Dogs will always hold the title of man's best friend. But Fido's not much help when it comes to generating income in retirement. For that, you're smart to lean on an unconventional type of friend -- a high-quality dividend ETF.
You might have a hard time accepting an income-generating security as a friend. That's understandable, but if you keep an open mind, you may feel differently when you reach the end of this article.
Here's a look at two dividend ETFs you'll want to know better, plus a summary of the qualities that make these funds so attractive.
1. ProShares S&P 500 Dividend Aristocrats ETF
First up is an ETF that holds Dividend Aristocrats: ProShares S&P 500 Dividend Aristocrats ETF (NYSEMKT:NOBL). A Dividend Aristocrat is a company that has increased its dividend annually for at least 25 consecutive years.
Take a minute to ponder the magnitude of that decades-long accomplishment. Some Aristocrats, including Lowe's, Coca-Cola, and Proctor and Gamble, have been pushing out annual dividend increases for 50 years or more. The economic challenges they've faced include:
- The Vietnam War
- 1970s stagflation
- Historically high interest rates in the 1980s
- Recession in the early 2000s
- The Great Recession
- The COVID-19 pandemic
Sticking with annual dividend increases through troubled economic times requires commitment and financial strength. A company that can fund a rising dividend over the long haul generally must have a disciplined approach to debt, plus strong and predictable cash flows. Those are good traits to add to your portfolio, even if you're not looking for dividend income.
Of course, history doesn't make any guarantees about the future. A Dividend Aristocrat could lose this coveted status, but therein lies the beauty of an ETF that's built around a portfolio of Aristocrats. It would be surprising for any one Aristocrat to cut or cancel its dividend. It's almost unfathomable that multiple Aristocrats would do so at the same time.
The NOBL portfolio includes 65 Dividend Aristocrats that are also S&P 500 companies. The stocks are equally weighted in the fund, and no single sector accounts for more than 30% of the portfolio. NOBL currently yields 2.0% and charges an expense ratio of 0.35%.
2. SPDR S&P Dividend ETF
Next is a fund that screens the companies in its portfolio to ensure quality: SPDR S&P Dividend ETF (NYSEMKT:SDY). The fund tracks the S&P High Yield Dividend Aristocrats index.
Stocks in the index (and the fund) must meet these criteria:
- History of increasing the dividend for at least 20 consecutive years
- Market capitalization of over $2 billion
- Average daily value traded must be $5 million or more for three months prior to index's quarterly rebalancing date
- Individual stocks are capped at 4% to maintain diversity
The index weights each stock by its yield, which strengthens the fund's yield. SDY yields 2.47% and charges an expense ratio of 0.35%. The portfolio includes 112 stocks spread across multiple sectors. The heaviest-weighted sectors are financials, utilities, consumer staples, and industrials, each accounting for 14% to 16% of the portfolio.
Qualities you want in a dividend ETF for retirement income
- Quality screen. The fund should limit the portfolio to mature, reliable companies. This can be done by setting a minimum market cap or focusing only on S&P 500 companies, for example.
- Reliability screen. You want your dividend payments to be reliable. A reliability screen might involve a minimum time frame during which the stocks in the fund have paid dividends. Or a fund could enforce a maximum payout ratio on its constituents. A payout ratio is the percentage of earnings the company pays out in dividends. A very high one could indicate that the company's dividend is not sustainable.
- Emphasis on rising dividends. Rising income in retirement helps you combat inflation with less impact on your lifestyle. Look for funds that hold stocks with long track records of increasing their dividends. Some terms can help you here. You already know what Dividend Aristocrats are. Dividend Achievers have increased their dividends for at least 10 years, and Dividend Kings have increased their dividends for at least 50 years.
- Yield. Dividend yield is the dividend divided by the share price. Quality dividend funds tend to yield 2% to 3%. There are funds with much higher yields, but those come with higher risk, too.
Dividend ETFs for a more comfortable retirement
The right dividend ETF for retirement income should have some serious friend-like qualities. Reliability is at the top of the list. Your dividend ETF should be there to support you throughout retirement.
Generosity is another must-have trait. The right dividend ETF should be generous enough to take you out and buy you dinner. Better still if your new benefactor can pay your bills too. That's what financial friends are for, right?