If you’re largely done working for a living and are now looking at your nest egg to provide the money to cover your expenses, a diversified portfolio of dividend-paying stocks could do the job. However, there may be a simpler, safer solution: dividend-oriented exchange-traded funds (ETFs). Beyond the fact they can rapidly provide you with more diversification than you typically could achieve by picking stocks on your own, owning these funds will also let you focus on enjoying your golden years without the need to keep constant tabs on your portfolio.
Here are three great dividend ETFs that current and future retirementes should consider.
iShares Select Dividend ETF
Not that you have to — or should — limit yourself to a single dividend-focused exchange-traded fund, but if you wanted to own just one, the iShares Select Dividend ETF (NASDAQ: DVY) is the one.
Built to mirror the Dow Jones US Select Dividend Index, the ETF around 100 hand-picked, higher-yielding US stocks, each of which holds at least a five-year history of paying dividends. Most of its holdings, however, have much longer track records than that. Some of its biggest positions include Altria, Valero Energyand IBM, and they’re among the larger holdings specifically because they sport above-average yields. Collectively, the fund’s current dividend yield stands near 3.2%.
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The utilities sector is the largest in the fund, accounting for about a quarter of its assets. Most other sectors account for slices of 12% or less, so the risks are pretty well spread out. And utility sector players are arguably among the world’s most reliable dividend payers, because people place an understandably high priority on keeping their lights on and the water running.
Although the iShares Select Dividend ETF is a great all-around pick, like any other investment, it does come with a trade-off: While it lets you plug into a healthy yield now, you won’t necessarily see inflation-beating payout growth . That may not be an issue for you, but if it is, there’s a solution.
Vanguard Dividend Appreciation ETF
That solution is to also invest in the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG). As the name suggests, its portfolio was crafted specifically to provide reliable payout growth over time.
The fund’s stock-selection strategy is simple enough — it replicates the S&P US Dividend Growers Index, which only includes US stocks with at least a 10-year track record of annual dividends increases. That group includes names like Johnson & Johnson and Microsoft.
However, the index also excludes the highest-yielding 25% of tickers that would otherwise be eligible for inclusion. The index managers’ assumption is that if a stock’s yield has moved that high, it ultimately carries too much risk — the other 75% will do just fine. The end result is lots of price stability, which most retirees want. This fund’s beta is only 0.84, meaning it only moves (on average) about 84% as far as the S&P 500 does on any given day.
The trade-off with this ETF is its relatively low yield — currently around 1.8%. So if you open a position, you won’t rake in a lot of cash early on. It may still be worth it though. The fund’s current annualized per-share payout of $2.86 is nearly 70% more than the fund’s dividend from five years ago, while the ETF’s shares themselves are up more than 50%.
First Trust Preferred Securities and Income ETF
Finally, if you’ve already secured some assets with reliable dividend yields and also tacked on some dividend growth potential, it wouldn’t be crazy to take on a bit more risk in an ETF designed to deliver markedly stronger yields. This higher-risk holding should make up the smallest fraction of your dividend ETFs, and you still don’t want to risk a great deal of your portfolio. A fund that holds nothing but preferred stocks could do the trick, and the First Trust Preferred Securities and Income ETF (NYSEMKT: FPE) is one of the best of this breed.
If you’re not familiar, a preferred stock is something of a hybrid of a common stock and a bond. Most come with a fixed coupon rate, although unlike bonds, preferred stocks’ dividend payments aren’t necessarily legal debt obligations. That’s why they tend to offer higher yields than traditional bonds do — there’s a bit more risk. Yet preferred stock dividends are almost always more Guaranteed than dividend payments on companies’ common stock, which is why their yields are typically higher than those from the tickers most of us watch on a regular basis. The downside: Preferred stocks rarely offer the potential for much capital appreciation, whereas common stocks do.
In other words, preferred stocks are only compelling if you want above-average yields right now and don’t necessarily need dividend growth or capital growth.
But what yields! The First Trust Preferred Securities and Income ETF’s current dividend yield is an impressive 7.4%, and the fund hasn’t failed to make some sort of monthly payment since 2013, when it was launched.
Again, it’s not a great first or only dividend ETF. The payout hasn’t increased much during that nine-year span, and the ETF itself is more or less priced where it was when it launched. Owners have been collecting great dividends the whole time though, in an environment where yields and interest rates on other types of holdings have been agonizingly low.
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James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Microsoft and Vanguard Dividend Appreciation ETF. The Motley Fool recommends Johnson & Johnson. The Motley Fool has a disclosure policy.