The Best Dividend ETF

The number of dividend ETFs has exploded over the last twenty years. But even then, there are over 70 dividend ETFs from which to choose. You have to look very closely at each one to determine what it is exactly that you are buying.

I prefer to invest in individual dividend stocks because I think I can get a better yield on my investments and I can control risk more carefully.

However, ETFs are a great investment vehicle for small investors who do not have a lot of time to manage their investments AND do not have the means to diversify through individual stock holdings.

• The cost to the investor is lower than that of a mutual fund.
• Unlike the mutual fund you can trade the ETF like you would a stock throughout the day.
• The stocks that make up the ETF were selected by fund managers who (hopefully) are experts and have designed the ETFs performance characteristics.

The diversification offered by an ETF may trick you in to thinking you don’t need to research the ETF. Don’t let this happen. You should be thoroughly convinced that the ETF is the right investment just as if you are buying an individual stock. After all, it is your money at risk, and ETFs have performed just as poorly as individual stocks despite the ETF being comprised of a basket of stocks.

These are some of the most important things to look at when evaluating an ETF:

1. Expense ratio.
2. Know the index or sector the ETF is designed to mimic.
3. Look at breadth and depth of the sector the ETF is tracking.
4. Consider how long the ETF has existed.
5. Determine the ETF's dividend yield like you would for any dividend paying stock.

When it comes to dividend ETFs there are usually two types of strategies that are employed: investing in stocks that are increasing dividends (dividend growth funds), and stocks that are dividend hogs (high dividend yield funds).

ETFs that focus on stocks that are increasing dividends puts more weight on high quality companies that have increased their dividends over time. These ETFs don’t focus on high dividends, but instead want companies that increase dividend payout over time. These companies typically have better cash flow and higher confidence in their future earnings (which are two things that we look for in good dividend stocks).

ETFs focus on dividend hogs fill their funds with stocks that distribute high dividends, but these companies may have high payout ratios which limits future dividend growth opportunities.

As I said earlier, the last time I checked there were over 70 ETFs that focus on dividends. The four largest ETF companies make up about half of the funds being offered: WisdomTree offers about 47 dividend oriented ETFs. iShares offers 4 ETFs that focus on dividends. Powershares offers about 6 dividend focused ETFs. Standard and Poors offers about 4 through their SPDRS.

Many of these funds focus on very narrow sectors. For example, WisdomTree offers funds like the Australia Dividend Fund, the Middle East Dividend Fund, the Japan Hedged Eqity Fund, and the India Earnings Fund. Powershares offers the Buyback Achievers Portfolio, Dividend Achievers Portfolio, High Yield Equity Dividend Achievers Portfolio, and the KBW High Dividend Yield Financial Portfolio. Do you really want to invest your money in such narrowly focused ETFs?

I looked through all the dividend ETFs that I could find. I really can not conclude that the wide variety of dividend ETFs provides the individual investor with more value. Most of them do not out perform basic dividend funds or dividends received from broad indices like the Dow Jones Industrial Average or S&P 500. If they do, the out performance tends to be short lived and the ETF is volatile because of its lack of breadth.

As an investor I like simple and effective. The following is a short list of ETFs that focus on dividend yield that do what ETFs are meant to do: diversify at a low cost. They are the ones I would consider buying if I needed to invest in an ETF.

SPDR Dow Jones Industrial Average ETF (DIA). This ETF is designed to track the performance of the Dow Jones Industrial Average. The DJIA is comprised of thirty "blue-chip" U.S. stocks. There are not many dividend ETFs that beat DIA’s performance.

SPDR S&P Dividend ETF (SDY). This ETF is designed to track the performance of the S&P High Yield Dividend Aristocrats Index. The index itself is comprised of the 60 highest dividend yielding constituents of the stocks of the S&P Composite 1500 Index that have increased dividends every year for at least 25 consecutive years. Fund operating expenses are 0.35%.

I am a huge fan of Value Line as an high quality, objective, independent research service. So, it’s no surprise that the First Trust Value Line Dividend Index Fund (FVD) is listed here. The ETF seeks to track the Value Line Dividend Index. The index itself is composed of stocks that are ranked by Value Line with a Safety ranking of #1 or #2. Companies that are registered investment companies, limited partnerships or foreign securities are excluded. Other criteria to make the cut for the index includes needing to have a higher than average dividend yield (as compared to the indicated dividend yield of the S&P 500 Composite Stock Price Index), have a market cap greater than $1 billion.

For those of you who want to look to diversification of dividend income from around the world you can look at the SPDR S&P International Dividend ETF (DWX) tracks the S&P International Dividend Opportunities Index. This index includes stocks from around the world (outside of the U.S.) that offer high dividend yields. Stocks must have a total market cap greater than $1 billion (a float-adjusted market cap greater than $600 million for developed market stocks, and US$ 300 million for emerging markets stocks). Also, stocks must have a positive 3-year earnings growth and profitability. They ensure diversification by limiting exposure to any single country to less than 25% (less than 15% for emerging market). You can also check out the WisdomTree International Dividend ex-Financials Fund (DOO)

The SPY and DIA ETFs listed above are market cap weighted so larger companies make up more of the index. You can invest in small cap dividend paying stocks through the WisdomTree Small Cap Dividend Fund (DES).

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