Supposing That the Sp 500 Pays Dividends Continuously at a Constant Yield What Must the Yield Be
The Best Dividend ETFs of October 2022
Methodology
We screened the entire universe of dividend ETFs using four factors:
- Low expense ratios.
- High distribution yield.
- Good five-year trailing returns.
- Top 20% category rank.
From the resulting list of the most attractive dividend ETFs, we selected a diverse mix of stock, bond and real estate funds that garnered neutral to high Morningstar ratings. Finally, we polished the list by choosing well-regarded fund families with reasonable investment strategies.
What Is a Dividend ETF?
Dividend ETFs are exchange-traded funds that hold stocks with a strong history of paying dividends to their shareholders. When you own a dividend ETF, fund managers ensure the holdings are always ones that pay out good dividends.
Like any other exchange-traded fund, the managers of a dividend ETF choose a portfolio of stocks to match the composition of a dividend index. The resulting portfolio provides the holders with an inexpensive income-generating investment asset.
Dividend ETFs can be a more convenient way to pursue income investing than owning and managing your own basket of individual dividend stocks. Unlike the coupon payments on bonds, dividend payments are never guaranteed—that makes maintaining a portfolio of dividend stocks more labor intensive for individual investors.
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How To Choose a Dividend ETF
Morningstar lists more than 130 dividend ETFs, making it imperative that you understand how to choose the right one for your portfolio. For example, two dividend funds might have a similar yield. But you might prefer the ETF, where dividends have historically grown at a faster rate.
When choosing a dividend ETF, you'll want to be aware of:
- Dividend yield. This is the percentage of the purchase price paid in dividends during the prior 12 months. If a $100 ETF pays $10 in dividends, it has a 10% dividend yield.
- Dividend growth. Just because a company pays a dividend now doesn't mean it will continue in the future. Even if it keeps its dividend, there are no guarantee payouts will rise over time. That's why some investors prefer buying into so-called dividend aristocrats. Companies in the S&P 500 have long histories of raising their dividends over time.
- Dividend quality. This applies to the quality and creditworthiness of the stocks owned by the ETF. If the fund owns riskier companies with lower credit ratings, then it's more likely that the value of the fund will decline, taking your total return with it. As a general rule of thumb. avoid funds using riskier companies to boost yields.
The highest-yielding dividend ETFs may feature more volatile yields over time and less certainty of maintaining those yields. It's not uncommon for the highest-yielding stocks to suffer greatly during market declines. That is why it's important to consider current yield, dividend growth and quality.
Traditional dividend ETFs own companies that don't grow as fast as the overall market. For this reason, investors need to understand the trade-off they might be making when seeking yield versus appreciation through rising stock prices.
If your goal is simply to earn the most with your money, you might opt for stocks positioned to grow in value more and then sell off shares as you need to for income.
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Types of Dividend ETFs
There are many categories of dividend ETFs, spanning index funds, regions and quality dividend stocks like the dividend aristocrats. Others focus on stock market sectors known for offering high yields, like REITs, utilities or on preferred stocks.
Below, we highlight some examples of leading dividend ETFs for each major category. Keep in mind that these are not endorsements of any particular fund. They're just meant to highlight the types of funds you might research as you seek out the best dividend ETF for you.
- Diversified Dividend ETFs. High-dividend ETFs include companies that make higher than average dividend payments. Typically, companies that pay higher dividends might have greater risk profiles and may be subject to more price volatility.
- International Dividend ETFs. International dividend ETFs work much like their domestic high dividend counterparts; they simply invest in international companies instead of those based in the U.S. This kind of international exposure can further diversify your portfolio. Their dividend payments may be taxed at a higher rate than U.S. companies. Check with a tax professional if you intend to rely heavily on international dividend ETFs.
- Real Estate Dividend ETFs. Real estate investment trusts own shares of companies that buy or loan money to income-producing real estate. By law, REITs must pay 90% of their income to shareholders, making them top choices for those seeking rich dividend payouts.
- Dividend Aristocrat ETFs. Dividend aristocrats are the gold standard of dividend-paying stocks, making them a go-to for people looking for consistent, steady dividend income.
Dividends ETFs and Taxes
Dividend ETFs are taxed similarly to the underlying securities within the fund. Even if you reinvest dividends, they still count as taxable income.
Most investors will receive tax forms, like a 1099-DIV, that explain whether their dividends are qualified or ordinary.
Qualified dividends are taxed at lower rates than ordinary income, such as long-term capital gains. Qualified dividends tend to come from U.S.-based companies.
Ordinary dividends, meanwhile, are taxed at your ordinary income rates; international companies are more likely to pay ordinary dividends.
Who Should Invest in Dividend ETFs?
Dividend ETFs may appeal to certain types of investors, like those who are more conservative with their investing dollars or more interested in cash flow for retirement. Aggressive investors looking to maximize their total returns may be better served by smaller, growth stock funds that provide the potential for higher capital gains.
Dividend ETF FAQs
What is a dividend?
Dividends are how companies distribute earnings to their shareholders. Dividend payments come in the form of cash or stock, and each share of stock you own may provide you with a specific dividend payout benefit.
Public companies are not required to pay dividends. Both private and public companies may pay dividends, they can decide whether to pay them monthly, quarterly or annually.
How are dividends taxed?
When it comes to taxation, there are two classes of dividends: qualified dividends and ordinary dividends. Qualified dividends are taxed under the capital gains tax rules, while ordinary dividends are taxed under the regular income tax rules.
Qualified dividends come from U.S. or foreign companies trading on major U.S. stock exchanges, or companies that trade in countries with a U.S. tax treaty. Ordinary dividends are issued by foreign companies that don't meet qualified dividend criteria, or that come from savings or checking accounts, REITs, employee stock benefits or tax-exempt companies.
What is a dividend yield?
Dividend yield is how investors understand the relative value of a company's dividend payments. To calculate dividend yield, divide a stock's annual dividend amount by its current share price. Dividend yield is always conveyed as a percentage.
The dividend yield is a good way to compare the value of dividends offered by different companies. For example, a stock with higher quarterly dividends might seem enticing, but if the stock price is also high, it will pull down the overall dividend yield.
How do you calculate dividend yield?
Dividend yield is calculated by dividing the stock's annual dividend amount by its current share price.
For example, consider a stock that's currently trading at $10 per share, and that pays quarterly dividends of 10 cents per share. That's a dividend of 40 cents for the year. To figure out the dividend yield for the stock, you divide 40 cents by $10 per share, giving you a dividend yield of 4%.
What does ex-dividend mean?
The ex-dividend date is the date by which you must own a dividend stock to be eligible to receive the payment. The ex-dividend date is important to know if you're hoping to receive dividends from a stock as an investor.
The ex-dividend date is usually one business day before the company that issues the stock checks its stockholder roster to determine who is eligible for dividends. Buying shares of the stock on or after the ex-dividend date will disqualify you from receiving the dividend payment.
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