Little things can turn into big things given enough time.
Looking for income? Veteran investors know that dividend stocks offer something bonds just can't. That's income growth that at least keeps pace with inflation. And given enough time, most of these names will also dish out respectable capital appreciation.
The question is, which stocks? Investors might also wonder if an exchange-traded fund would be an easier, better choice as it lets them own a basket of stocks. An ETF would indeed be a better choice for most people starting out with less experience and a relatively small amount of money, say, $1,000. But which fund?
(Partial) spoiler alert: Investor favorite Vanguard Dividend Appreciation ETF (VIG 0.63%) didn't make my list and neither did ProShares S&P 500 Dividend Aristocrats ETF (NOBL 0.63%).
Don't misread the message, and don't panic if you're already holding the Vanguard fund in question! You're not facing financial ruin by owning the world's most popular dividend growth ETF. Ditto for the ProShares exchange-traded fund I named above.
However, there's a case to be made for instead buying the iShares Core Dividend Growth ETF (DGRO 0.57%), which gives investors a piece of some smaller companies with shots at bigger growth without adding too much risk of weak dividend growth, which you might normally expect from such stocks.
Similar, but different enough
Contrary to a common assumption, not all ETFs in the same category are built the same. The aforementioned Vanguard Dividend Appreciation ETF mirrors the S&P U.S. Dividend Growers Index, for example. This is a basket of stocks of companies that have raised their dividend payments every year for at least the last 10 years, excluding the 25% of these names with the highest yields in an attempt to weed out yield traps that have a high yield because of a falling stock price. This index also largely excludes real estate investment trusts -- or REITs -- which are great income-producing investments in their own right, but also very different than conventional stocks.
The ProShares S&P 500 Dividend Aristocrats ETF reflects the collective performance of all the market's Dividend Aristocrats®. (The term Dividend Aristocrats® is a registered trademark of Standard & Poor's Financial Services LLC.) These are S&P 500 constituents with a track record of no less than 25 uninterrupted years of annual payout increases, although most have been upping their payments for far longer.
So how is the iShares Core Dividend Growth ETF different than either of these other options? First and foremost it's based on the Morningstar US Dividend Growth Index.
While superficially similar to the S&P U.S. Dividend Growers Index, the Morningstar index is different in a couple of key ways. Inclusion in this index requires only five consecutive years of annual dividend growth, but also a dividend payout ratio of less than 75%. The thinking is that companies should be investing enough of their earnings to sustain continued earnings growth. If they're passing along more than three-fourths of their bottom line to shareholders, there may not be enough reinvested in the business to sustain the profit growth needed to support rising dividend payouts, the thinking goes.
It's worth adding that Morningstar's dividend growers index isn't limited to large-cap stocks like the S&P U.S. Dividend Growers Index effectively is, and as being a Dividend Aristocrat® officially requires.
It includes smaller, higher-growth companies as well. That's always an advantage for investors, but particularly so right now. If we're headed into a period of lethargic economic growth in the shadow of pending rate cuts, these smaller names could fare markedly better than larger companies. See, smaller, nimbler companies are generally better equipped to navigate challenging and turbulent environments. They're particularly well positioned to perform right now, after years of lagging behind large-cap technology names.
And the small differences between these seemingly similar ETFs are already making a big impact on their performances.
The things that matter
These may all be exchange-traded funds investing in dividend-paying stocks. They each prioritize dividend growth. They're hardly the same, however.
One of these differences is their yields, though the difference is not a huge one.
DGRO Dividend Yield data by YCharts
The trailing dividend yields of all three of these ETFs are fairly close, ranging from 1.7% to 2.2% as I write this. So there's not one runaway winner based on yield.
Investors will want to look deeper, into the stocks the funds own.
These exchange-traded funds have different rules and they end up with very, very different holdings. The Dividend Aristocrats® ETF's top positions at this time are The Clorox Company, Stanley Black & Decker, and a company called Kenvue, which spun off a year ago from Johnson & Johnson.
The market-cap-weighted Vanguard Dividend Appreciation ETF's biggest holdings right now are Apple, Broadcom, and Microsoft. This underlying index is clearly overweighted with technology names that have led the market higher in just the past few years!
The iShares Core Dividend Growth ETF's top constituents? JPMorgan, Johnson & Johnson, and drugmaker Abbvie, although the noteworthy differences don't end there.
The iShares fund holds a bunch of small caps that the other two ETFs just don't.
This is how this particular fund delivers about the same yield (or more) as either of the other ETFs, while at the same time offering more value-driven capital appreciation potential. As was noted above, given enough time, small-cap stocks can and frequently do outperform bigger ones, boosting the net gains of this fund's shares. This ultimately translates into a chance for a better overall net return than with either of the alternatives.
VIG Total Return Level data by YCharts
Don't sell the others, but DGRO is the pick of the litter right now
Nothing stays the same. The economic backdrop and market environment change in ways that favor certain kinds of stocks over others. Companies can come and go. Investors' goals change, too. Maybe you'd rather collect a little more income right now in exchange for slightly less rewarding price appreciation. The nickels and dimes add up.
If your goal is finding a reasonable balance between solid dividend growth right out of the gate -- with better-than-average stocks capable of outperforming blue chips with longer-lived dividend pedigrees -- an ETF based on the slightly less picky Morningstar US Dividend Growth Index is actually the smarter move.
Again though, don't panic if you own one of the other two funds discussed here. They're both solid dividend-growth ETFs as well, and certainly worth sticking with the for the time being if swapping them out would also create an unwanted, taxable capital gain.
JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple, JPMorgan Chase, Kenvue, Microsoft, ProShares Trust-ProShares S&P 500 Dividend Aristocrats ETF, and Vanguard Specialized Funds-Vanguard Dividend Appreciation ETF. The Motley Fool recommends Broadcom and Johnson & Johnson and recommends the following options: long January 2026 $13 calls on Kenvue, long January 2026 $395 calls on Microsoft, and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
