Dividend ETFs: Look Before You Leap

Includes: TDIV, VIG
by: Tom Lydon

Considering the paltry yields in U.S. Treasury bonds and money market funds, investors have turned to dividend-producing stocks and exchange traded funds to help generate some extra cash. However, like with any investment product, investors should take a moment to look over what they are getting themselves into, and the potential risks.

Different dividend-focused ETFs follow different strategies and portfolio construction methodologies.

For instance, the Vanguard Dividend Appreciation ETF (NYSEARCA:VIG) tracks companies that have increased dividends for at least ten consecutive years, offering access to steady and stable firms. However, the fund does not provide access to high yielding stocks as they are riskier in nature. Consequently, VIG only has a 2.27% 30-day SEC yield. In comparison, the S&P 500 yields 2.11%.

Dan Caplinger for DailyFinance questions the ETFs growing focus on yield generation. For example, he highlights the new First Trust Nasdaq Technology Dividend Index Fund (NASDAQ:TDIV) and the low yield barrier for entry - the ETF includes companies with dividend yields of under 1%.

James Bianco, president of Bianco Research, at the The Big Picture blog emphasizes that dividend stocks should be viewed as a slightly less risky form of stock investing.

"As such, we should expect dividend-paying stocks to outperform during bear markets and underperform during bull markets," Bianco wrote.

While dividend stocks may have outperformed the overall markets earlier this year, dividend payers began to underperform after the April 2, 2012 peak.

"We believe this is due to there being no real sense of direction in the stock market," Bianco added. "If the bull market continues, we can expect to see equal weight index outperform dividend-paying stocks."

Max Chen contributed to this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.