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Summary

  • Dividend paying stocks have outperformed the broad market year-to-date as the market's preference shifts from growth to value.
  • Many dividend ETFs currently yield 3% or more compared to the S&P 500's current yield of 1.86%.
  • Many dividend ETFs are becoming more broadly diversified as dividend growth rates are being led by gains in financials and technology.

In 2013, hot names like Tesla (TSLA) and Netflix (NFLX) were all the rage but in the last few months that's all changed. Rapid growth businesses are falling out of favor (Tesla is down roughly 20% and Netflix is down almost 30% since the beginning of March) and replacing them are less glamorous dividend paying companies. As concerns about future economic growth escalate and interest rates continue to remain at all-time lows, investors are turning to large dividend payers for safety and income. While the S&P 500 (SPY) returned 1.7% in the first quarter of 2014, the iShares Select Dividend Index ETF (DVY) returned 3.6% in the same period.

And for income investors the current pickings are pretty slim. Money market funds and short-term Treasury bills are yielding mere basis points. According to Bankrate, the average 2 year CD is yielding just 1%. With the current annual inflation rate sitting somewhere between 1% and 1.5%, income investors are falling behind unless they lock up their money for multiple years or increase risk.

That's why so many are turning to equities for yield. The S&P 500 has a current yield of 1.86% but the aforementioned iShares Select Dividend Index ETF has a juicy 3.04% yield. According to Zacks, 2013 is the fourth consecutive year of double digit dividend growth having been led by growth in the financial and technology sectors. With many companies maintaining balance sheets with large amounts of cash, double-digit dividend growth is expected to continue into 2014.

Anybody who's looking to improve the income component of their portfolio should consider the following four ETFs. They specialize in identifying companies solid or growing dividends with future growth potential.

Vanguard Dividend Appreciation ETF (VIG)

Yield: 1.90%

Expense Ratio: 0.10%

Assets: $22.90B

This fund is designed to track the NASDAQ U.S. Dividend Achievers Select Index. Its components are companies that have a long history of paying and increasing dividends.

The NASDAQ just announced updates to the composition of the index and many of the additions should help improve the overall yield of the ETF. Supporting the notion that the technology sector is leading the way on dividend growth, companies like Intel (INTC), Qualcomm (QCOM) and Texas Instruments (TXN) will be added which should help boost not only the yield of the ETF but the fund's growth potential as well.

The PowerShares Dividend Achievers ETF (PFM) also seeks to track the dividend achievers index, but I prefer the Vanguard ETF due to its lower expense ratio - 0.10% versus 0.58% for the PowerShares ETF.

FlexShares Quality Dividend Index Fund (QDF)

Yield: 2.50%

Expense Ratio: 0.37%

Assets: $421M

Operated by Northern Trust, this ETF uses the Northern Trust Quality Dividend Index as its benchmark but seeks to identify companies based on factors like cash flows and solid management.

Its yield of 2.5% is well above the S&P 500's yield of 1.86% and as would be expected with higher dividend paying stocks compares favorably by most valuation metrics. Its price/earnings, price/book, price/sales and price/cash flow are all below those of the S&P 500.

Leading the way are holdings in technology and financials including names like Wells Fargo (WFC) and Cisco (CSCO).

iShares Select Dividend Index ETF

Yield: 3.04%

Expense Ratio: 0.40%

Assets: $13.09B

We might as well wrap up this list with the ETF that I mentioned right at the start.

The first two funds mentioned are more diversified but this ETF targets the more traditional sector for dividend yield - utilities. Select Dividend dedicates roughly 35% of its assets to utilities like Entergy Corp. (ETR). This helps boost the yield on the fund - currently over 3% - but also makes the fund much more interest rate sensitive.

By focusing on companies that have decades-long history of paying and raising dividends, this fund invests in cash flow rich businesses that are able to insulate themselves against volatile markets and maintain cash positions in order to remain flexible.

Conclusion

This year we've begun to see a shift from growth to value and dividend paying stocks and the ETFs that hold them have provided investors with not just income but growth potential as well.

Even with high income equities gaining market favor currently, ETFs like these deserve a place in the portfolios of young and old. Historically, dividends have made up roughly 40% of equities' total return. Given this, it makes sense to develop a core position in your portfolio with some of the names mentioned above.

Source: 3 Dividend ETFs That Belong In Every Portfolio