Dividend index funds are investment vehicles that track a rules-based benchmark made up of dividend-paying stocks.
They are typically offered as exchange-traded funds (ETFs) or mutual funds. The result is a hands-off way to generate income without managing or monitoring individual companies.
Dividend index funds are not ideal for every investor. They generally prioritize income over rapid growth. However, for investors focused on steady cash flow, simplicity, and diversification, they can be an effective solution.
Top dividend index funds to consider
Here are eight dividend index funds (in no particular order) that have relatively low expense ratios but varying dividend yields and risk levels.
Fund | Dividend Yield | Expense Ratio | Risk Level |
|---|---|---|---|
Invesco S&P 500 High Dividend Low Volatility ETF (NYSEMKT:SPHD) | 4.65% | 0.30% | Below average |
iShares Core High Dividend ETF (NYSEMKT:HDV) | 2.93% | 0.08% | Average |
ProShares S&P 500 Dividend Aristocrats ETF (NYSEMKT:NOBL) | 2.05% | 0.35% | Average |
Schwab U.S. Dividend Equity ETF (NYSEMKT:SCHD) | 3.38% | 0.06% | Average |
Vanguard High Dividend Yield ETF (NYSEMKT:VYM) | 2.41% | 0.04% | Average |
Vanguard Dividend Appreciation ETF (NYSEMKT:VIG) | 1.66% | 0.04% | Average |
iShares Core Dividend Growth ETF (NYSEMKT:DGRO) | 2.01% | 0.08% | Average |
WisdomTree U.S. Quality Dividend Growth Fund (NASDAQ:DGRW) | 1.29% | 0.28% | Average |
1. Invesco S&P 500 High Dividend Low Volatility ETF
NYSEMKT: SPHD
Key Data Points
The Invesco S&P 500 High Dividend Low Volatility ETF (SPHD +0.70%) tracks the S&P 500 Low Volatility High Dividend Index. It isolates the highest-yielding stocks in the index and then selects the 50 with the lowest volatility. Each sector is limited to a max of 25% spread across no more than 10 stocks, with individual stocks capped at 3%. One thing to note with this ETF is that it pays monthly dividends.
2. iShares Core High Dividend ETF
NYSEMKT: HDV
Key Data Points
Exchange-Traded Fund (ETF)
3. ProShares S&P 500 Dividend Aristocrats ETF
NYSEMKT: NOBL
Key Data Points
The ProShares S&P 500 Dividend Aristocrats® ETF (NOBL +0.99%) tracks the performance of Dividend Aristocrats® -- S&P 500 members that have increased their dividends annually for at least 25 consecutive years. (The term Dividend Aristocrats® is a registered trademark of Standard & Poor's Financial Services LLC.) The index is equal-weighted.
4. Schwab U.S. Dividend Equity ETF
NYSEMKT: SCHD
Key Data Points
The Schwab U.S. Dividend Equity ETF (SCHD +0.78%) seeks to track the total return of the Dow Jones U.S. Dividend 100 index. This benchmark uses a composite score that screens for at least 10 years of dividend payments, along with a composite metric that assesses free cash flow to total debt, return on equity, dividend yield, and five-year dividend growth rate.
5. Vanguard High Dividend Yield ETF
NYSEMKT: VYM
Key Data Points
The Vanguard High Dividend Yield ETF (VYM +0.83%) tracks the performance of the FTSE High Dividend Yield Index, which selects a market cap-weighted portfolio including 55% of the highest-yielding stocks on a forward-looking basis from a broader universe of U.S. equities. However, it excludes real estate investment trusts (REITs) to maintain tax-efficiency.
6. Vanguard Dividend Appreciation ETF
NYSEMKT: VIG
Key Data Points
The opposite of the Vanguard High Dividend Yield ETF, the Vanguard Dividend Appreciation ETF (VIG +1.15%) tracks the S&P U.S. Dividend Growers Index. It screens potential holdings for at least 10 consecutive years of dividend growth, excludes the top 25% of the highest-yielding stocks to ensure quality, and omits REITs. Holdings are market cap-weighted with a 4% limit.
7. iShares Core Dividend Growth ETF
NYSEMKT: DGRO
Key Data Points
8. WisdomTree U.S. Quality Dividend Growth Fund
What to look for in index funds that pay dividends
A good first step is to determine your overall asset allocation and, as a follow-up, how much you want allocated to dividend-paying stocks or equity index funds.
Once that groundwork is done, you can use any major online brokerage platform to screen and compare ETFs based on cost, holdings, and income characteristics.
One area that often confuses investors is yield. There is more than one way to measure it, and each tells you something slightly different:
- The first is the 30-day SEC yield. This is a standardized measure that looks at the fund's income over the past 30 days, net of expenses, and annualizes it. It is the most apples-to-apples way to compare income across funds.
- The second is the 12-month trailing yield. This looks backward at what the fund actually paid out over the last year and divides it by the current price. It reflects real cash received, but it may not represent what you will earn going forward.
- The third is the annualized distribution yield. This takes the most recent distribution, whether monthly or quarterly, and projects it forward over a full year. It gives a quick estimate of current income, but it assumes the payout stays constant, which is not always the case.
It's also important to remember that dividend yield alone is not a perfect indicator of future performance. Focusing only on companies that pay dividends leaves out many that grow through price appreciation, such as those in big tech.
Make sure you construct a diversified portfolio that spans a broad range of underlying firms with different capital strategies.
Why invest in dividend index funds?
Benefits:
- Provide a steady income for investors seeking regular cash flow.
- Offer diversification across many dividend-paying companies, reducing the risk of owning individual stocks.
- Help identify value-oriented companies through high-yield dividend strategies.
- Dividend growth funds focus on firms with strong balance sheets and consistent payout increases, signaling quality.
- Typically have low fees and offer an easy, passive way to gain exposure to income-generating stocks.
Risks:
- Dividend cuts can occur during market downturns or recessions.
- High-yield funds may include riskier or slower-growing companies.
- Interest rate changes can affect investor demand for dividend funds, affecting prices.
- Dividend index funds may underperform growth-oriented ETFs during bull markets led by high-growth sectors like tech.
- Even qualified dividends can create some tax drag in taxable accounts, reducing your net return.
Tips for investing in dividend index funds
Check distribution frequency: Some dividend index funds pay monthly, while others pay quarterly. Monthly distributions can be more practical for income planning, while quarterly payouts may suit long-term reinvestment strategies just as well.
Prioritize tax-sheltered accounts: Dividend income compounds most efficiently in accounts like a Roth IRA, where distributions are not taxed immediately. This is especially important for higher-yield funds.
Use a DRIP if income is not needed: If you do not need the cash flow, setting up a dividend reinvestment plan helps compound returns automatically and removes the temptation to time reinvestments manually.
Dividend index funds are long-term investments
The stock market can be volatile in the short term. So, it's important to keep in mind that dividend index funds are meant to be held for the long run.
First, the longer you hold your index funds, the better performance you're likely to see. Longer holding periods allow for more compounding, enabling your money to grow rapidly in later years.
Second, short-term market movements tend to be unreliable for successful investing. As we've seen this year, short-term market swings can be erratic both in direction and magnitude.
However, longer-term investment horizons have reliably trended upward, especially for dividend-paying blue chip stocks.
Finally, longer holding periods also make your portfolio more tax-efficient. If you keep your dividend index funds for longer than a designated holding period, you'll be eligible for qualified dividends, which are taxed at a lower capital gains rate when earned.
If you do choose to allocate a portion of your portfolio to dividend index funds, know that short-term price movements are entirely normal. A long-term focus has historically been a preferable strategy.
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FAQ
Dividend index funds FAQ
Tony Dong has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends ProShares S&P 500 Dividend Aristocrats ETF, Vanguard Dividend Appreciation ETF, and Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.
