Seasoned investors know the importance of dividends, particularly when investing over the long-term. Historical data suggest reinvested dividends can account for 40% or more of total returns over long holding periods.

Another advantage of dividend stocks is that, historically, dividend payers are less volatile than their non-payout counterparts. And with dividend stocks being less volatile and experiencing smaller drawdowns during bear markets, dividend payers often perform stocks that do not have payouts over the long haul.

For investors that do not want to pick individual dividend stocks or that want to supplement such allocations with diversified baskets of dividend payers, there is no shortage of dividend-oriented exchange-traded funds (ETFs) for North American investors to consider. In fact, there are nearly 200 dividend ETFs available on U.S. and Canadian exchanges.

Five of the 100 largest U.S.-listed ETFs are dividend funds and as a sub-category of the smart beta universe, dividend ETFs are one of the biggest contributors to combined smart beta assets and asset growth.

 

Exploring Different Dividend ETF Strategies

While there are scores of dividends ETFs to consider, many of which have names that imply these funds are almost twins, investors should be careful to note that not all dividend ETFs deliver income in the same way.

One of the most popular weighting methodologies for dividend ETFs is selecting stocks with a requisite dividend increase. For example, several of the largest dividend ETFs mandate stocks included in the fund have minimum dividend increase streaks of 10, 20 or 25 years. The S&P 500 Dividend Aristocrats Index requires its components to have payout increase streaks of at least 20 years while the S&P 500 High Yield Dividend Aristocrats Index has a 25-year dividend increase streak mandate. There are ETFs dedicated to both benchmarks.

The Vanguard Dividend Appreciation ETF (VIG) is home to nearly $24 billion in assets, making it the world's largest dividend ETF. It tracks the NASDAQ US Dividend Achievers Select Index, which holds companies with minimum payout increase streaks of 10 years. Advantages of emphasizing payout consistency include the potential for an ETF's roster to be comprised of quality companies with strong balance sheets that can afford their current dividend obligations as well as being able to afford future payout increases.

Another popular strategy used by providers of dividend ETFs is weighting components by yield. Typically, yield-weighted ETFs have dividend yields that are noticeably above broader equity benchmarks and government bonds.

That is the goods news. The risk with yield-weighted strategies is that they are typically heavy on defensive, high-yielding sectors that are not only richly valued, but also highly sensitive to interest rate changes due to their bond-like traits. Additionally, some high-yield dividend payers hail from companies that are not financially healthy. Financially strained dividend companies can suspend or eliminate payouts to conserve cash.

The Vanguard High Yield Dividend ETF (VYM) is an example of a high-yield ETF that does not expose investors to some of the aforementioned yield-weighted risks. VYM, also one of the largest dividend ETFs, holds 428 stocks, but its allocations to bond-like sectors, such as telecom and utilities, are light. That underscores the point that VYM offers yield with a quality filter.

 

International Dividends

Income investors should not overlook the potency of ex-US dividends. With about half the world's dividend-paying stocks hailing from outside the U.S., there are plenty of international dividend ETFs to consider. That universe includes developed and emerging markets.

The WisdomTree Emerging Markets High Dividend Fund (DEM) is one of the most venerable names among emerging markets dividend ETFs. DEM, which is almost a decade old, follows a fundamentally-weighted index that screens stocks for yield and then weights those holdings based on cash dividends paid.

Two of the newest entrants to the world of international dividend ETFs are the Vanguard International High Dividend Yield ETF (VYMI) and the Vanguard International Dividend Appreciation ETF (VIGI), the international equivalents of the aforementioned VIG and VYM.

Dividend ETFs For All Kinds of Stocks

Investors often associate dividends with large-cap equities, but mid- and small-cap stocks have some dividend payers as well. In fact, there are significant advantages that come along with small-cap dividend payers, including less volatility and lengthy out-performance of smaller stocks that do not pay dividends.

The WisdomTree MidCap Dividend Fund (DON) is more than 11 years old and has nearly $3 billion in assets under management. DON, which weights its components by dividends paid, has spent much of its more than 11 years on the market outpacing traditional, passive mid-cap funds as well as actively managed competitors, often with less volatility.

The $2 billion WisdomTree SmallCap Dividend Fund (DES) also weights its holdings by dividends paid and has established a long track record of topping standard small-cap vehicles, such as the Russell 2000 Index.

Investors can also apply the income-generating potency and volatility-reducing capabilities of dividend ETFs to mid- and small-cap stocks in ex-US developed and emerging markets. While U.S. small-cap benchmarks are struggling in 2017, international rivals, including dividend ETFs, are soaring.

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