The Dividend ETF: A Good Alternative to Stock Picking

Dividend ETFs are a great option if you want to build long term wealth with dividend growth investing but do not have the desire to research and select individual companies.

What exactly is a dividend exchange traded fund?

They are usually funds that are designed to hold the same stocks as and mimic the performance of a particular dividend stock index. 

For example, the Vanguard Dividend Appreciation ETF, with an annual management fee of only 0.13%, holds the same group of companies and seeks to track the performance of the NASDAQ US Dividend Achievers Select Index.  To belong to this index, a company has to have increased their dividends every year for at least 10 consecutive years.  Many have been increasing their dividends for much longer than 10 years.

How do you purchase Dividend ETFs?

ETF dividends trade like any other stock on the exchanges throughout the world.  To purchase them, you need to first open an online brokerage account.  There are many to choose from and not all of them are created equally.  While doing your research, it is important to consider the commissions that they charge you for purchasing shares.  The lower the better! Click here for our recommended Online Stock Brokers for U.S. and Canadian long term dividend investors.

After opening an account, simply decide which ETF you would like to invest in and purchase the shares through your broker.  Reinvesting all dividend payments will accelerate your wealth building efforts over the long term and some brokerages allow you to reinvest automatically at no cost.

This strategy is considered dollar cost averaging and is a good option if you are a passive investor.  Your growing dividend income will buy you more shares that will also pay you a growing stream of dividend income... your very own compounding machine!

Otherwise, you can allow the dividends to accumulate along with new money you have added in your account and invest when the transaction fee becomes small compared to the amount you are investing.  Click here to find out how we manage transaction costs when purchasing high paying dividend stocks.

The Good and Bad of Dividend ETFs

Let’s start with the good.  The best thing about these funds is that they make the powerful compounding strategy of dividend growth investing accessible to the masses.  If you are too busy or can’t be bothered to teach yourself what you need to know in order to invest in individual companies, no problem... you can buy the dividend ETF. 

The fees are very reasonable and much lower than a typical mutual fund.  As mentioned above, they are very easy to purchase because they trade like any other share on the major stock exchanges.  Just open a brokerage account and buy the shares!

You will still get a stable and growing stream of dividend income that you can reinvest to really harness the power of compounding and some brokers allow dividends to be reinvested at no cost. 

Now for the bad... but keep in mind that this is from the perspective of someone who invests in individual companies.

The first thing is that although very reasonable, you will still pay an annual management fee in addition to the transaction costs of purchasing the shares.  Individual stocks are cheaper to own.

Second, you will own usually 100+ companies.  Within the bunch, there will be companies with too much debt and who are not performing as well as some of the others.  The top performers will be dragged down by the mediocre.

You should be able to generate a better return over time by selecting only the best dividend paying companies of the pack and purchasing them for the right price.  These will be the companies with the highest returns on equity and invested capital, clean balance sheets, good management teams and steady earnings and dividend growth.

You can think of them as the all star teams among the professional sports leagues out there.  Click here to learn how we go about evaluating a dividend paying stock.

However, picking stocks is a commitment and you may not have the time or want to put in the effort required to identify these companies and manage them to ensure that they continue to perform.  That is perfectly fine because ETF dividends are a great option for you and if you continually invest and hold them for the long term, you will do fine.  Click here for an article on building wealth with stocks that pay dividends.

So there you have it... you are now no stranger to the Dividend ETF.  Good job!

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