High Dividend ETF

When the economy is doing well, people prefer to invest in growth stocks- stocks which are bound to do very well and which would give very good returns on their investment.  But when there is economic turmoil, steady income becomes important and the same investors may gravitate towards dividend yielding stocks.  However, if the economy worsens even further, these stocks would also be abandoned and investors would flock to bonds and precious metals.

Value Investing

Value investing is one of the oldest equity strategies and is very popular with investors.  Investors using this strategy look for companies with high dividend yields and invest in them.  This could be done by either investing directly in dividend yielding stocks or buying units of a high - dividend ETF (exchange traded fund).

Exchange Traded Fund (ETF)

Just like there are mutual funds which invest in a basket of stocks, there are funds called exchange traded funds or ETFs.  These may restrict their investments to only one asset class like stocks or they may invest in a variety of assets. Though mutual funds cannot be bought and sold on the exchange, ETF units can be traded in the market.

High - Dividend ETF (Exchange Traded Fund)

An exchange traded fund which invests only in companies with high dividend yields is called a high – dividend ETF. 

ETFs use various weighting methodologies to allocate investments.  A high - dividend ETF follows the dividend weighting methodology.  This kind of ETF is usually based on an index which measures performances of dividend paying companies.  The index is dividend weighted to reflect each company’s projected cash dividend based on the latest dividend declarations.

An investor wanting to invest in a high - dividend ETF (exchange traded fund) today, has plenty of options.  These ETFs are in great demand in an economic downturn.  Their popularity however decreases when equity markets are doing well.  At such times, ETFs which are weighted by market capitalization and earnings do much better.

Arguments in favor of the High - Dividend ETF:

  • Just like a stock that pays dividend is valuable, a high dividend paying ETF is also beneficial to the investor.
  • The dividends received from a high - dividend ETF (exchange traded fund) help to save tax as these dividends are taxed at a lower rate than bank deposits.
  • Most of the returns of the stock market have been in the form of dividends. Investing in a high dividend ETF would be the right thing to do if one wants steady income over a long period of time.
  • High dividend ETFs are less risky compared to some other ETFs which invest in high risk assets.

Counter-Arguments:

  • As soon as dividend is paid out, the stock price reduces by the extent of dividend.  The same holds good for a dividend ETF.
  • For saving on tax, tax free bonds are an even better option than a high - dividend ETF.
  • Returns from stock investments need not be only in the form of dividends.  Companies which do not pay out dividend may be using the money for business expansion which will surely benefit the shareholder.
  • Studies have shown that high dividend stocks are not devoid of risk and can be even more volatile than the broad market.

Points to be kept in mind before investing in a High - Dividend ETF (Exchange Traded Fund)

  • Check the expense ratio of the high dividend exchange traded fund and do not invest in it if the expense ratio is too high.
  • If you want high dividends, you can also consider an REIT (Real Estate Investment Trust) fund which would pay even higher dividend.

Invest in a high dividend ETF only after considering all its pros and cons and ensuring that it would fulfill your investment needs.