Dividend paying ETFs

A dividend paying ETF could provide you with good alternatives to investing in single stocks if you're attracted to dividend income. 

In this article we take a look at some reasons why you may favor a dividend paying ETF over single stocks or mutual funds:

1. Time

To buy individual shares can be intimidating especially if you don't want to allocate a lot of time to researching stocks. If you are to pick individual stocks effectively then you really should take the time to read their releases to the market (quarterly filings, annual reports etc.) but, to a lot of people, this is time consuming and they'd rather spend their time doing something else.

2. Diversification

A dividend paying ETF can give you instant diversification whereas building up your own portfolio can take time and quite a lot of money to develop adequate diversification. Even though brokerage costs have come down enormously over the last 20 years they can still eat into your returns. For example, if you only buy $500 worth of stock and your dealing cost is $15 then this is effectively a 3% charge on day one. That could be a whole year's worth of dividends.

If you're putting together a portfolio with say $5,000, you could just make one purchase of an S&P 500 tracker where a fixed dealing cost of $15 represents only 0.3% of your original capital. If you were buying individual stocks you may want to have 10 different companies' shares. This would mean you would have to put $500 into 10 different shares and your total dealing cost would be $150 - a hefty 3% of your portfolio.

3. Performance

There are a huge number of fund managers, individual investors, hedge funds etc dedicating lots of time to picking stocks. By definition they can't all outperform the market. In fact study after study has shown that most mutual fund managers underperform the market. Jeremy Siegel noted in Stock For The Long Run that "In the last 25 years (to 2012), there have been only 6 years when more than one half of equity mutual funds outperformed the broad market."

So simply matching the market is actually a pretty good performance. Indeed, even the great Warren Buffett has told his trustees to put most of his estate after he dies in index funds. He explains in his 2013 letter to shareholders "My advice to the trustee couldn't be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors - whether pension funds, institutions or individuals - who employ high-fee managers."

4. Fees

A lot of mutual fund managers underperform due to their fees. ETFs typically have very low fees and you can get very close matching the overall market with these funds. For example, Vanguard's S&P 500 ETF (which aims to track the S&P 500) has an expense ratio of just 0.05%. That means over ten years you will pay just $118 in fees on a $10,000 investment. Incidentally, this ETF will pays dividends every March, June, September, and December... good if you like regular income.

5. Sector options

Let's say you like the story behind pharmaceuticals. You know that developed world nations have ageing populations that are likely to spend more on drugs in future years. The problem is that you don't know which drug companies to buy or which companies will come out with the next blockbuster drugs.

ETFs can give a way to buy into the sector as a whole and effectively have exposure to a "basket" of drug companies. An example of a dividend paying ETF in the pharma sector is the PowerShares Dynamic Parmaceuticals ETF.

6. Transparency

This is an advantage of ETFs in general over mutual funds. ETFs must disclose all their holding daily where as an open-end mutual fund will typically disclose their holdings only once a quarter. Although it's likely to be of interest only to keen market watchers, this transparency helps to keep the funds honest and to avoid over-exposure to certain sectors/names.

Other examples of dividend paying ETFs:

There are many ETFs out there which pay dividends. Here are some further examples of the more well-known dividend paying ETFs. Click on the links to reach the company homepages:

iShares Dow Jones Select dividend paying ETF
PowerShares Dividend Achievers ETF
SPDR S&P International dividend paying ETF
Vanguard High Dividend Yield ETF
Vanguard S&P 500 ETF

Mike - six-figure dividend earner

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