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Picking dividend earning ETFs

Lesson in Course: ETFs and mutual funds (beginner, 8min)

Building out an income or dividend portfolio creates a steady flow of cash. What are some good examples of dividends ETFs and how do we compare them?

Eureka!

What it's about: Dividends are an excellent source of income from our investments.

Why it's important: Some industries tend to pay higher dividend yields than others.

Key takeaway: Buying ETFs across a few industries increases our investment income and provides more diversification.

Adding a few dividend-paying ETFs to our portfolio is a great way to take advantage of dividend stocks without the requirements of analyzing individual companies. There are a few industries/sectors that consistently pay great dividends; Utilities, REITs, and Telecoms. Let's take a look at the sectors below and briefly compare 3 popular ETFs in each sector. 

We'll compare expense ratio and yield. The best options are the ones with the highest dividends and lowest expense.

Comparing expense ratios and dividend yields

An ETF with an expense ratio of 0.10% and a dividend yield of 4% means that for every $100 invested, we will pay $0.10 towards management fees but will also generate $4 worth of dividends. 

We can compare different ETFs by taking yield and subtracting the cost of management to calculate how much the fund generates. In this case, we'd receive $3.90 of income for every $100 invested after fees.

 

Utilities

Utility companies provide basic amenities such as water, sanitation, electricity, and natural gas. These companies are essential for public infrastructure and are often heavily regulated by the government for price protection.

Utility companies issue out stable dividends

These companies can pay dividends because they operate under a cost-plus model. 

What is Cost-plus?

The cost-plus model is a direct markup paid by consumers on the cost of providing a good or service.

For example, if it costs the company $20 to provide us electricity, the company may charge $30, a $10 markup. If costs rise to $30, our bill would be $40, ensuring profitability for the company.

Popular utility ETFs

The following yields shown are based on 2020

XLU - has an expense ratio of 0.13%, is diversified with 29 companies, and pays out a yield of 3.36%.

VPU - has an expense ratio of 0.10%, is diversified with 69 companies, and pays out a yield of 3.10%.

FUTY - has an expense ratio of 0.08%, is diversified with 66 companies, and pays out a yield of 3.12%.

$XLU stands out because the fund generates $3.20 compared to $3.00 for $VPU and $3.04 for $FUTY for every $100 invested. Compared to the other two, the fund, XLU is less diversified—while 29 companies provide good diversification, we can pick $FUTY if we want additional diversification.

 

REITs

REITs provide good exposure to the housing market without having to own a house or property. They are also required to distribute 90% of their earnings via dividends. 

REITs manage rental and commercial properties

Real estate companies secure stable and long-term cash flow from rents and leases and distribute them back to the shareholders. However, the dividends from REITs are taxed differently.

Popular REIT ETFs

The following yields shown are based on 2020

RWR - has an expense ratio of 0.25%, is diversified with 94 companies, and pays a yield of 4.54%.

VNQ - has an expense ratio of 0.12%, is diversified with 184 companies, and pays out a yield of 4.25%.

FREL - has an expense ratio of 0.08%, is diversified with 181 companies, and pays out a yield of 4.01%.

$RWR generates the most for us with $4.19 compared to $4.13 from $VNQ and $3.93 from $FREL for every $100 invested. The difference between the diversification benefits between 90 companies compared to 180 companies isn't substantial.

Telecommunications

Telecoms are large entrenched businesses because the cost to run lines and communication across the country is so high. New companies and startups just can't get the resources and amount of money to compete.

Telecom companies have little competition and issue stable dividends

As a result, telecom companies have very little competition. They make a lot of money through multiple bundled services and pay stable dividend yields.

Popular telecom ETFs

The following yields shown are based on 2020

XLC - has an expense ratio of 0.13%, is diversified with 27 companies, and pays out a yield of 1.01%.

VOX - has an expense ratio of 0.10%, is diversified with 114 companies, and pays out a yield of 1.11%.

FCOM - has an expense ratio of 0.08%, is diversified with 105 companies, and pays out a yield of 1.04%.

$VOX generates the most providing us $1.01 compared to $0.88 from $XLC and $0.96 from $FCOM for every $100 invested. $VOX also has the most diversity built into the fund.

It's pretty noticeable that the yield for Telecoms is much lower than the other two sectors. An important consideration to add telecoms even with lower yields is the larger growth potential of the share prices. Innovations such as 5G wireless networks can drive significant growth in the sector compared to the other two.

 

Actionable ideas

Adding REITs to your portfolio not only provides great income generation but also gives exposure to the real estate market if you don't currently own property. Your portfolio also benefits more from diversification if you include funds from different sectors like the ones above.

While these are some of the most popular ETFs, it's always a good idea to do your own due diligence before making any investment. It's important to find the ones that fit your specific investment goals. When in doubt, look for professional help!

Supplementary materials

Here is a good resource for looking up expense ratios, holdings, and yields of any ETF.
https://www.etf.com/

Glossary

What is Cost-plus?

The cost-plus model is a direct markup paid by consumers on the cost of providing a good or service. For example, if it costs the company $20 to provide us electricity, the company may charge $30, a $10 markup. If costs rise to $30, our bill would be $40, ensuring profitability for the company.