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For Dividend ETFs, Watch Large Weightings

NEW YORK ( TheStreet) -- One of the first categories of specialized exchange traded funds was dividend ETFs, with the first one popping up in late 2003. Since then, many other ETF providers have created dividend ETFs, including WisdomTree, whose founding was solely based on the category.

I've written quite a few articles about broad-based dividend ETFs, each with the same refrain: Watch the financial sector exposure. Regardless of the methodology, most of the funds had 30% to 40% weightings in the industry when they debuted a few years ago versus roughly 20% for the S&P 500 Index. Owning a fund with 40% in financial stocks isn't necessarily a bad thing. But if your other funds have a large chunk in financials, then you'll be overexposed.

The case for dividends is compelling for long-term investors. The stock market has had an average annual return of roughly 10% over the long term, about 40% of which has been generated by dividends. If dividends produce a big piece of an investor's returns, he'll be able to sleep peacefully, as his risks are reduced. The investor won't have to expect too much from price appreciation.

After the latest financial crisis, many dividend funds now have much smaller weightings in financials, making them more balanced and, perhaps, less risky than they used to be.

A case in point is the iShares DJ Select Dividend Fund (DVY), which was the first dividend-centric fund. Five years ago, the fund's weight in financial stocks was 40%; today it's 14%. The reason for the drop is simple: Many financial companies no longer pay dividends, and those that do, pay much less than they used to be. Utilities are now the largest sector in the fund, at 24%, followed by industrials at 20% and consumer goods 17%. Just as financials at 40% were an extreme overweight back then, utilities are an extreme overweight today, as is basic materials at 10% of the fund versus 3% for the S&P 500.
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