Dividend ETF's

What is a Dividend ETF?

2011-09-08T18:54:00.001-04:00

First, let's start with the question "What is an ETF?" ETF stands for "exchange traded fund." They are securities that track an index or commodity. ETF's trade like stock and prices change through out the day. They are an easy way to get started investing and be instantly diversified. ETF's are excellent alternatives to mutual funds due to the fact that exchange traded funds have minimal management fees because of they are not actively managed like mutual funds. There are various types of ETF's ranging from broad ones that mirror the S&P to ETF's that are specific to different countries. There are even gold ETF's that have become very popular in the past several years. My favorite are dividend ETF's which are geared toward income and appreciation.

Dividend ETF's is like buying a basket full of shares in different companies that pay a dividend. Want to buy shares in Chevron, McDonald's, Coca-Cola, AT&T or General Electric? Only have $500 to invest? An easy entrance would be buying shares in an ETF to get holdings in most of these companies. There is less risk involved when compared to buying shares in one or 2 dividend companies. If you purchased shares in two individual companies and one cut their dividend your income would be impacted greatly. If you have an ETF and one of the companies cut a dividend the holdings are so diversified that there will be little impact.

Dividend ETF's are great for starters. When you mature as an investor you may feel more comfortable selling out of your ETF holdings and investing in individual stock in companies. Until them I highly recommend ETF's for beginners and people with no time to manage their investments.

Benefits of an ETF

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There are 3 major benefits exchange traded funds (ETFs) provide over individual stocks & mutual funds.

1) Diversification
2) Tax Benefits
3) Transparency

The combination of the above benefits do not leave much room for argument in the mutual funds corner. It has been seen year after year that most mutual funds fail to have a better return than the S&P 500 index, which is a broad market index.

Investments in individual stocks give you greater control of your money if you have the time and knowledge to follow companies and you have enough cash to invest in a range of different sectors for diversification. I actually prefer to invest in individual companies do no expense ratios and I know exactly how many shares of what company I own. On the flip side most of my friends & co-workers want to save & invest, but don't know where to put their money. This is where ETF's come in handy. All they have to do is select 3 or 4 ETF's to contribute monthly (i.e. a dividend ETF, Bond ETF, & Growth ETF). With dividends & interest reinvested this puts people on a good road toward retirement down the road. They are turning that dirt road into a paved road as they invest without much work involved in studying and analyzing companies.

ETFs Provide Transparency

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Mutual fund holdings are typically only available on a quarterly basis. Exchange Traded Funds (ETFs) on the other hand typically have their holdings available on a daily basis. This benefit provides you the opportunity to rebalance your portfolio easily. For example, let's say you are invested in an ETF that has 5% of its holdings in Exxon Mobil. Now an oil spill occurs and the cleanup can potentially cost BILLIONS. The stock price will be significantly affected by this disaster. You may decide to sell your position and purchase an ETF that is less consolidated in Exxon Mobil.

This transparency allows you to make quick & accurate decisions on your holdings.

ETF's Provide Diversification

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ETF's provide instant diversification for new investors trying to get started with investing. Dividend ETF's invest in dividend paying companies that typically invest in a wide range of sectors. With one purchase you can own shares of companies like AT&T, General Electric, Southern Company, Procter & Gamble, & Exxon Mobil (Exhibit 1). Every quarter you receive dividends to reinvest or invest in something else.

Diversification puts up a shield against troubles to an individual company. Beginner investors only have enough cash to invest in a few companies and if one of those companies were to have problems that affect the company value or go belly up then your holdings would be significantly reduced due to the large percentage of your portfolio being invested in that company. With an ETF most funds keep it's holdings in one security down below 5% of the portfolio. This diversification lowers the price swings that you would experience from major swings in individual securities.

Exhibit 1:

ETFs Provide Tax Benefits

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ETFs can provide tax benefits for investors due to their low turnover. Mutual funds are actively managed by a manager who may trade in and out of positions as the market advances or declines. On the other end of the spectrum ETFs follow indexes and have a lower turnover rate. The difference between having short term or long term capital gains can add up over time.

Also on another note, since exchange traded funds have lower turnover rate there are less trading cost involved, which plays a small part in why the expense ratio is much lower. The main reason of course being that it isn't actively managed due to the fact it follows an index.