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Pros and Cons of Dividend ETFs

Dividend ETFIn low-rate environments, high-yielding assets become attractive for those seeking income. Dividend Exchange Traded Funds (ETFs) are a common choice for income investors. They hold a basket of dividend paying REITs, preferred stocks, or common stocks. Investors have three options when buying dividend producing investments. They can purchase individual stock, buy dividend mutual funds, or invest in ETFs. All three choices have merit, but dividend ETFs stand out for several different reasons. In this post we will explore the pros and cons of dividend ETFs, and highlight a few worth taking a second look at.

5 Dividend ETF Pros

  1. Liquidity. Dividend ETFs are highly liquid. They trade like stock, so investors can buy and sell them throughout the day. Unlike mutual funds, investors have the choice to sell ETFs short or exercise options.
  2. Diversification. A dividend ETF is a more diversified than an individual stock. Although ETF share prices can fluctuate just like stock, they are less risky. A stock can go to zero, this scenario is unlikely with a diversified ETF.
  3. Lower Expense Ratios. Dividend ETFs are passively managed and track a specific index. That means they have lower expense ratios when compared to actively managed dividend mutual funds.
  4. Tax Benefits. Dividend ETFs are superior to mutual funds when it comes to taxes. Mutual funds may hit investors with unexpected taxes, even if they haven’t sold. Dividend ETFs have lower turnover and a lower tax bill. Capital gains are realized upon sale of the ETF.
  5. No Minimums. Like regular ETFs, dividend ETFs have no minimums. This makes them ideal for small investors who want to diversify, but don’t have enough cash to reach a mutual fund minimum purchase amount.

3 Dividend ETF Cons

  1. No DRIPS. Some individual dividend stocks offer dividend reinvestment plans (DRIPS). These programs are a way for investors to build a stock position over time, using the dividends paid out to repurchase new shares. Dividend ETFs do not have DRIPS.
  2. Trading Fees. Since ETFs trade like stock, you pay commission for each buy and sell. This means that ETFs are not ideal for dollar-cost averaging. Mutual funds have the advantage over dividend stocks or ETFs in this area. But keep in mind that mutual funds have higher expense ratios than ETFs.
  3. Lower Yield. Dividend ETFs invest in a portfolio of high-yielding dividend stocks. Since a dividend ETF is a basket of securities, it’s yield is an average of all the holdings. That means that some individual dividend stocks can have higher yields than the the aggregate ETF.

Should You Buy Them?

Yes, dividend ETFs should be a part of your diversified portfolio. If you are looking for income, then the pros outweigh the cons. Here is a list of dividend ETFs to get you started. Take a look and see if these are right for your portfolio.

- S&P/TSX Canadian Dividend Aristocrats Index Fund (CDZ)
- BMO Canadian Dividend (ZDV)
- iShares Dow Jones Select Dividend Index (DVY)
- SPDR S&P Dividend (SDY)
- WisdomTree LargeCap Dividend – (DLN)
- Vanguard Dividend Appreciation – (VIG)
- Market Vectors Uranium & Nuclear Energy (NLR)*

*NLR is not a “dividend” ETF, but it currently offers an attractive yield

About the Author: Mario Favela is a freelance content writer whose specialties include small business and technology. He writes about investing and personal finance at gatorfinance.com. You can also follow him on Twitter.

Image: FreeDigitalPhotos.net

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2 Responses to "Pros and Cons of Dividend ETFs"

  1. Yilmaz says:

    I regularly invest in ETF’s. I have to add to correction to CONS in your posting.
    1) Some ETF providers allow you DRIP.
    2) Some discount brokers now offer you commission-free ETFs. However, Questrade will charge commission if you sell them.

    In my opinion, they seem to be a better investment option than mutual funds. I still own mutual funds at the moment. No investment vehicle is best for everyone. One CON is though, as you know you need a brokerage account to buy/sell ETFs.

  2. You should always look at the top holdings of any ETF before you buy. You may be surprised what comes out. The #2 holding of CDZ up until last week was Atlantic Power Corporation, which just cut its dividend by 65% and dropped by over 50% (and down almost 70% since last October). Ouch. Amazing how a company that has only been paying dividends since 2009 and is not profitable is the #2 holding of a Dividend Aristocrat ETF.

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