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Making Your Investments Pay: Equity Income ETFs
The allure of dividend investing is simple to understand. Regular cash payments from the company provide much needed retirement income, enhanced returns via dividend reinvestment and helps keep away the cold hand of inflation. Unfortunately, 2008 is shaping up to be one lousy year for stocks and those in equity income funds are feeling the brunt of the damage. These funds often have a healthy dose of financial stocks, and as we have seen so far in this crisis, dividends are not guaranteed payments. Many banks have cut their distributions to shareholders repeatedly over the proceeding months.
But in the current market place, we are facing an interesting conundrum. High yield once meant risky yield. As investors ran to anything that showed signs of pure safety, stock prices fell. Today, solid dividend paying companies are trading for a fraction of what they did only a few months ago. Long-term investors can lock in 5% dividend rates, destroying the paltry rates on treasury bonds. The three month T-bill was recently trading at 0.01% and the 10-year at under 2.75%. (For an in-depth look into ETFs, read our Exchange Traded Funds Tutorial.)
Taking the ETF Approach
While there are many equity income style mutual funds available for purchase, nothing beats exchange traded funds (ETF) in terms of operating expenses. Luckily for investors, all of the major ETF sponsors have such funds in their arsenal.
My favorite in the sector due to its low allocation to financial stocks, currently at only 23.7%, is the Vanguard High Yield Dividend ETF (NYSE:VYM). The fund is based off of the FTSE High Dividend Yield Index which tracks U.S. companies that pay higher than average dividends, not including real estate investment trusts. The ETF also holds the largest basket of stocks at 531. These include investments in Johnson & Johnson (NYSE:JNJ) and rural telecom provider Windstream (NYSE:WIN). The expense ratio for the fund is relatively low at 0.25% compared to 0.40% for its mutual fund counterpart High Dividend Yield Index Fund Investor Shares (VHDYX) The fund is currently yielding 4.35% and is down about 35% for the year
The State Street Dividend SPDR (AMEX:SDY) is in essence a smaller, more concentrated version of the Vanguard fund. The dividend Spider comprises 51 common stocks in the Standard & Poor's High Yield Dividend Aristocrats Index. The fund has a nearly 60% weighting toward financial and utility stocks. With Synovus Financial (NYSE:SNV) and Consolidated Edison (NYSE:ED) counted as top holdings. The ETF yielded 5.36% and has a cheap expense ratio of 0.35%. (Learn more about these types of investments in The Lowdown On Index Funds.)
For investors who believe that the worst of credit crisis is behind us and that financial stocks are close to a bottom, the Powershares High Yield Equity Dividend Achievers Portfolio (AMEX:PEY) is for you. The fund has the highest allocation to banks, insurance and monetary service stocks out of any of the ETFs on this list at 67.41%. The portfolio follows the Mergent Dividend Achievers Index. The index is composed of the 50 highest yielding companies with at least 10 years of consecutive dividend increases. Top holdings include mostly regional banks such as Associated Banc (Nasdaq:ASBC) and National Penn Bancshares (Nasdaq:NPBC). The fund does have the nice feature of monthly dividends and is currently yielding 7.44% with expenses running 0.61%.
Powershares also offers equity income investors a way to profit from international stocks. The International Dividend Achievers Portfolio (NYSE:PID) follows a similar index to its U.S. sister ETF (PEY) using relatively the same method for stock picking. Top country allocations go the U.K. and Canada with only 34.7% of the fund's 95 holdings in financial stocks. The fund has also performed better than its sister, returning 3.55% since inception versus a -4.89% for High Yield Equity as of September 30, 2008. The fund pays distribution quarterly at 5.74% and charges 0.60% in fees and expenses. (To learn how to use ETFs without having to predict a market bottom, read Dollar-Cost Averaging With ETFs.)
Bottom Line
The flight to extreme quality has reduced treasury yields to non-inflation beating instruments, and the equity income market seems ripe for the picking. Prices of good dividend paying stocks have fallen, producing juicy yields. While cheap stocks can get cheaper, it maybe time for long-term investors to think about adding stock income funds as an addition to their core holdings. The exchange traded funds we've covered all offer a low-cost way to do just that.
But in the current market place, we are facing an interesting conundrum. High yield once meant risky yield. As investors ran to anything that showed signs of pure safety, stock prices fell. Today, solid dividend paying companies are trading for a fraction of what they did only a few months ago. Long-term investors can lock in 5% dividend rates, destroying the paltry rates on treasury bonds. The three month T-bill was recently trading at 0.01% and the 10-year at under 2.75%. (For an in-depth look into ETFs, read our Exchange Traded Funds Tutorial.)
Taking the ETF Approach
While there are many equity income style mutual funds available for purchase, nothing beats exchange traded funds (ETF) in terms of operating expenses. Luckily for investors, all of the major ETF sponsors have such funds in their arsenal.
My favorite in the sector due to its low allocation to financial stocks, currently at only 23.7%, is the Vanguard High Yield Dividend ETF (NYSE:VYM). The fund is based off of the FTSE High Dividend Yield Index which tracks U.S. companies that pay higher than average dividends, not including real estate investment trusts. The ETF also holds the largest basket of stocks at 531. These include investments in Johnson & Johnson (NYSE:JNJ) and rural telecom provider Windstream (NYSE:WIN). The expense ratio for the fund is relatively low at 0.25% compared to 0.40% for its mutual fund counterpart High Dividend Yield Index Fund Investor Shares (VHDYX) The fund is currently yielding 4.35% and is down about 35% for the year
For investors who believe that the worst of credit crisis is behind us and that financial stocks are close to a bottom, the Powershares High Yield Equity Dividend Achievers Portfolio (AMEX:PEY) is for you. The fund has the highest allocation to banks, insurance and monetary service stocks out of any of the ETFs on this list at 67.41%. The portfolio follows the Mergent Dividend Achievers Index. The index is composed of the 50 highest yielding companies with at least 10 years of consecutive dividend increases. Top holdings include mostly regional banks such as Associated Banc (Nasdaq:ASBC) and National Penn Bancshares (Nasdaq:NPBC). The fund does have the nice feature of monthly dividends and is currently yielding 7.44% with expenses running 0.61%.
Powershares also offers equity income investors a way to profit from international stocks. The International Dividend Achievers Portfolio (NYSE:PID) follows a similar index to its U.S. sister ETF (PEY) using relatively the same method for stock picking. Top country allocations go the U.K. and Canada with only 34.7% of the fund's 95 holdings in financial stocks. The fund has also performed better than its sister, returning 3.55% since inception versus a -4.89% for High Yield Equity as of September 30, 2008. The fund pays distribution quarterly at 5.74% and charges 0.60% in fees and expenses. (To learn how to use ETFs without having to predict a market bottom, read Dollar-Cost Averaging With ETFs.)
Bottom Line
The flight to extreme quality has reduced treasury yields to non-inflation beating instruments, and the equity income market seems ripe for the picking. Prices of good dividend paying stocks have fallen, producing juicy yields. While cheap stocks can get cheaper, it maybe time for long-term investors to think about adding stock income funds as an addition to their core holdings. The exchange traded funds we've covered all offer a low-cost way to do just that.
by
Aaron Levitt
Aaron Levitt is a SABEW investment journalist and analyst living in State College, Pennsylvania. His work appears in several high profile publications in both print and on the web. Aaron is a graduate of The Pennsylvania State University where he studied Economics and International Business and he is an advocate for long-term investing with a global framework. You can follow his picks and pans at @AaronLevitt
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