Many companies offer dividends to shareholders, which communicates the strength of the company and also allows companies to share their profits with shareholders. In essence, sharing their profits allows companies to "thank" their shareholders by providing a steady stream of income in the form of dividends.
But there are more opportunities available to shareholders than just investing in dividend stocks — you can also invest in exchange-traded funds (ETFs) as well. Dividends can be an excellent strategy for winning the long game and for immediate returns, according to research from The Hartford Funds. From 1930 to 2021, dividend income’s contribution to the total return of the S&P 500 Index averaged 40%.
In this piece, we'll go over the definition of dividend stocks ETFs, how dividends work, how to invest in dividend ETFs, what to look for, and how dividends are taxed. We'll also help you decide whether dividend ETFs deserve a place in your portfolio.
What Are Dividend ETFs?
A dividend ETF is an exchange-traded fund (ETF), a basket of securities that tracks an underlying index. In this particular case, a dividend ETF's "basket of securities" includes dividend-paying stocks. Investors who purchase the ETF can take advantage of periodic dividends later on.
The benefit of investing in dividend ETFs is that they offer more diversification than when you invest in individual stocks.
Here's why: When you put a lot of securities in one basket, each security will ebb and flow, depending on the stock market. However, when you invest in a single company, you're literally putting all your eggs in one basket. This means that if the stock completely disintegrates, your money will go with it as well.
Learn more: ETFs vs. Dividend Stocks: Which Should You Invest in?
How Dividends Work
If you're a dividend shareholder, you'll receive dividends just for owning the stock, typically every quarter. Company dividends are collected by the ETF issuer and distributed to investors. You're usually in good hands with dividend-paying companies because they are usually more stable and "flush with cash" than companies that do not offer dividends. Companies that don't offer dividends are usually trying to get themselves going.
You'll usually receive cash dividends for owning stocks, though you could receive stock through a dividend reinvestment plan (DRIP). You must own the stock up until the ex-dividend date, also called the ex-date. If you purchase stock after the ex-dividend date, you will not receive a dividend. (The stock exchange where the company’s stock is traded sets the ex-dividend date, which usually occurs up to three days before the record date.)
Here's an example. Let's say you own a dividend-paying ETF that pays 50 cents per share. Most companies pay dividends quarterly, which means you'll receive a payment of 12.5 cents for every share you own. You may also choose to reinvest your dividends, which means buying more shares of the company instead of taking a dividend payout.
8 Dividend ETFs to Consider for Your Portfolio
Need some ideas? Take a look at a few options below with the dividend yield listed for each. (We'll also explain how to find dividend yield and go over a step-by-step guide on how to invest in dividend ETFs in the next section.)
How to Invest in Dividend ETFs
If you think you want to invest in dividend ETFs, take a look at this quick investment guide.
Step 1: Know your financial goals.
The first thing you may want to consider doing is to walk through your financial goals. Answer this question above all else: Why am I investing?
You may want to consider having a financial advisor help guide you through that process. A professional will help you decide your risk tolerance, investment timeline, and more. Before you invest, you want to make absolutely sure that dividend ETFs make sense for your personal goals, because a different type of investment approach might make more sense. It's also a good idea to consider your investment timeline — when do you need the money? Investing in dividend ETFs might be a great approach if you're taking a long-term approach to invest.
Step 2: Do your research.
Next, research. It's not the most fun part but it'll make you feel better about your investments. Become like a paleontologist, scraping one layer of dirt at a time. You'll want to look at an ETF's past performance (though it doesn't guarantee future performance) to check out its dividend history, expense ratios, commissions (most brokerages are commission-free, but it doesn't hurt to check before you buy), total holdings, trading prices and more. If possible, make sure you're evenly diversified over many sectors. Sometimes, concentrating on one sector can be a mistake because if one company in a sector goes down, they all might follow.
When researching dividend ETFs, don't ignore the dividend yield, which you can find by dividing the annual dividend payment by the share price, which is shown as a percentage. Why is it important? It shows how much the ETF pays in relation to its stock price.
Here's an example of how to calculate dividend yield: Let's say an annual dividend payment is $3. If the share price is $100, the dividend yield would be 3% in this case with 75-cent quarterly distribution per share. You can add up the dividend yield for an ETF very similarly to the way you'd add up the dividend yield for an individual stock.
In addition, some ETFs might have less liquidity than some funds, so check on how easy it is to buy and sell your investments. You don't want a lack of liquidity to hinder you.
Step 3: Invest your funds in an appropriate number of shares.
Next, invest! All that you have to do next is navigate to the trading section of your brokerage’s website. You'll have to know the ticker symbol of your ETF and enter the number of shares you want to purchase. Choose between four types of orders:
- Market order: With a market order, you'd buy the ETF right now at the best available price.
- Limit order: A limit order means you'll buy an ETF at a specified price (or lower).
- Stop order: A stop order means you'll buy after a specified price (the stop price) has been reached.
- Stop-limit order: Once the stop price has been reached in a stop-limit order, the trade turns into a limit order and is filled to the point where specified price limits can be met.
Step 4: Stay on top of your investments.
Finally, the last leg of the journey: Keep checking your investments. Stay hands-on with your finances and remember that while you're subject to risk (just like you are with any investment type) the dividends may offer many great opportunities for the future, and so will the ETF itself.
How Are Dividends Taxed?
If you receive over $10 per year in dividend payments, the IRS wants to know about it. Dividend stocks are generally treated as income by the IRS unless your holdings reside in a tax-deferred account like an IRA or 401(k).
There are two types of dividends: qualified dividends and nonqualified dividends.
Qualified dividends must come from a U.S. corporation or a qualifying foreign entity. Tax rates are based on the capital gains tax rates — a 0%, 15%, or 20% tax rate. The tax rate you'll end up with depends on your filing status.
Nonqualified dividends are taxed at ordinary income rates (which can go up to 37% because they're based on your federal income tax bracket), while qualified dividends receive more favorable tax treatment because they're taxed at capital gains rates.
Are Dividend ETFs a Good Investment for You?
Do you think ETF investing makes sense for your needs? Dividend-paying ETFs can help you grow wealth over the course of time. Not only will you earn distributions from dividends, you may also potentially want to sell down the road, such as when you need more cash to live off during retirement.
First and foremost, consider your entire portfolio and future goals to make sure that dividend ETFs deserve a place in your portfolio. When you double down on both dividend payments and ETF returns, you can mightily impact your future.
Make sure you do your research! Consider focusing on some of the dividend ETFs we've chosen to highlight in this article because they can be a great way to get the hang of investing in ETFs. You may want to invest just a few shares at first if you're a brand-new investor, then eventually work your way up into a larger portfolio.
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Companies Mentioned in This Article:| Company | Current Price | Price Change | Dividend Yield | P/E Ratio | Consensus Rating | Consensus Price Target |
|---|
| Vanguard Dividend Appreciation ETF (VIG) | $174.09 | +0.3% | 1.71% | 24.56 | N/A | N/A |
| Vanguard High Dividend Yield ETF (VYM) | $115.93 | +0.8% | 2.80% | 15.82 | N/A | N/A |
| SPDR S&P Dividend ETF (SDY) | $126.79 | +0.9% | 2.52% | 19.41 | N/A | N/A |
| iShares Select Dividend ETF (DVY) | $118.70 | +1.6% | 3.76% | 12.98 | N/A | N/A |
| ProShares S&P 500 Aristocrats ETF (NOBL) | $97.04 | +0.7% | N/A | 21.27 | N/A | N/A |
| Schwab US Dividend Equity ETF (SCHD) | $76.65 | +1.1% | 3.34% | 15.00 | N/A | N/A |
| SPDR Portfolio S&P 500 High Dividend ETF (SPYD) | $39.01 | +1.4% | 5.08% | 14.65 | N/A | N/A |
| iShares Core Dividend Growth ETF (DGRO) | $55.71 | +0.7% | 2.10% | 18.84 | N/A | N/A |
About Melissa Brock
Experience
Melissa Brock worked as an associate editor & contributing writer for DividendStocks.com from 2021 to 2024.
She currently works as a full-time freelance writer and financial editor covering higher education, investing, personal finance, mortgages, college savings, insurance, and more.
Areas of Expertise
Dividend Stocks, Retirement
Education
Bachelor of Arts in Communication Studies, Central College, Pella, Iowa
Past Experience
Melissa graduated summa cum laude with a bachelor of arts in communication studies with minors in psychology and Spanish from Central College. She's a longtime member of the National Association of College Admission Counseling (NACAC). While working in college admission, Melissa Brock pursued a freelance writing and editing career.