In a low interest rate environment, such as the one in which we currently find ourselves, it's natural for investors to look at reallocating their portfolio from low-paying income securities to assets that offer a higher yield. This shift toward income has been one of the most significant factors driving rising interest in dividend-paying stocks.
Investing in dividend-paying stocks has many advantages. A company that consistently pays dividends over many quarters is considered financially healthy with consistent cash flow. Dividend-paying companies tend to be blue chip names that are less volatile than most publicly traded companies. If held long enough, the amount of cash flow that is earned from compounding can often be sizable enough that the distributions are often used by retirees as their primary source of income. For more on this topic, see Introduction to Dividends: Investing In Dividend Stocks.
In this article we’ll take a look at a couple of the most popular exchange traded funds, along with a few key components that are used by investors to increase exposure to dividend paying stocks.
Dividend Stocks vs. Major U.S. Indexes
Since the end of February, income investors have dramatically outperformed holders of major market indexes, such as the Dow Jones Industrial Average and the S&P 500. The chart below, which does not include income from dividends, illustrates that strictly from a capital gains perspective, dividend ETFs have been a great investment.
The Vanguard High Dividend Yield ETF
For investors looking for an opportunity to increase exposure to dividend-paying stocks, look no farther than the Vanguard High Dividend Yield Index ETF (NYSE:VYM). This ETF has an ultra-low expense ratio of 0.10%, which, according to Vanguard, is 91% lower than the average expense ratio of funds with similar holdings. This ETF consists of 391 stocks and has total net assets of $10.9 billion. Looking at the components, several of the top holdings in this fund include Cupertino, Calif-based Apple Inc. (Nasdaq:AAPL), Irving, Texas-based Exxon Mobil Corp. (NYSE:XOM), Redmond, Wash.-based Microsoft Corp. (Nasdaq:MSFT) and New Brunswick, N.J.-based Johnson & Johnson (NYSE:JNJ). The size, quality, liquidity and low expense ratio makes this an extremely popular ETF for retail and professional investors.
With regard to performance, as you can see from the three-year chart shown below, VYM has been in a steady uptrend over the past three years. Looking at the technical indicators, there currently do not seem to be any red flags that suggest that the uptrend should reverse any time soon. From a risk management perspective, many long-term traders would likely look to set their stop-loss orders directly below the 200-day moving average, which is currently at $59.78. For more, see Why Dividends Matter.
iShares Select Dividend ETF
Another great option for investors looking to add dividend-paying ETFs to their portfolios is the iShares Select Dividend ETF (NYSE:DVY). This ETF is equipped with a 0.40% management fee, which is reasonable given that the managers attempt to give holders access to the top 100 dividend-paying domestic stocks based on a five-year history of dividend growth. DVY consists of 101 stocks and has total assets of $13.48 billion. In terms of components, the makeup of DVY is significantly more weighted toward utilities than the Vanguard fund. Several of the top holdings include San Ramon, Calif.-based Chevron Corp. (NYSE:CVX), New Orleans-based Entergy Corp. (NYSE:ETR) and NextEra Energy, Inc. (NYSE:NEE) of Juno Beach, Fla. As you can see from the chart below, its performance and trend lines are nearly identical to the Vanguard ETF so a similar risk management strategy would be appropriate.
The Bottom Line
Given the rise in popularity of exchange-traded funds, such as the Vanguard High Dividend Yield ETF and the iShares Select Dividend ETF, it has never been easier for a retail investor to increase exposure to a basket of high-quality, dividend-paying stocks. For more on this topic, check out Six Popular ETF Types For your Portfolio.
At the time of writing, Casey Murphy did not own shares of any company mentioned in this article.