Dividend ETFs, at least in some allocation, belong in just about every portfolio. It may seem a bit counterintuitive in the current environment given that growth stocks and small-caps have been on a tear, while dividend funds, in general, have been laggards for the past few years.
Over the long-term, however, dividend stocks have been winners. Studies have shown that over periods of decades, stocks that pay dividends have outperformed those that haven't. On top of that, they're generally less volatile, are backed by healthier balance sheets and provide an important source of income that can help cushion some downside risk.
The ETF industry has a vast menu of options if you're looking to add dividend stocks to your portfolio. Whether you're targeting a specific strategy, a specific region of the world or a specific style, odds are the ETF marketplace has you covered.
Therein lies part of the problem though. There are well over 100 different ETF available that target dividend payers in some form or fashion. That make distinguishing the best from the rest a little challenging. You've probably heard most financial pundits talk about focusing on funds with low expense ratios. That can certainly be a big factor in deciding which ETF to go with (it's probably the most important factor, in my view), but there are a lot of things that could go into make the right choice.
That's where I'm going to try to make things easier for you. Using a methodology that I've developed which takes into account many of the factors that should be considered and weighting them according to their perceived level of importance, we can rank the universe of available ETFs in order to help identify the best of the best for your portfolio.
Now, this certainly won't be a perfect ranking. The data, of course, will be objective, but judging what's more important is very subjective. I'm simply going off of my years of experience in the ETF space in helping investors craft smart, cost-efficient portfolios.
Methodology And Factors For Ranking Dividend ETFs
Before we dive in, let's establish a few ground rules.
First, all of the data is used is coming from ETF Action. They have gone through the ETF universe to identify those ETFs using a dividend-focused strategy. There are more than 130 that qualify and we'll be using their categorization as a starting point. Many thanks to them for opening up their vast database for my use.
Second, let's run down the factors I used in the ranking methodology.
- Expense Ratio - This is perhaps the most important factor since it's the one thing investors can control. If you choose a fund that charges 0.1% annually over a fund that charges 1%, you're automatically coming out ahead by 0.9% annually. You can't control what a fund returns, but you can control what you pay for the portfolio. Lower expense ratios equal more money in your pocket.
- Spreads - This relates to how cheaply you can buy and sell shares. Generally speaking, the larger the fund, the lower the spreads. Bigger funds usually have many buyers and sellers. Therefore, it's easier to find shares to transact and that makes them cheaper to trade. On the other hand, small funds tend to trade fewer shares and investors often need to pay a premium to buy and sell. Considering expense ratios and spreads together usually give you a better idea of the total cost of ownership.
- Diversification - Generally speaking, the broader a portfolio is, the better chance it has at reducing overall risk. A fund, such as the Energy Select Sector SPDR ETF (XLE), provides a good example. 45% of the fund's total assets go to just two stocks - ExxonMobil and Chevron. By buying XLE, you're putting a lot of faith in just those two companies. An equal-weighted fund, such as the Invesco S&P 500 Equal Weight Energy ETF (RYE), would score higher on diversification than XLE.
- FactSet ETF Scores - FactSet calculates its own proprietary ETF ranking for efficiency, tradeability and fit. They basically are designed to tell us if an ETF is doing what it sets out to do. I'm not going to copy and paste that work that they're doing, but there is some influence there to make sure my rankings are on the right path.
There are a few minor other factors thrown into the mix, but these are the main factors considered.
One thing that's not considered are historical returns. Most ETFs are passively-managed and are simply trying to track an index, not outperform. ETFs shouldn't be penalized for low returns simply because the index they're tracking is out of favor at the moment.
I'm ranking ETFs based on more basic structural factors. Are they cheap to own? Are they liquid? Do they minimize trading costs? Do they maintain risk-reducing diversification benefits?
Being in the bottom half of the list doesn't automatically make a fund "bad". It simply means that due to a low asset base, a high expense ratio, a concentrated portfolio or some other factor, it poses additional costs or downside risks.
Not surprisingly, the biggest ETF issuers are well-represented at the top of the list. Vanguard, State Street, BlackRock and Schwab own the majority of the top 10 spots, but WisdomTree, ProShares, Fidelity and Invesco all appear in the top 20.
The top 6 ETFs on this list all have expense ratios of 0.08% or less underscoring how important low fees are. Expense ratios mostly climb to at least 0.25% beyond that, so there is a significant gap on the expense front.
The Vanguard Dividend Appreciation ETF (VIG) and the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) are great if you're looking for dividend growth. The Vanguard High Dividend Yield ETF (VYM), the SPDR Portfolio S&P 500 High Dividend ETF (SPYD) and the iShares Core High Dividend ETF (HDV) all rank highly if you're looking for a high yield. The iShares Core Dividend Growth ETF (DGRO) and the Schwab U.S. Dividend Equity ETF (SCHD) are among the best that combine multiple strategies in one.
There are plenty of solid choices outside the top 20 as well.
Here's where you get into some of the more specialty dividend ETFs. For example, you'll see funds focused on small-caps, financials, international stocks and unique styles, such as revenue-weighting.
Expense ratios here are generally higher, but that shouldn't automatically disqualify some of these choices. The Invesco High Yield Equity Dividend Achievers ETF (PEY) is a favorite of mine even though it comes in at #34.
The next batch show that cost isn't everything.
The Invesco Dow Jones Industrial Average Dividend ETF (DJD) has an expense ratio of just 0.07%. It has just $90 million in assets though making trading costs higher than average. It also scores lowly on diversification since its universe is only 30 stocks and it's top heavy on top of that.
The JPMorgan U.S. Dividend ETF (JDIV) is a fund that I'm a little surprised hasn't caught on better. It's cheap, it's got a solid strategy and an above average yield, but at just $16 million in assets, but it scores poorly on tradeability. If it builds up its asset base, I can see JDIV becoming a top 20 ETF.
Here's the bottom half of the rankings.