Tags: Dividend | ETFs | invest | bonds

Look Before You Leap on Dividend ETFs

Sunday, 05 Aug 2012 05:33 PM

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Bottom-scraping Treasury rates are pushing investors into all kinds of directions in search of income — and into a new world of risk. Retirees who should be sitting on municipal bonds and CDs are branching out in junk bonds, international equities, and all kinds of dividend-paying stocks.

With 10-year rates below the inflation rate, who can blame them? The unofficial policy of the government is to use what’s known as “financial repression” — paying lower-than-inflation rates on U.S. bonds — to force investors to take more risk. That pushes up stock prices, which politicians hope in turn will kindle a wealth-effect wave that will resuscitate the economy.

Meanwhile, inflation gnaws at those dollar-denominated holdings. In time, public debts will be paid back, but using inflated dollars. If the current trends hold, a lot of wealth will waste away unless retirees find inflation-beating yields to compensate.

That has created huge demand for safer ways to get that yield, which of course Wall Street is happy to provide, for a fee. The result has been a boom in dividend-paying exchange-traded funds.

The ETF structure promises quite a lot of good things, including tax efficiency and higher levels of transparency and liquidity compared to a typical mutual fund. Nevertheless, investors should carefully consider what is inside a given fund before taking the leap.

For instance, a review of the top-yielding dividend ETFs shows some great rates. KBW High Dividend Yield Financial Portfolio (KBWD) pays 10.49 percent. The S&P Global Dividend Opportunities Index ETF (LVL) pays 7.52 percent.

Meanwhile, the appealingly named SuperDividend ETF (SDIV) comes in at 7.38 percent. Nine of the top 10 funds listed by the website ETFdb.com come in north of a 5 percent yield. Not bad.

Nevertheless, a look inside the top-yielding funds might give a conservative investor pause. KBWD, for instance, is primarily a vehicle for real estate investment trusts and mortgage-backed investments. The LVL fund invests in a lot of the same firms but also has a heavy weighting in international stocks. SDIV simply buys the highest yielders it can find.

None of these funds is trying to misrepresent themselves. Nevertheless, if a conservative investor were after stability with income, the top fund choices might appear quite different.

For instance, among the lowest beta ETFs covered by ETFdb.com included High Dividend Yield ETF (HDIV) and US Dividend Equity ETF (SCHD).

Part of the reason these funds have lower betas, that is, lower volatility, is that they tend to track consistent long-term dividend payers, mostly big U.S. firms with long histories of paying, and raising, their dividends.

The yields are lower, of course, but that’s the price one pays for consistency over time. Investors seeking income using ETF funds should seek to balance yield with reliability, rather than simply buying a high-paying fund with “dividend” in the name.

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