Top Dividend ETFs for Reliable Investment Income (2024)

Generating Reliable Investment Income with Dividend ETFs

Are you seeking immediate and reliable investment income that grows over time? Dividend stocks are a common answer, but the challenge of managing individual dividend payers can be daunting. Dividend-paying stock baskets -- in the form of exchange-traded funds (ETFs) -- offer a simpler, potentially just-as-effective solution.

However, it's a misconception that all dividend ETFs are created equal. Most major dividend ETFs employ distinct methodologies for selecting holdings, impacting their performance. Some ETFs are better aligned with specific investor needs than others.

Recommended Dividend ETFs to Consider

Here's a closer look at two dividend-oriented ETFs that represent solid choices for income-seeking investors currently, along with one dividend ETF you might want to steer clear of, at least for now.

Buy the Schwab U.S. Dividend Equity ETF (SCHD)

With a trailing yield hovering around 3.8%, the Schwab U.S. Dividend Equity ETF (SCHD) satisfies a crucial requirement for many income-focused investors. While higher yields exist, finding comparable quality stocks or ETFs with significantly higher yields can be difficult. Major holdings include Chevron, pharmaceutical giant AbbVie, tobacco powerhouse Altria, and PepsiCo. Based on the partially equal-weighted Dow Jones U.S. Dividend 100 Index, the fund's composition undergoes quarterly rebalancing, leading to regular changes in its top holdings.

The index's construction is notable. While most funds are cap-weighted, this index prioritizes reliable dividend payments alongside other factors. Dow Jones' parent company, Standard & Poor's, also evaluates eligible equities based on cash flow and return on equity.

This methodology proves effective. The ETF emphasizes value stocks that, while not necessarily exhibiting explosive revenue or earnings growth, offer solid growth potential rooted in the quality of their underlying businesses. Generous stock buyback programs also often contribute to the fund's performance. Over the past five years, this Schwab fund has risen by 45%, and over the last 10 years, it's up by over 130%.

Those gains don't even factor in reinvested dividends. Including dividend payments adds another 60% to 70% to the fund's performance. While this lags the S&P 500's performance over the same periods, the reduced risk profile and value-oriented nature of the fund makes it an attractive trade-off for income investors seeking relative safety.

Buy the Vanguard Dividend Appreciation ETF (VIG)

With roughly $100 billion in assets under management, the Vanguard Dividend Appreciation ETF (VIG) is a popular dividend-focused ETF.

The fund's appeal is easy to understand. Tracking the S&P U.S. Dividend Growers index, VIG holds some of the market's most consistent dividend growers. Broadcom, Microsoft, and JPMorgan are among its largest holdings, and its quarterly payment has almost doubled over the past 10 years. It delivers as advertised.

Capital appreciation has also been impressive, with the ETF's price increasing by 186% over the same period. This reflects the benefits of holding dividend-paying technology stocks that have thrived on the rise of cloud computing and artificial intelligence.

One potential drawback of VIG is its relatively low yield compared to alternatives. The ETF's trailing 30-day dividend yield is just above 1.6%, and hasn't consistently exceeded 2% since 2018. More lucrative options exist.

This lower yield stems from Standard & Poor's selection criteria for the S&P U.S. Dividend Growers Index. While requiring a minimum of 10 consecutive years of dividend increases, it excludes the top 25% highest-yielding stocks, presuming that these high yields may indicate limited growth prospects or underlying financial issues. This is a sensible precaution.

However, it can impact investor returns. While VIG generates above-average long-term capital gains, it isn't necessarily the highest-yielding income stream. It's best suited for growth-oriented investors comfortable with some taxable income who don't require immediate income to cover expenses.

Avoid the Vanguard High Dividend Yield ETF (VYM)

Conversely, if your primary goal is recurring investment income, the Vanguard High Dividend Yield ETF (VYM) might not be the best choice, at least in the near term.

Ironically, this Vanguard fund falls short of delivering on its primary promise: a high dividend yield. Its average 30-day yield is a relatively modest 2.5%. Investors can find better options, such as the Schwab U.S. Dividend Equity ETF, which focuses on high-quality companies that happen to pay dividends.

The current underwhelming trailing yield is somewhat unusual. Prior to last year, VYM's trailing yield typically ranged from 2.7% to 3.3%. It has declined significantly since late 2023 as major holdings like Broadcom, JPMorgan, and Walmart soared alongside the broader market. Dividend growth among these companies has not kept pace with share price appreciation.

The fund's cap-weighted structure hasn't helped. A small number of the market's largest, best-performing companies have driven the majority of the gains.

This doesn't mean that the Vanguard High Dividend Yield ETF will never be a worthwhile investment. The underlying FTSE High Dividend Yield Index remains fundamentally sound. However, the recent market dynamics since late 2023 have inflated the fund's price, diminishing its yield. It may take some time for the situation to correct, and numerous more attractive dividend-paying alternatives exist in the meantime.