My thoughts on dividend ETFs

When I started investing a decade ago, I primarily focused on dividend equities. They provided a reliable source of income and stability.

I needed the stability back then because I was looking at divesting my equities within five years, together with my dividends received, to pay for my MBA.

Fast forward to today, I only hold less than 5% of my portfolio in dividend equities. Does that mean that such equities are unattractive?

Before I answer that question, let us look at one of the popular dividend equities: Dividend ETFs.

Dividend ETFs are exchange-traded funds that hold companies with a strong history of paying dividends to their shareholders.

Like any other ETF, the fund managers of a dividend ETF choose a portfolio of stocks to match the composition of a dividend index.

There are generally 4 types of dividend ETFs:

1. Diversified Dividend ETFs

2. International Dividend ETFs

3. Real Estate Dividend ETFs

4. Dividend Aristocrat ETFs

The first three are pretty obvious as their names suggest. As for Dividend Aristocrat ETFs, these ETFs hold companies that have the gold standard of paying dividends. They provide consistent and steady dividend income.

Dividend ETFs appeal to investors who are conservative or more interested in cash flow for retirement. It provides the investors with a cost-effective income-generating investment asset.

The ETFs can be a more convenient way to pursue income investing than owning and managing your basket of individual dividend stocks.

However, dividend ETFs own companies that traditionally do not grow as fast as the overall market. This is a trade-off between dividend yield versus capital appreciation.

It is for this reason that I minimize my allocation for my dividend equities after paying for my MBA. As I do not foresee any major financial expenditure in the near term, I have a longer time horizon to hold onto my capital appreciation stocks.

Moreover, as a Singaporean investing in dividend ETFs in the United States, I am subjected to a 30% tax. The effective return is no longer attractive to me.

I also want you to know that, unlike the coupon payments on bonds, dividend payments are never guaranteed.

For those who are interested in investing in dividend ETFs, there are three considerations that I want you to pay attention to.

First is the dividend yield. This is the percentage of the purchase price paid in dividends during the prior 12 months. If a $100 ETF pays $5 in dividends, it has a 5% dividend yield.

The highest-yielding dividend ETFs tend to have volatile yields over time and less certainty of maintaining those yields. It is common for the highest-yielding stocks to suffer during market declines.

Next is the dividend growth. Just because a company pays a dividend now does not mean it will continue in the future. Even if it keeps its dividend, there is no guarantee that the payout will rise over time.

The final consideration is the dividend quality. This applies to the quality and creditworthiness of the stocks owned by the ETF. As a rule of thumb avoid funds using riskier companies to boost yields.

So, it is not that dividend equities are unattractive. It is just not suitable for my situation. With a longer time horizon and higher risk profile, I prefer investing in companies that appreciate in capital.

Well, when I am approaching my sixties, maybe I will start allocating more to dividend equities for passive income while enjoying my Mojito somewhere.