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These 3 Dividend ETFs Are a Retiree's Best Friend

By James Brumley – Dec 13, 2021 at 2:35AM

Key Points

  • Inflation is too strong (and now likely too long-lived) for any income investor to ignore.
  • Not all companies are equally equipped to deal with rising inflation and the subsequent increase in interest rates.
  • Retirees must consider the sustainability of dividend payments for any prospective future.

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Safety, reliability, continued growth of principal, and now inflation are all factors to consider once you're past your working years.

If you're already retired -- or at least approaching that time of your life -- generating spendable income is probably on your mind. And rightfully so. Although your spending needs typically fall once you're no longer working, the average retiree still needs around three-fourths of their pre-retirement income. Social Security payments aren't likely to cut it alone (and were never intended to do so), even for people augmenting that income with pension checks. It's up to your investments to make up the difference. Most retirees turn to dividend stocks to do so, which of course are riskier than more reliable bonds.

This challenge is going to be even tougher in the foreseeable future, now that inflation is starting to ramp up.

Two retired friends talking on a park bench.

Image source: Getty Images.

The good news is, there are some simple, effective solutions built for just this particular job. Here's a look at three dividend-oriented exchange-traded funds (ETFs) that all current or future retirees may want to consider adding to their portfolios.

1. Vanguard Short-Term Inflation-Protected Securities Index ETF

This can't be stressed enough: Ignore rampant inflation at your own peril. Last month, consumer price increases reached their highest annualized levels since 1982, and despite the "transitory" rhetoric, not every expert believes the current cost surge is going to fade away in the near future. This inflation reduces the buying power of whatever dividends (or interest payments on bonds) a company is dishing out.

The Vanguard Short-Term Inflation-Protected Securities Index Fund (VTIP -0.23%), however, adapts to inflationary ebbs and flows so owners never suffer the impact of price changes.

It invests in something called Treasury inflation-protected securities, or TIPS, for short. These government-issued bonds generate interest payments twice per year. Their principal values aren't entirely market-based the way other bonds are, though. Rather, the principal value of TIPS is adjusted to reflect the impact of inflation. Almost needless to say, the principal prices at which current owners could sell their TIPS or a TIPS-based fund have been driven higher in recent months thanks to brisk inflation.

It should be noted that the amount of the bi-annual payment made by TIPS doesn't change; the principal value is where the adjustment is made. TIPS also only make two payments per year, which might not work for all retirees. Vanguard's short-term TIPS fund solves both problems for folks needing something a little more responsive and real-time, though, as it's continually swapping out maturing TIPS for newly issued ones. This has caused the ETF's dividend payout to change a bit from one quarter to the next, but that may be what a retiree needs.

2. Consumer Staples Select Sector SPDR ETF

This option wasn't designed to be a dividend ETF per se. Rather, it's meant to be a way of adding exposure to a particular sector without requiring the selection of a specific stock. The Consumer Staples Select Sector SPDR ETF (XLP 1.70%) is also a means of defending yourself -- and your income -- from the inflationary pressures we're seeing now that may not abate anytime soon.

Think about the nature of the sector itself, and how its companies can adjust to their operating environment. While the fund's constituent companies like Procter & Gamble, PepsiCo, and Walmart clearly don't like paying more for wages, transportation, and the goods or products they're selling, it's not like anyone can suddenly stop eating or buying basic necessities like soap or toothpaste just because they cost a little more. Consumer staples brands actually enjoy quite a bit of pricing power and that enables them to pass their higher costs along to customers.

Do note that the current backdrop isn't one that sets the stage for profit growth that drives significant (if any) dividend growth. Indeed, rampant inflation may not be the direct cause for any increased payouts. At the very least, though, this ETF's above-average current dividend yield of 2.5% is very well protected.

3. iShares Core Dividend Growth ETF

Finally, current and prospective retirees may want to add the iShares Core Dividend Growth ETF (DGRO 0.85%) to their watch list, if not their portfolios.

Unlike the Consumer Staples Select Sector SPDR ETF, the iShares Core Dividend Growth ETF is built specifically for income-minded investors. Although its holdings aren't necessarily companies that can effectively adapt to soaring inflation, the fund seeks out those with the kind of raw, proven strength to grow their dividends regardless of the environment. Indeed, at a minimum, the fund requires its constituent stocks to have at least five consecutive years of dividend growth, but these companies can't dish out more than 75% of their earnings as dividend payments. It's a way of ensuring there's room and reason to expect continued payout growth.

Of course, given some of the ETF's top holdings, there's little reason to doubt rising dividends are in the cards. Microsoft, Apple, and Pfizer are its biggest three positions. These companies are not only going to survive, they're apt to thrive for the foreseeable future.

The fund's dividend yield of 2% is admittedly modest, the lowest of the three ETFs. Retirees looking for (or needing) big yields right away won't find it here. For anyone able to wait just a few years, however, the size of the payout on an investment made right now could be much bigger. The size of DGRO's current dividend is about 50% greater than what it was just five years ago. Never even mind the principal appreciation these stocks have experienced in the meantime.

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. James Brumley has no position in any of the stocks mentioned. The Motley Fool owns and recommends Apple and Microsoft. The Motley Fool recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.

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