Exchange-traded fund ("ETF") investing has become ubiquitous over the past two decades -- and for good reason. An ETF allows an investor to own many different stocks at once, thereby reducing risk while still allowing for significant upside potential. Using that concept as a foundation, ETFs can be constructed to satisfy a number of different goals. One of these goals is developing passive income -- a common need or want among retirees who are no longer earning a steady paycheck. Here, we'll dive into three dividend ETFs which almost any retiree can find appealing.
Why dividend ETFs in retirement?
The central benefit to holding dividend ETFs in retirement, as opposed to high-yield stocks, is that your risk is spread across many companies. You don't need to depend on any single company to increase in value over time or to hit a certain dividend yield. Instead, you need to consider the collective performance of all the underlying companies taken together. This diversification effect allows you to depend on the ETF's income stream with less concern for any particular stock's dividend distribution.
It's also important to mention that when choosing an ETF for dividend income, underlying company quality matters. Many funds in the marketplace will boast yields of 5% or higher but contain underlying investments that are quite volatile. The distribution yield is attractive on these funds, but if the fund's price swings wildly or falls negative for an extended period of time, your total return has the potential to turn negative as well -- despite a high dividend payout. This is why choosing a dependable ETF that not only has a strong dividend yield but also solid built-in fundamentals is the best option.
1. Vanguard High Dividend Yield ETF (VYM)
The Vanguard High Dividend Yield ETF (NYSEMKT:VYM) contains primarily U.S.-based corporations that have generally both grown their stock price and sustained high dividends. The fund pays just over 3.1% and boasts a measly 0.06% expense ratio. While this ETF is still a pure stock fund exposed to broad equity market risk, it has an underlying portfolio that has been quite dependable as a long-term investment. A retiree seeking dividend income in addition to solid capital gain potential should consider this fund without much reservation.
2. ProShares S&P 500 Dividend Aristocrats ETF (NOBL)
Similar to VYM, the ProShares S&P 500 Dividend Aristocrats ETF (NYSEMKT:NOBL) boasts a reputable underlying portfolio of companies. In this fund, however, the portfolio companies not only pay solid dividends -- with the ETF yielding 2.7% -- but they have also grown their dividends for at least 25 years -- with some doing it for over 40 years. The expense ratio is a bit higher at 0.35%, but for convenience, simplicity, and quality, the purchase can be justified. This fund can work for retirees seeking supplemental income and for those wanting exposure to companies with unusually strong fundamentals.
3. iShares International Select Dividend ETF (IDV)
For those seeking an "ex-U.S." dividend fund, the iShares International Select Dividend ETF (NYSEMKT:IDV) provides exposure to high-dividend companies stationed anywhere other than the United States. The fund is not the cheapest you'll find with an expense ratio of 0.49%, but it does provide diversified income from developed international markets at an attractive yield of approximately 5%. This ETF can work if you're willing to commit to holding it through its inevitable ups and downs, and if you're willing to pay a premium for larger cash payouts.
Consider all options for new income
While any one of the three ETFs above will satisfy most retirees' needs for dividend income, you always have the option of constructing your own "fund" and avoiding expenses by simply buying the stocks held within each ETF. This strategy is more complicated but can save you a bit on expenses and achieve nearly the same dividend results -- if you have the time, energy, and inclination to do so.
Alternatively, you can focus on total return (capital gains plus dividend income) when thinking about how to invest your retirement savings. With that said, it's wise to not rely too much on dividends when thinking from a "total portfolio" perspective. Before concentrating your portfolio too heavily on one income generator, consider all streams of income -- Social Security, pensions, IRAs, part-time work -- when devising a broader strategy (and tax plan) for your retirement years.