Investors love dividends. And why not -- they provide regular income that can be reinvested or pocketed and spent (or saved) as the investor sees fit. Many investors, particularly those in retirement, seek out stocks that provide the best dividend income. They should also know that there are exchange-traded funds, or ETFs, that produce dividends. In fact, there are an entire class of ETFs that focus on generating dividend income.
The dividend income produced by ETFs is different from that of stocks. Because there are dozens, if not hundreds, of underlying stocks within an ETF, the dividend is based on all the stocks within that ETF that pay out dividends -- calculated and distributed to investors on a pro rata basis. A potential negative is that the dividend will fluctuate more than a single stock dividend, because it's based on multiple stocks. On the other hand, the ETF dividend is from a diversified group of stocks, which means that if some are cut, others may be increasing.
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The objective of dividend ETFs is to provide good dividend income, so they track indexes or baskets of stocks that have that objective. Two of the best dividend-producing ETFs are the iShares Select Dividend ETF (DVY 0.18%) and the Vanguard High Dividend Yield ETF (VYM -0.25%).
iShares Select Dividend ETF offers a top dividend payout
The $14 billion iShares Select Dividend ETF is built to produce dividend income. It tracks the Dow Jones U.S. Select Dividend Index, which measures the performance of 100 high dividend paying companies, screened by dividend per share growth rate, dividend payout percentage rate, and dividend yield, among other criteria. They all have five-year records of paying dividends.
In the third quarter, this ETF paid out one of its highest dividends ever, $0.95 per share. Over the past 12 months, the fund has paid $3.58 per share, which works out to a dividend yield of around 3.8%. Over the last five years, the quarterly payout has grown by 46%.
The top five holdings are Prudential Financial, Altria Group, International Paper, LyondellBasell Industries, and Wells Fargo.
While you're getting a great dividend, this ETF is more expensive than many of its peers with an expense ratio of 0.39%. That means you'll pay $3.90 in fees for every $1,000 invested. This ETF is down about 8% year to date, but over the past 10 years it has a total return of 101%. That calculates to an average annual return of about 7%.
Vanguard High Dividend ETF has a solid dividend with lower expenses
The Vanguard High Dividend Yield ETF doesn't have as high a dividend yield as the iShares Select Dividend ETF, but it certainly has a solid dividend and some other great features that make it worthy of a buy. This ETF tracks the FTSE High Dividend Yield Index, which includes U.S. stocks in the FTSE Global Equity Index with the highest dividend yields. It has more than 400 stock holdings, which is a lot more than the iShares Select Dividend ETF has. That provides more diversification.
This ETF paid out a $0.70 dividend in the third quarter, bringing its payout over the past 12 months to $2.88 per share. That gives the fund a yield of 3.2%. Over the last five years, the dividend has increased by 34%.
The largest holdings in the fund are among the most well-established, stable companies on the market, including Johnson & Johnson, Procter & Gamble, JPMorgan Chase, Verizon, Pfizer, and Walmart.
Where it beats the iShares Select Dividend ETF is in fees and total returns. The ETF has a tiny expense ratio of 0.06%, which means investors pay just $0.60 in fees for every $1,000 invested. It also has better performance, with a 112% total return over the past 10 years. That comes out to an average annual return of about 9%. Year to date the ETF is down about 3%.
You really can't go wrong with either of these ETFs in your portfolio. If income is your top priority, the iShares Select Dividend ETF may be the better choice, but if you want a solid dividend and a better long-term return, the Vanguard High Dividend ETF is the way to go.
Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool owns shares of Vanguard High Dividend Yield ETF. The Motley Fool recommends Johnson & Johnson and Verizon Communications. The Motley Fool has a disclosure policy.
