage to reinvest your dividend payments into new shares of the ETF. You can do this with most ETFs that make dividend payments to investors, not just dividend-focused ETFs. 

Dividend ETF Yield

Just as some investors concentrate on dividend yield when assessing dividend-paying stocks, you can do likewise with ETFs. For example, as of the end of February, SCHD yields about 3.5%. This means you can expect roughly $35 in dividend income for every $1,000 invested in SCHD, not counting how dividend reinvestment and other factors might impact this number. 

Living Off Of Dividend ETF Income?

As we noted in a couple of those above-linked Juices, the idea that you can live off of dividend income might be one of the most overhyped and deceiving concepts floated in the investment world. The reality is that to live off of dividend income, you need a huge amount of capital invested to start from. 

That said, you can certainly use dividend income to supplement life. And you can do this via dividend ETFs. 

Let’s say you have $500,000 invested between SPY, the Invesco QQQ ETF (QQQ), and a couple of pure dividend ETFs. Let’s say that, taken together, they pay a weighted average yield of 3.0%. That’s $15,000 in annual dividend income. 

Now, depending on your situation, it might just make sense to continue reinvesting that money. However, if you choose to collect your dividends as cash, that $15,000 breaks down to $1,250 per month. In Thursday’s Juice, we’ll cover the tax situation around this. But here, for illustration purposes, we’ll keep it simple and call it $1,250 per month. You’ll deal with taxes on all of your income come April (or whenever, or on Thursday!). 

You might have a house payment of $1,250, something that could be scary in retirement, so you could link your dividend income to that bill. Maybe you also have $2,000 a month coming in via Social Security. That covers the rest of your expenses. Maybe you bring in another $1,500 a month from some part-time work you do. Link that to some other expense. And do likewise with the rest of your investment or other income. That’s a viable plan, not some pie-in-the-sky, spend your life investing only in dividend stocks to end up disappointed fantasy. 

The Bottom Line: Like dividend stocks, dividend ETFs can make sense as one part of a comprehensive investment approach. However, we would hesitate on going exclusively with pure dividend ETFs only. Maybe you buy one or two, in addition to your holdings in SPY and QQQ, which also pay dividends. 

In tomorrow’s Juice, we define and discuss another income-producing type of ETF, covered call ETFs. Then, on Thursday, yes we will hit that subject the most ardent dividend growth investors love to ignore or, at least, gloss over, the taxes you might have to pay on your dividend income.

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