Shareowner Online that shows my reinvested dividends multiplying away. The trade in me loves the volatility and potential for short-term gains that many ETFs offer.
Fortunately, all investors can have their cake and eat it too when it comes to dividends and ETFs. One question folks ask me all the time is “How do dividend ETFs work?” Generally, they’re wondering what’s the difference between owning a dividend ETF and a dividend stock in terms of how the payout is delivered.
Dividends received within a dividend ETF are not used to purchase more shares of the stock paying dividend. Remember, most dividend ETFs are based on passive indexes and using the dividends to buy more shares of the company delivering the payout turns the investment style from passive to active and that would run up your expenses. Rather, the ETF dividends can be used to buy more shares of the ETF, which is akin to dividend reinvestment ETF-style.
There are also some tax issues with dividend ETFs investors should note and perhaps you just went over some of these with your CPA. At issue is whether the ETF dividend is qualified or unqualified. Unqualified dividends are taxed at the normal rate while qualified dividends are subject to different rules, such as how long the investment is held.
Alright, that was the boring part. Now let’s get to the good stuff and a look at a couple of dividend ETFs that conservative investors can embrace. I’m only going to mention two ETFs today, but trust me, there are dozens of dividend ETFs out there, many of which I would give my personal seal of approval to.
Dependable And Familiar Names
The iShares Dow Jones Select Dividend Index (NYSE:DVY) is a collection of solid, familiar dividend payers that has about $6 billion in assets and has a 12-month yield of about 3.4%. Don’t get confused by the name. DVY doesn’t represent a collection of Dow Jones Industrial Average (NYSE:DIA) members. Of DVY’s top 10 holdings, only Chevron (NYSE:CVX) and McDonald’s (NYSE:MCD) are Dow components. Other top 10 holdings include Kimberly-Clark (NYSE: KMB), and Entergy (NYSE: ETR), an electric utility and we all know how good utilities can be for income investors.
DVY’s holdings are spread out pretty well as the top 10 holdings account for just 20.2% of the ETF’s total assets. Think of DVY as your grandfather’s dividend ETF.
Tracking Large Caps
If you want the relative dividend safety offered by blue chip companies without the cost burden of investing in dozens of these names, the WisdomTree LargeCap Dividend ETF (NYSE:DLN) might be an option for you. DLN employes an interesting concept that an actually work in the investors favor, that being the index the ETF tracks is weighted to reflect the expected cash dividends each member of the index is expected to pay in the coming year.
The weighting factors in the most recent dividend paid by the companies and while this approach may sound risky, it really isn’t. At least not when you consider that DLN’s top-10 holdings are chock full of chronic dividend raisers such as Chevron, Johnson & Johnson (NYSE:JNJ) and Procter & Gamble (NYSE:PG).
Another way of looking at DLN is that you’re benefiting from a company’s reputation and with some of these names, that’s a very good reputation to play. In fact this approach, delivers sound returns as the chart indicates.
The bottom line is you can have your cake and eat it too with dividend ETFs and I expect more dividend ETFs to keep popping up, creating even more choices for investors.
Todd Shriber is an ETF fanatic, a former hedge fund trader, and a journalist. Todd started his professional career with Bloomberg News, where he covered banks, energy and technology. After leaving Bloomberg, Todd became a trader at a California-based hedge fund where he specialized in trading financials, energy, basic materials, and ETFs.
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