One of the easiest ways for public companies to communicate financial stability to shareholders is to pay cash dividends. The more established companies often share a portion of their profits with investors, rewarding them with cash dividends. For investors, dividends provide a steady stream of passive income.

Owning companies that pay dividends through exchange traded funds (ETFs) can be very effective. A dividend ETF is a fund that invests exclusively in companies that pay dividends. Fund managers select these companies based on specific attributes such as size, industry, geographic region, and dividend history. Then, they group them together in a basket of assets representing an investment category such as “dividend aristocrats”.

Once you have selected a dividend investing style, each holding in that ETF will have a similar profile.

For example, suppose you choose a fund that only invests in large cap companies that are used to paying dividends on a regular basis. In this case, a fund manager cannot deviate from this investment strategy. This is important because the style of investing you choose will determine the varying degrees of risk and potential returns.

For retail investors, ETFs are convenient because they offer instant diversification at low cost. This added benefit makes dividend ETFs attractive to market participants, especially when stock selection requires a certain level of investment knowledge.

Best dividend ETFs

Below are some of the most widely held dividend ETFs in the market. (Data as of September 1, 2021)

Vanguard Dividend Appreciation ETF (VIG)

VIG tracks the performance of the NASDAQ US Dividend Achievers Select Index. The investment strategy focuses on dividend growth, selecting companies that have consistently increased their dividend payouts for at least a decade.

Fund dividend yield: 1.6 percent

Main titles: Microsoft (MSFT), JPMorgan Chase (JPM) and Johnson & Johnson (JNJ)

Spending rate: 0.06 percent

Assets under management: ~ $ 75 billion

Vanguard High Dividend Yield ETF (VYM)

VYM tracks the performance of the FTSE High Dividend Yield index. The index selects high yielding dividend paying companies based in the United States, excluding REITs (Real Estate Investment Trusts).

Fund dividend yield: 2.8 percent

Main titles: JPMorgan Chase (JPM), Johnson & Johnson and Home Depot (HD)

Spending rate: 0.06 percent

Assets under management: ~ $ 49 billion

SPDR S&P Dividends ETF (SDY)

SDY tracks the performance of the S&P High Yield Dividend Aristocrats Index. The index selects companies that have consistently increased their dividend payouts for at least 20 consecutive years.

Fund dividend yield: 2.6 percent

Main titles: AT&T (T), Exxon Mobil (XOM) and Chevron (CVX)

Spending rate: 0.35%

Assets under management: ~ $ 20 billion

IShares Select Dividend ETF (DVY)

DVY tracks the performance of the Dow Jones Select Dividend Index. The index selects high yielding companies – about 100 of them – based in the United States.

Fund dividend yield: 3.1 percent

Main titles: Altria Group (MO), ONEOK (OKE) and AT&T (T)

Spending rate: 0.38 percent

Assets under management: ~ $ 18 billion

ProShares S&P 500 Dividend Aristocrats ETF (NOBL)

NOBL tracks the performance of the S&P 500 Dividend Aristocrats Index. The index selects the names of well-known multinationals with a history of dividend-raising for at least 25 years, some of them doing so for more than 40 years.

Fund dividend yield: 1.9 percent

Main titles: Nucor (NUE), Albemarle (ALB) and West Pharmaceutical Services (WST)

Spending rate: 0.35%

Assets under management: ~ $ 9 billion

How dividends work

Dividend payments are generally made to shareholders on a quarterly basis, although in some cases there may be special dividends which act as a one-time bonus. To be entitled to a future dividend, a shareholder must own shares of a company up to and including what is known as the ex-dividend date.

Investors pay special attention to dividend yield, emphasizing how much a company or fund pays relative to its share price. Dividend yields are calculated by taking the annual dividend payment and dividing it by the stock price. The yield is shown as a percentage. Returns can be calculated based on payments made in the past year or expected payments in the following year.

For example, if a company’s annual dividend is $ 4 and the stock price is $ 100, you will see a dividend yield of 4% with a quarterly distribution of $ 1.

Of course, a high return does not always mean a solid investment opportunity. This is because many investors view higher returns as a red flag, as a company’s shares may have been affected, causing returns to rise. Or, maybe, a company is trying to attract investors with high returns.

As a rule of thumb, be sure to look at the entire financial picture of a business before investing. Paying a dividend is just the icing on the cake.

How to invest in dividend ETFs

A strong dividend strategy is an essential component of every investor’s portfolio. Since the 1930s, dividends have represented 41% of total returns on the S&P 500, according to a study by Hartford Funds. And when dividends are reinvested, the returns are even higher, accounting for 84% of the S&P’s total returns since 1970.

By nature, investing in dividends tends to be less risky. Companies that can make regular payments are often richer in cash than those trying to grow their businesses quickly. Well-established names also have a habit of increasing their dividend payouts every year and are very proud to do so.

When choosing dividend ETFs, here are four steps to consider:

• Determine your financial goals: The type of investment you choose depends on what you are trying to achieve. For example, someone who is about to retire is likely to take a more conservative approach to investing. So always let your financial goals guide your decision making.
• Research Dividend Fund: When selecting dividend ETFs, pay attention to factors such as dividend history, dividend yield, fund performance, expense ratios, major holdings, and assets under management. Investors can find this information in a fund’s prospectus.
• Describe your asset mix: Before investing, take an inventory of what you own and how you want to allocate your assets. Remember, the key is to stay diverse.
• Know what you have: By periodically reviewing your investments, you can take charge of your finances and make the necessary adjustments. Take advantage of your broker’s free resources, like meeting with a financial planner, and always ask questions. Ultimately, investing without intervention does not exist.

Like any other investment, Dividend ETFs are susceptible to losses. The magnitude of potential losses is linked to the level of risk contained in the portfolio. So a fund that invests heavily in potentially riskier assets like emerging market companies will have a very different risk profile than a fund that invests in established and proven names. Macroeconomic factors such as the interest rate environment also play a role.

Depending on the type of investment account you hold, dividend distributions are taxed as regular income or at a reduced rate under certain conditions. These rules only apply to holdings outside of tax-advantaged accounts like a 401 (k) or IRA.

History shows that dividends have been an important source of income for investors. When consistent dividend payments and rising stock values ​​are combined, they can be a powerful wealth building tool.

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Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past performance of investment products is not a guarantee of future price appreciation.