Many investors enjoy the dividend income that stocks produce on a quarterly -- or in some cases, monthly -- basis. What some investors may not realize is that exchange-traded funds (ETFs), which are baskets of stocks or other types of securities that trade on exchanges like a single stock, can also produce dividend income -- just like a stock. In fact, there are ETFs that are designed for the primary purpose of generating dividend income.
How do dividends work in an ETF? ETFs pay out dividends based on the dividends distributed within the underlying stocks they hold. So, if there is an ETF that tracks the S&P 500, all the stocks within that fund that pay out dividends would be calculated and paid out to the ETF investors on a pro-rata basis. The dividends could also be used to reinvest in the ETF.
While a dividend ETF will fluctuate based on the dividends in the underlying stocks, in particularly volatile markets, that diversification can be a good thing as some companies may be slashing or suspending dividends while others are raising or maintaining them. If you are looking for stable income, even in uncertain markets, here are two great dividend ETFs to consider: the SPDR S&P Dividend ETF (NYSEMKT: SDY) and the Invesco S&P 500 High Dividend Low Volatility ETF (NYSEMKT: SPHD).
SPDR S&P Dividend ETF: Dividend Aristocrats only
The SPDR S&P Dividend ETF includes the best, most consistent dividend stocks in the S&P 500. Specifically, it tracks the S&P High Yield Dividend Aristocrats Index, which only includes companies that have increased their dividend for at least 20 consecutive years. These are called Dividend Aristocrats, and they are stable, established companies with a history of strong performance.
Currently, the index includes approximately 120 stocks. The stocks in the ETF are weighted by yield, so the largest holding is AT&T followed by ExxonMobil, National Retail Properties, Peopleʻs United Financial, Federal Realty Investment Trust, Leggett & Platt, Franklin Resources, Realty Income Corp., Chevron, and IBM. The largest holding in the ETF is only about 2.14%.
As would be expected from such a concentration of stocks that consistently produce good dividends, the ETF currently pays out a quarterly dividend of $0.68, which comes out to about $2.72 annually per share. The dividend has been fairly consistent but is down from $0.79 per share at the end of 2019. However, over the last three years it has grown about 5.7% per year, and over the past five years it has an annual growth rate of 8.1%. It has a dividend yield of 2.8%, which is the percentage it pays out in dividends annually in relation to its stock price.
As for returns, the ETF is down about 8.8% year to date through Aug. 31 but has a five-year annualized return of 9.8%. That is less than the S&P 500 in both cases, but this is an ETF that prioritizes dividend income over return -- and given its makeup of Dividend Aristocrats, it is poised to deliver on its mission.
Invesco S&P 500 High Dividend Low Volatility ETF: Consistent monthly payouts
The Invesco S&P 500 High Dividend Low Volatility ETF is a good dividend ETF for these times. Investors who are wary of high market volatility and dividend uncertainty can rest assured that this ETF will deliver consistent results. As the name suggests, the ETF tracks the S&P 500 High Dividend Low Volatility Index, which is comprised of just 50 stocks that are deemed the least volatile high dividend-yielding stocks in the S&P 500. It uses price volatility as a screen to avoid dividend traps, which are stocks with dividends that look good but are not sustainable. Stocks that fall into this trap are typically more volatile.
The index looks at the top 75 dividend producing stocks in the S&P 500 and then takes the 50 from that number that have the lowest volatility. Currently, the top 10 holdings are Iron Mountain, Century Link, Altria Group, Dow, H&R Block, Vornado Realty Trust, PPL Corp., ExxonMobil, Philip Morris, and Huntington Bancshares. Utilities make up 16.9% of the portfolio, followed by real estate (14.1%), information technology (12.5%), and materials (11.9%).
The ETF generates a monthly dividend of $0.15, which has been pretty consistent over the past two years. The annual payout is about $1.80 per share at a generous yield of 5.22%. It has a three-year annual growth rate of 6% and a five-year annual growth rate of about 11%. The ETF is down about 19% year-to-date through Aug. 31, and over the past five years it has posted an annual return of about 6.2%. It is not flashy, but this is an ETF for income investors who want safe, stable monthly income they can count on, particularly in the most volatile of markets.
There are many good dividend ETFs out there -- and some that will produce even more income than these per year -- but these two ETFs in particular are solid choices for stable dividends in volatile times.
10 stocks we like better than SPDR S&P Dividend
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and SPDR S&P Dividend wasn't one of them! That's right -- they think these 10 stocks are even better buys.
*Stock Advisor returns as of August 1, 2020
The business news you need
With a weekly newsletter looking back at local history.