Investors can't get enough of dividend stocks. With their unique combination of capital gain potential and regular income, stocks that pay dividends have never been in greater demand.
One of the most influential groups of investors who have been turning to dividend stocks lately have been those in or near retirement. After all, retirees need their long-held investment portfolios to generate cold hard cash -- cash they can't afford to go without. With more traditional conservative investments, such as bank CDs and Treasury bonds, paying extremely low interest rates lately, retirees have had difficulty making ends meet -- and the temptation to turn to riskier investments like stocks has become increasingly difficult to resist.
The question, though, is how to earn dividend income without exposing yourself to a huge amount of risk. Although dividend ETFs don't eliminate the risk of owning stocks entirely, they do help spread out that risk -- and the different strategies they follow hold some clues that observant investors can follow on their own.
3 trails to dividend cash
You can choose from many different dividend ETFs. But the strategies each fund follows can be vastly different from others, so you need to be sure you know what you're buying before you invest. In general, you can divide the vast bulk of dividend ETFs into three broad categories.
One group of ETFs, including the popular iShares Dow Jones Select Dividend ETF
A second group of ETFs looks beyond dividend yield, choosing stocks with a demonstrated history of rising dividends. SPDR S&P Dividend ETF
Finally, some ETFs follow different guidelines to pick stocks. The WisdomTree Large-Cap Dividend ETF
Which should you use?
Perhaps the most obvious way to choose from among these ETFs is to look back at how each of them has performed in recent years. A quick look confirms that the high-yield strategy has resulted in a net loss for iShares investors in the past five years, while the SPDR fund has brought annual gains of around 2.6%, just edging out the S&P 500's 2% yearly average gain. The WisdomTree fund hasn't been around that long, but in the past four years, it also falls short of the SPDR's returns.
Past results, though, only tell part of the story. In my opinion, relying on stocks with a long track record of dividend consistency is simply the more conservative way to play. Yet during the financial crisis, long streaks of dividend payments from companies like General Electric and Dow Chemical came to an end, throwing investors for a loop and sending share prices plummeting. Before the crisis, banks had been among the best dividend stocks in the stock market, and so their losses had a disproportionate impact on dividend investors.
Dividend stocks deserve a place in the portfolios of retirement savers. But you should never think they're as safe as government-insured CDs. After all, they're stocks, and stocks are risky. But to minimize your risk and try to eke out better returns, the right dividend ETF may serve you well.
The best dividend stocks combine all sorts of valuable traits. Find them by reading the Fool's special report, "13 High-Yielding Stocks to Buy Today." It's free.
Fool contributor Dan Caplinger likes boosting his income. He owns shares of the Vanguard Dividend Appreciation ETF. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy gives you a big boost.