Investing in dividend stocks can be like betting on a horse race. You try to identify the one that you think is most likely to finish ahead of the others. You put your money on it. And then you wait to find out whether or not you were right.
But while the two can be alike, they don't have to be. You don't have to pick a winner in dividend stocks. Here's why.
Buy a basketful
Instead of buying one, two, or a few individual dividend stocks, you can instead buy an exchange-traded fund (ETF) that owns a basketful of dividend stocks. The ETF will pick the potential winners for you.
One option is to invest in an index ETF. For example, the Vanguard 500 Index Fund (VOO 1.00%) attempts to track the most widely followed index around -- the S&P 500. Its dividend yield currently stands at nearly 1.5%. While not every member of the S&P 500 pays a dividend, many of them do.
Stocks in the Dow Jones Industrial Average typically pay higher dividends than the average S&P 500 stock does. The SPDR Dow Jones Industrial Average ETF Trust (DIA 0.36%) attempts to track the Dow Jones. Its dividend yield is 1.9%.
In addition to the dividend yield, you'll want to pay attention to the expense ratios for any ETF that you buy. The Vanguard 500 Index Fund has a very low expense ratio of only 0.03%. The SPDR Dow Jones Industrial Average ETF Trust's expense ratio is 0.16%.
Boosting your dividend income
The main drawback to these two ETFs for income investors is that their primary focus isn't on maximizing the amount of dividends received. However, there are other ETFs that attempt to do just that.
The Vanguard High Dividend Yield ETF (VYM -0.20%) owns 462 dividend stocks with an average earnings growth of 12.4%. The ETF's dividend yield tops 3%. Its expense ratio is 0.08%.
You can get an even higher dividend yield at a lower cost with the Schwab U.S. Dividend Equity ETF (SCHD -0.10%). The fund's top holdings include large-cap companies with exceptional dividends such as Amgen, Cisco, and AbbVie. Its dividend yield currently stands above 3.4%. The ETF's expense ratio is only 0.06%.
For just a little additional cost, you can further boost your income. The SPDR Portfolio S&P 500 High Dividend ETF (SPYD -0.15%) owns 80 stocks. Its yield is close to 4.9% with an expense ratio of 0.07%. The ETF's top holdings include Amgen, Seagate, and Hasbro.
If you want to try to pick individual winners
There are also plenty of other ETFs that focus specifically on dividend stocks. But if you want to try to pick individual winners, keep three things in mind.
First, higher dividend yields can often come with higher risk. In some cases, the high yields are a result of a stock that has been beaten down for good reasons.
Second, just because a company has paid an attractive dividend in the past doesn't mean that it will be able to continue doing so in the future. Look at the dividend-payout ratio, which measures the dividend as a percentage of earnings. The lower the ratio is, the better. If a company has a high dividend-payout ratio (for example, 80% or above), investigate why that's the case.
Third, know that dividends are only one way that a stock can generate value. Share appreciation is another important consideration. It's possible that you could make lower total returns by focusing too heavily on the dividends paid.
This last point is also applicable to dividend ETFs, too. You might actually make more money over the long run by buying an ETF with a lower dividend yield but better growth prospects. Even with ETFs, some are bigger winners than others.
