Dividend investing has become increasingly popular over the past several years. With low interest rates and high uncertainty, many investors have looked towards dividend stocks for a combination of safety and yield that’s difficult to find elsewhere in the market. The increased interest has also led to higher prices and valuations for these equities, which has caught the eye of many growth investors seeking opportunities for capital gains.
The easiest way to gain exposure to dividend stocks is through exchange-traded funds (ETFs), which provide an introduction to a broad number of companies in a single security. While all dividend ETFs provide exposure to these companies, there are many different ways that this contact is constructed. These differences can have a big impact on the portfolio’s risk characteristics and yields, as evidenced by the performance differences on ETFdb’s comparison.
Below, we take a look at the strategies used by the two most popular dividend ETFs and what the different approaches mean for investors.
Vanguard’s Dividend Appreciation ETF
Vanguard’s Dividend Appreciation ETF (VIG ) is the most popular dividend ETF with approximately $21 billion in assets under management, as of June 15, 2016.
The ETF uses the NASDAQ U.S. Dividend Achievers Select Index as its underlying index – a modified market-capitalization-weighted index comprised of companies with at least ten consecutive years of increasing annual regular dividend payments. In order to be eligible for inclusion in the index, companies must meet a number of size and liquidity requirements, as well as a number of proprietary metrics used by NASDAQ to assess quality.
These strict criteria are designed to construct a dividend portfolio more focused on quality than yield. After all, the index is weighted in a way that favors large and growing companies with an established track record, rather than small companies that may be offering higher yields. Investors looking for a combination of safety and yield may appreciate this approach as a way of building a sustainable source of income over time.
iShares Select Dividend ETF
iShares’ Select Dividend ETF (DVY ) is the second most popular dividend ETF with approximately $15 billion in assets under management, as of June 15, 2016.
The ETF uses the Dow Jones U.S. Select Dividend Index as its underlying index – a dividend-weighted index consisting of 100 stocks graded by dividend yield, dividend per share growth rates, dividend payout ratios and daily dollar trading volume. The weighting of any individual stock is also capped in order to ensure the index remains fully diversified – even if a single equity happens to pay a high dividend yield.
These criteria are designed to prioritize yield over quality, since smaller companies with higher dividends may be overweight compared to larger established companies. While this may be great for investors looking purely at yield, those looking for safety in their portfolios may want to choose an ETF that has a less risky approach. That said, the Index’s other screening factors do help reduce some risks associated with simply focusing on yield alone.
The Bottom Line
Dividend investing has become increasingly popular over the years and the rise of ETFs has made it easier than ever. While all of these ETFs offer exposure to dividend stocks, there are many important differences in their indexing strategies. We looked at the key differences between the two most popular dividend ETFs, but investors should also carefully read ETF prospectuses before purchasing any dividend ETF to understand exactly what they’re buying.
