If you’re outside the US looking in, there are important pros and cons to adding exchange traded funds from America to your portfolio, writes John Heinzl, reporter and columnist for Globe Investor.

There’s good news and bad news when it comes to investing in US dividend stocks.

The good news is that there are scores of great companies south of the border that regularly raise their dividends. The bad news? With so many dividend stocks to choose from, trying to pick the best ones for your portfolio can turn into a full-time job.

That’s where exchange traded funds come in. Like mutual funds, ETFs give you instant diversification. Unlike mutual funds, they have low fees and can be traded throughout the day. That explains why more investors are gravitating toward ETFs, and why companies are falling over each other to launch new ones.

With bond yields at microscopic levels and investors eager for income, it should come as no surprise that dividend ETFs are among the hottest products out there. We don’t have time to look at all of them, so today we’ll examine the five largest US dividend ETFs, in descending order of assets under management.

There are a couple of things to keep in mind:

  • First, US ETFs expose you to currency fluctuations. So if your local currency rises, the value of your investment will fall. If you’re uncomfortable with that, you could consider a currency-hedged ETF such as the iShares S&P US Dividend Growers Index Fund (Toronto: CUD). But remember that there are costs for currency hedging, and it’s far from an exact science.
  • Second, Canadians should consider holding US dividend ETFs in a registered retirement savings plan or registered retirement income fund. That way, there should be no US withholding tax on the dividends.

Vanguard Dividend Appreciation ETF (VIG)

Assets: $13.3 billion

Holdings: 134

Expense ratio: 0.18%

Yield: 2%

This bargain-priced ETF proves that you don’t need an outsized yield to generate solid results. VIG had the highest annualized five-year return (4%, including dividends) and a year-to-date return (7.6%) near the top of the pack, according to indexuniverse.com (all returns are as of March 31).

Designed to track Mergent’s Dividend Achievers Select Index, the fund features companies with consistent earnings growth and dividends that have risen for at least ten consecutive years. Think Coca-Cola (KO), Procter & Gamble (PG), Wal-Mart (WMT) and McDonald’s (MCD), to name a few.

iShares Dow Jones Select Dividend Index Fund (DVY)

Assets: $10.1 billion

Holdings: 100

Expense ratio: 0.4%

Yield: 3.4%

You’ll pay a bit more for this ETF, but you’ll also get the highest yield of the group. The above-average yield reflects two things: a hefty 31% exposure to utilities, and a methodology that gives the heaviest weightings to the fattest yielders in the index.

Proving once again that yield isn’t everything, however, the five-year annualized return is an uninspiring negative 0.9%—the only ETF in the red for this period. But the ETF redeems itself with a three-year return of nearly 26%—good for top spot.

SPDR S&P Dividend ETF (SDY)

Assets: $9.2 billion

Holdings: 60

Expense ratio: 0.35%

Yield: 3.1%

This ETF seeks to match, before expenses, the performance of the S&P High Yield Dividend Aristocrats Index, which comprises the 60 highest-yielding S&P 1500 members that have raised dividends annually for at least 25 consecutive years.

It has the fewest holdings, but the ETF is reasonably diversified, with consumer staples, financials, industrials, and consumer discretionary making up about two-thirds of the total. Three-year and five-year annualized returns are 18.1% and 2.3%, respectively, which puts it in the middle of the pack.

Vanguard High Dividend Yield Index ETF (VYM)

Assets: $4.5 billion

Holdings: 439

Expense ratio: 0.13%

Yield: 2.8%

This fund has two big advantages: The lowest management expense ratio and the largest number of holdings, including all the big-cap dividend names you’d expect—Exxon Mobil (XOM), Microsoft (MSFT), General Electric (GE), Procter & Gamble (PG), Pfizer (PFE) and so on.

Based on the FTSE High Dividend Yield Index, the ETF has the second-best three-year annualized return (20.7%) and third-best five-year return (1.9%).

iShares High Dividend Equity Fund (HDV)

Assets: $1.4 billion

Holdings: 75

Expense ratio: 0.4%

Yield: 2.5%

It’s hard to make any definitive statements about this ETF because it’s only been around for a little more than a year, but one thing stands out: the excessive weighting of some stocks. AT&T (T), for example, accounts for nearly 10% of the portfolio, Pfizer represents about 8%, and Johnson & Johnson (JNJ) makes up about 7%.

The 0.4% MER isn’t exactly cheap, either, and the performance numbers are uneven. The one-year return of 15.8% is good for first place, but the year-to-date return of 3.9% ranks dead last.

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