One of my biggest struggles as an aspiring dividend investor
is the difficulty of selecting high-yielding stocks that are also good long-term investments.
The more I try to research, the more I realize how difficult it is to successfully pick stocks
that will beat the market over long-term periods - and that’s why 70%
of professional fund managers fail to beat the market annually - and 90% of them fail over a
10-year period. If financial professionals can’t consistently beat the market by stock picking,
it’s safe to assume that I won’t be able to do it either as an average individual investor.
So, lately I’ve turned to ETFs to secure stable high-dividend payouts without compromising on
long-term potential. In this video, I’m going to show you my methodology
for finding the best dividend ETFs and the two specific ETFs I’ve decided to use for
dividend investing. This combo is looking at an estimated dividend yield of over 5%
with historical growth of nearly 8% annually, so stick around!
Before we get into things, if you’re new to the idea of dividend investing,
you might want to check out the video where I explained some of the nuances of
dividend investing and why it’s a strategy that I am pursuing. It’s become a pretty
popular strategy lately, but I think there’s still some misconceptions about it out there
so you should definitely take a closer look before you decide to commit to this strategy.
But let me explain what I’ve been going through
lately that led me to look at an ETF dividend investing strategy.
I’ve spent hours and hours looking into dividend paying stocks in order to find
above-average dividend yields. And I really don’t have a good metric for this, other than
the fact that I’m greedy and I wanted to build a portfolio that yields above 4%. The problem is,
a lot of those bread-and-butter blue-chip dividend stocks like Jonhson & Johnson, Coca-Cola and 3M,
have pretty average yields of about 3%, and these are at the higher end.
So as I dug deeper and got more exclusive with my stock selection, I came across stocks like AT&T,
IBM and AbbVie, which fit the dividend yield profile that I was looking for. But at the
same time, I’ve continued to do research into the overall market, and there’s so much data
that shows the S&P500 is the safest choice for securing competitive annual returns.
So while I’ve continued to invest in some of these higher-yielding stocks,
I can’t shake the idea that I need to be diversifying into more of the market to
ensure that I don’t miss out on returns over the next several years. But since the average
dividend yield of the S&P500 is only about 2% in recent years, I wanted to find a more aggressive
option when it comes to dividends, and that’s when I started to look into dividend-paying ETFs.
The problem is there are hundreds of dividend paying ETFs to choose from. Since it would take
months for me to analyze every dividend paying ETF on the market, I used an ETF screener at ETFDB.com
to find the ETFs that met my strict criteria. So I’ll walk you through the metrics that I used
to rule out most of these ETFs and my reasoning behind them. Keep in mind that these metrics just
fit my personal investment goals and beliefs, so they won’t provide the perfect solution for
every investor. But hopefully by showing you my process, you’ll be able to tweak it and
find the best ETFs for your investing strategy if you don’t agree with the ones I’ve picked.
So for starters, since I’m looking for a dividend yield of at least 4%, I’ll use this as one of my
first screening metrics. But I know I’m going to be paying taxes on these dividends, so I’m
actually going to use 4.75% as my minimum dividend yield. This assumes my dividends will be qualified
dividends, and will therefore be taxed at the 15% capital gains tax rate based on my tax bracket.
So after paying taxes on that 4.75% yield, I would be left with just over 4%.
And also, since I want to lock in that qualified dividend tax rate,
I’m going to limit my ETF search to ETFs that only include U.S.-based stocks.
This is because dividends from foreign companies generally aren’t qualified dividends.
The next concern I have is diversification. The whole reason I’m pursuing dividend ETFs is to
diversify my investments, so I want to make sure the ETF I choose satisfies that need.
Now there’s a lot of debate over how many stocks are required to be truly diversified.
A study published in 1987 suggested that a minimum of 30 stocks creates sufficient diversification.
A study published in 2001 suggests that a 50-stock portfolio will provide adequate diversification.
And most recently, in 2007, a study claimed that a 100-stock portfolio gives you a 96% chance
of financial success. Any of these numbers will give me more diversification than I’ve got now,
so I’m not too concerned with having a TON of stocks in my dividend ETF. I’m more concerned
that the ETF is diversified into stocks from different industries, which is something
we’ll look into down the line. So for now, I’ll just use 30 for the minimum number of holdings.
Next is a big one, and this is expenses. ETF expenses are expressed as a percentage,
and it’s the amount of your portfolio that the ETF issuer is going to collect annually for managing
your assets. A study by NerdWallet looked at the cost of management fees over the long-term,
and found that a 1% fee costs the average investor over half a million dollars over a 40-year period.
The more complicated ETFs get, the higher these fees will be. Obviously you can decide how much of
a fee you’re willing to settle for, but I’m going to limit my fees at .5%. This will theoretically
save me about $250,000 over a 40 year period. Ideally, I’d like to pay even less in fees,
but this is something we can come back to later when narrowing down our options.
We’re also going to rule out any actively managed funds. Like I said earlier, 90%
of fund managers fail to beat the market, and they also tend to have higher management fees.
So I’ll trust the market and the lower expense ratios of passively managed funds.
At this point, we’ve whittled our options down from 2,314 ETFs to just 17 ETFs. But the screener
failed to rule out some of the ETFs that are focused on specific sectors like Energy. This
sector is known to have higher dividend payouts, but coming back to the idea of diversification,
this isn’t going to work for me. So I’m ruling out some of these specialized ETFs and a few
of the stragglers that didn’t get screened out for including international businesses.
So now we’re down to just 7 ETFs that meet my goals for dividend investing.
So to narrow it down further, I’m going to introduce another aspect to my dividend investing
strategy that I’d like to consider. And this is the growth potential of the assets in the ETF.
One of the most attractive parts of dividend investing is the snowballing or compounding
effect of dividend reinvesting. This is where you collect your dividends
and reinvest them into your portfolio. If the stocks you reinvest into continue to grow and
continue to increase their dividends, you’ll gradually build wealth faster and faster.
The problem is, not a lot of stocks both appreciate in value and increase their dividends.
In fact, many high-dividend paying stocks are either stagnant or decreasing in price over time.
So, in order to achieve the dividend growth that I want from a dividend ETF,
I need to make sure the underlying stocks are capable of achieving this growth.
Since the remaining ETFs are passively managed, they’re all using a predetermined
methodology for selecting and weighting the stocks in their portfolios. So what I want
to see is that these methodologies have been effective in driving both capital appreciation
and dividend growth in the past. I know past performance is no guarantee of future returns,
but I think this will be the quickest way to assess whether the underlying funds will at least
somewhat mimic the trends of the total market. The S&P500 has performed pretty consistently
over the last 10 years, so I’ll be comparing the growth here to that of the remaining ETFs.
So let’s take a look at the 10 year charts of these 7 ETFs.
First we have XSHD, the Invesco SmallCap, high dividend low volatility ETF.
It’s got a dividend yield of 8.5%. Unfortunately, it’s only been around for 3 years,
and as you can see by the chart, it’s struggled to achieve any capital growth during that time.
SmallCap stocks simply won’t offer the stability and sustainability of dividend
growth that larger companies offer, so we’re going to rule this one out.
Next we’ve got DIV, the Global X Super Dividend ETF, with a huge dividend yield of 10.5%.
Again, coronavirus aside, the chart shows that this ETF has actually lost value since
its inception in 2013, a time period where the S&P500 has achieved a nearly 100% price increase.
This is just another example that dividends aren’t everything - yes,
you’re getting 10% dividend payouts, but your investment is not increasing in value.
This may be suitable for a retiree looking to live off their investment, but not for
me as someone who wants to grow their wealth while also collecting dividends. DIV is out!
Next is SPDV. This so-called high dividend value ETF is a newer ETF,
created in 2017 and currently offering about a 5% div yield. It aims to invest in undervalued
stocks that have high dividend yields, and it looks pretty well diversified across various
industries. Being so new, I don’t want to put too much weight in their disappointing price history.
However, I think it’s important to note that most ETFs that follow a value investing methodology
tend to underperform compared to growth strategies and the overall market.
Furthermore, the dividends from this ETF are taxed as income - not as capital gains.
Based on these tax consequences and its uncertain performance, I’m ruling this one out.
Now is where things get interesting, because we have just 4 ETFs left,
and all of their charts are at least trending upwards!
We’ve got FDL, The First Trust Morningstar Dividend Leaders ETF
with a 5% dividend yield and .45% expense ratio.
We’ve got RDIV, the Invesco Ultra Dividend Revenue ETF, with a 6.4% yield and a .39% expense ratio.
We’ve got SPYD, the spider high dividend ETF,
with a 5.5% yield and a very attractive .07% expense ratio.
And we’ve got SPHD, the Invesco High Dividend Low Volatility ETF,
with a 5.5% yield and a .3% expense ratio.
I personally think these remaining ETFs are pretty decent options for dividend investors.
They check all of the boxes we wanted; they’re qualified dividends with an annual yield over 5%,
they have reasonable expense ratios, they all have over 50 different holdings and the underlying
methodologies seem to be selecting growing stocks. But we’re going to have to get a little pickier.
FDL is the first one I’m going to rule out, and here’s why. First, I like the methodology behind
FDL - it’s focused on large cap companies, it’s composed of 100 holdings and it requires that
each company currently offers a higher dividend than it did 5 years ago. But what I don’t like is
that it’s pretty top heavy - it’s top 10 holdings make up 60% of its portfolio. This isn’t offering
as much diversification as I’d like, especially considering that I already own sizable positions
in 4 of these stocks. This ETF has the longest track record of our remaining options, but I also
don’t like that it has the highest expense ratio at .45% and the lowest yield at just about 5%.
Overall, it’s not a bad option, but I like our other dividend options better.
Next we’re going to rule out RDIV, and here’s why. I really want to like this one because it
offers the highest yield, but it’s also got a significant expense ratio. I also really like
its methodology - it uses the S&P900, giving some exposure to mid-caps. It also excludes
the top 5% of companies with the highest payout ratios and dividend yields, which are typically
the businesses most likely to be paying out unsustainable dividends and that are at risk
of dividend cuts. What I don’t like is that it’s weighted by revenue, so it’s invested heaviest
into the companies that make the most money. This sounds good in theory, but this results in the
fund being heavily weighted into the financial and energy sectors, two industries that are
good for income but that I’m not personally very bullish on in terms of price appreciation. Plus,
this is another top-heavy fund, with just 10 of the holdings making up 1/2 of the ETF.
So if you’ve made it this far, we’re down to the LAST TWO dividend ETFs
and they are certainly worthy candidates. Now SPYD and SPHD are pretty similar in
terms of dividend yield and methodology. So let’s take a closer look at how these
portfolios work so you can determine if you want to invest in either or both of them!
So SPHD is the Invesco S&P500 High Dividend Low Volatility ETF.
It tracks the S&P500 High Dividend Low Volatility Index. This index functions by ranking all of the
companies in the S&P500 by dividend yield. It then takes the 75 highest yielding companies,
limiting each industry’s representation to a maximum of 10 different stocks.
So this helps ensure diversification among different industries and produces a well-rounded
group of high yielding stocks. But there’s one more step - out of these 75 companies,
the index selects the 50 least volatile stocks based on their movement within the last
year. Furthermore, each company is then weighted by yield - so more money will go
into the higher yielding stocks - and each stock is capped at 3% of the fund’s makeup.
So this ETF is a great way to get quickly diversified into high yielding stocks for
dividend investors. The unique quality of this fund is its consideration of a stock’s volatility.
With less volatility, it slightly lessens some of the drops you see from the S&P500, which you can
see by comparing their performance over the last 10 years. So this might be a more desirable option
for someone looking to build a more stable or predictable source of passive income. It
pays its dividend monthly, and its dividends have been consistently increasing since its inception.
Obviously, when you look at the chart, SPHD has underperformed compared to the S&P500.
I think one of the main causes of this is that it lacks the exposure to non-dividend paying growth
stocks like Amazon and Tesla, or low-yielding but growing stocks like Apple, all of which
have driven huge growth to the market in recent years. So this kind of goes back to the dividend
investing vs growth investing debate, which I’ve already covered in my video on dividend investing.
And our last ETF, SPYD, is the Spider S&P500 High Dividend ETF. Similar to the SPHD ETF, it starts
by ranking all of the companies in the S&P500 by dividend yield. But, it has no other criteria for
selecting the stocks held in the fund. It just takes the top 80 stocks by dividend yield. Unlike
SPHD, it doesn’t cap any stock’s inclusion by sector. So whereas SPHD limits each sector to
10 stocks, the SPYD accepts the top yielding stocks without question. This means it will be
slightly biased towards those industries that just tend to have higher dividend yields, like
financials and utilities. Then, every stock will be given an equal weight in the portfolio, meaning
as prices fluctuate, each stock should make up approximately 1 to 1.5% of the total portfolio.
SPYD pays a quarterly dividend, and while they’ve been trending upwards over time,
they’re definitely a little less consistent than the dividend increases from SPHD.
And I think the problem with this comes down to their lack of screening qualities
when selecting stocks for the fund. SPHD chooses the least volatile stocks,
which means they’re probably more likely to maintain their dividends
and those higher dividend yields. With SPYD, it just selects the highest yielding stocks,
without properly diversifying across different industries. This means it will inevitably be
a riskier investment that might bring a risk of dividend cuts or decreases.
Plus, each fund only rebalances their holdings twice a year. So if SPYD happens to invest in a
bad egg that cuts their dividend, that won’t be swapped out for another 6 six months,
and that could result in a lower yield than expected for a given quarter. On the other hand,
SPHD’s methodology better protects it from bad eggs and makes it a safer dividend choice.
So while SPYD includes more stocks, it’s actually less balanced and might
be a riskier dividend investing strategy. That said, with a lower cost and a larger portfolio,
it’s slightly outperformed SPHD but at the cost of slightly increased volatility.
SPHD has a slightly higher cost, but I think it’s more appropriately diversified and has a safer
dividend outlook. Both have limited growth potential compared to the overall market,
but still offer a suitable vehicle for capital appreciation by investing
in large cap S&P500 dividend payers, which historically are strong market performers.
So ultimately, these two ETFs are very similar, and both are reasonable options for dividend
investing with ETFs. I’ll be splitting my dividend ETF investments between these two options,
bringing down my costs slightly, increasing my diversification
and hopefully delivering a happy medium of returns between the two.
I don’t think I’ve ever gone this deep into the facts and figures behind an ETF, and if that’s
not worth a subscribe, I don’t know what is! No really, please subscribe guys it’ll really
help me out, and let me know if this video has helped you decide how to approach dividend ETFs,
because whether you’re going to invest in the ones I talked about or other ETFs out there,
I’d be really interested to hear your take. In any case, best of luck with your dividend investing,
and I hope to see you right back here next week.