Investors who like dividend-paying stocks should love exchange-traded funds (ETFs) that focus on dividend stocks – they provide the same benefits but with diluted risks.
With the stock markets gyrating and traditionally "safe haven" investments like U.S. Treasuries offering historically low yields, dividend stocks offer the lure of a reliable income stream.
"Dividends provide you with an income far better than you can get in bonds and with considerable protection against a down market," said Martin Hutchinson, Money Morning's Global Investing Strategist.
Yet dividend stock ETFs also provide some measure of protection from a financial crisis at an individual company.
"Dividend ETFs mitigate the risk a company might commit the ultimate sin: suspend or cut a dividend," Matt Krantz writes for USA Today. "By owning one ETF, which owns shares of hundreds of dividend-paying stocks, if just one company halts its dividend, the impact to the investor will be relatively small."
ETFs own stocks like mutual funds, but are traded on the markets in "units" just like stocks. The units can be created (requiring the fund to buy more shares of the underlying stocks) or destroyed (requiring the fund to sell shares) to accommodate investor demand.
The Power of Dividends
Many investors underestimate the power of dividends. Hutchinson pointed to a study by Yale economist Robert Shiller that showed that dividends accounted for 67% of the average real return on common stocks from 1889 to 1998.
"While stock prices have been plunging, dividend payments are rising," Hutchinson said. "Through Aug. 31, 243 companies in the Standard and Poor's 500 Index increased or initiated a dividend payment. In fact, dividend payments are expected to end 2011 up 18% from 2010."
Companies that manage ETF funds have created an increasing number of dividend stock ETFs to serve investors hungry for ways to add more dividend income to their portfolios.
The Four Best Dividend Stock ETFs
Standard & Poor's Capital IQ Equity Research recently analyzed 1,100 ETFs to see which of the funds that focused on dividends had the best yields and excelled in several other criteria, including performance, risk, credit rating and volatility (based on its standard deviation).
That narrowed the list to 13 funds, of which most were general funds. Four of those ETFs, however, are specifically focused on dividend stocks.
- WisdomTree Total Dividend (NYSE: DTD): This fund looks specifically for dividend-paying stocks in the U.S. markets, and weights them according to the size of the yield. That means the fund's biggest holdings are in AT&T Inc. (NYSE: T), ExxonMobil Corp. (NYSE: XOM) and Chevron Corp. (NYSE: CVX). According to Morningstar, it has a 12-month yield of 3.20%.
- WisdomTree LargeCap Dividend (NYSE: DLN): This fund has a lot in common with its cousin mentioned above, but holds large cap stocks exclusively, slightly altering the mix. It consists of the 300 largest companies ranked by market capitalization from the WisdomTree Dividend Index. It has a 12-month yield of 3.03%.
- Vanguard High-Yield Dividend (NYSE: VYM): This Vanguard Group Fund uses an index of stocks characterized by high-dividend yields that have a solid track record of better-than-average payouts. The top three holdings are ExxonMobil, Microsoft Corp. (Nasdaq: MSFT) and Chevron. Its 12-month yield is 3.14%.
- SPDR S&P Dividend (NYSE: SDY): The SPDR S&P Dividend fund uses the S&P High Yield Dividend Aristocrats Index, which consists of the 50 highest dividend-yielding stocks in the S&P Composite 1500 Index that have also increased dividends every year for at least 25 years. Thus, the stocks feature both capital growth and dividend income. The top holdings are Pitney Bowes Inc. (NYSE: PBI), CenturyLink Inc. (NYSE: CTL) and Cincinnati Financial Corp. (Nasdaq: CINF). Its 12-month yield is 3.56%.
Of course, investors on the hunt for still more dividend stock ETFs should pay attention to such things as the yield, the stability of the company behind the fund, potential volatility (measured by the standard deviation) and fees.
But there's no doubt that stock dividend ETFs should be a part of most investors' portfolios.
"Dividends are more important than ever right now," Hutchinson said. "Trouble is, most retail investors either don't know it, or won't admit it."
You can get more of Martin Hutchinson's invaluable insights by subscribing to his Permanent Wealth Investor service. For more details, click here. Better still, Chief Investment Strategist Keith Fitz-Gerald has the inside story on a dividend-paying stock in a fast-growing emerging market in today's issue of Money Morning Private Briefing.
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