Consider This Investment for Dividends and Diversification

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As with most other investment categories, income investors have options other than choosing individual stocks that pay dividends. There are several exchange-traded funds (ETFs) that specialize in dividend-paying stocks.

One example is the Dow Jones Select Dividend Index Fund (NYSEMKT: DVY). Launched in November 2003, DVY is a passively managed ETF designed to track the performance of the Dow Jones U.S. Select Dividend Index, which is an index comprised of securities based on their dividend yield.

An alternative to low-yielding bonds

One reason for the attractiveness of dividend-based ETFs is that current bond yields are still historically low, pushing income investors toward better yielding vehicles.

The Dow Jones Select Dividend index holds 100 stocks of companies that it deems as providing high dividend yields on a consistent basis. Stocks are screened on the basis of dividend per share growth rate, dividend payout percentage rate, and average daily dollar trading volume, then selected based on dividend yield.

Analysts say DVY is appropriate for investors who want consistent income, regardless of the economic environment. The fund itself pays out a current yield of around 3.5%.

The fund’s expense fee is 0.40%. As of Mar. 31 this ETF had net assets totaling $11.76 billion with 101 stocks in its portfolio. The fund’s performance has been nearly identical to the index performance over the past five years. As of Mar. 31, the fund’s one-year return was 17.67%, its three-year return was 15.46% and its five-year return was 5.97%. It has a beta compared with the S&P 500 index of 0.65, meaning it’s volatility is about 65% of what the S&P’s volatility measures. Shares of the fund trade at a price to earnings ratio of about 19.

DVY has traded in the $53 to $65 range over the last 52 weeks, having set a new high in mid April before backing down to its current price just above $63. It has been on steady upswing since November, rising from about $55.

Because of its emphasis on dividends, it’s not surprising that utility companies make up 30% of its holdings, followed by consumer goods (16.79%), industrials (15.71%), financial companies (10.22%), basic materials (6.15%), and consumer services (5.88%). Some of its top holdings are: Chevron, McDonald’s, and Kimberly-Clark.

Beware Rising Interest Rates

Analysts warn that an inevitable rise in interest rates will be a threat to the utility sector. Historically, rising rates are bad for utility stocks as more attractive bond yields are viewed as safer competition for investment capital. When rates do increase, whenever that occurs, utility stocks and funds heavy in that sector are likely to get hurt.

Experts also point out that dividend ETFs have different approaches that should be taken into consideration.

Some dividend ETFs weigh individual stocks by their dividend yield, or by total dividends paid in dollars. Others weigh companies by size or market cap.

Indices that follow a dividend yield-weighted methodology produce more income, but the strategy comes with greater risks. Specifically, the funds would lean toward more distressed, high-yield and small-cap firms than other types of broad equity ETFs.

In contrast, ETF indices weighted by total dividends paid would lean toward large-caps since larger stocks would dish out the most overall dividends. Additionally, the large-cap tilt provides lower volatility in times of market distress. DVY falls into this category.

Alternatives to DVY

Examples of ETFs that employ the dividend-weighted methodology include:

SPDR S&P Dividend ETF

The fund employs a sampling strategy to track the performance of the S&P High Yield Dividend Aristocrats Index. It generally invests substantially all, but at least 80%, of total assets in the securities comprising the index. It has a 12-month yield of 2.82%.

SPDR S&P International Dividend ETF (NYSE: DWX)

The fund employs a sampling strategy to track the performance of the S&P International Dividend Opportunities Index. It invests substantially all, but at least 80%, of its total assets in the securities comprising the index. The index is designed to measure the performance of the approximate 100 highest dividend-yielding common stocks and ADRs listed in primary exchanges of countries included in the S&P Global BMI. It has a 12-month yield of 6.30%.

WisdomTree Dividend ex-Financials Fund (NYSE: DTN)

The fund is designed to track the performance of the WisdomTree Dividend Ex-Financials Index. The index is comprised of the 10 highest dividend-yielding companies in each sector, selected from the three hundred largest companies by market value in the WisdomTree Dividend Index (other than companies in the financial sector). It has a 12-month yield of 3.88%.

Two ETFs, in addition to DVY, that employ the total dividends paid design include:

WisdomTree Emerging Markets Equity Income Fund (NYSE: DEM)

The fund seeks to track the price and yield performance, before fees and expenses, of the WisdomTree Emerging Markets Equity Income Index. The index is a fundamentally weighted index that is comprised of the highest dividend yielding stocks selected from the WisdomTree Emerging Markets Dividend Index. The fund has a 12-month yield of 3.31%.

iShares High Dividend Equity Fund (NYSE: HDV)

This ETF seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Morningstar Dividend Yield Focus Index. The underlying index measures the performance of a select group of U.S. equity securities issued by companies that have provided relatively high dividend yields on a consistent basis. It has a 12-month yield of 3.22%.

Daniel Murray has no position in any stocks mentioned. The Motley Fool recommends Kimberly-Clark and McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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