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What is Dividend ETF?
A dividend ETF is a type of Exchange Traded Fund that invests in a group of stocks with the potential to offer high dividends. These are passively managed funds that track a particular index. However, the underlying index is tracked quantitatively to include companies with a track record of paying regular dividends. Also, these funds invest in bluechip companies as they are less risky. Therefore, investors must check the track record of underlying stocks involved in the index.
The expense ratio of these funds is less than or equal to the lowest expensive or no-load mutual fund. Investors can buy or redeem no-load mutual funds after a specific time without commission or sales charge. Therefore, these funds best suit investors with low-risk tolerance levels and looking for regular income for their investment portfolio.
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What are the Advantages and Disadvantages of Dividend ETFs?
Advantages
- Diversification: These funds offer investors to buy diversified dividend stocks in just a single dividend ETF, which consists of multiple holdings.
- Convenience: These ETFs are easy and convenient investments to manage in comparison to individual dividend stocks. Investors can simply find the best dividend ETF that suits their needs in one portfolio rather than analysing and researching multiple stocks to hold in a portfolio.
- Income: These funds provide regular income and thus create a revenue stream for investors.
- Stability: These funds tend to be less volatile than broader market indexes, especially growth-oriented stocks.
Disadvantages
- Lack of Control: Like other ETFs or mutual funds, investors have no control over security selection with dividend ETFs.
- Average Income: These funds payout dividend yield that is an average of all underlying stock holdings. If some holdings in the fund reduce the dividends, the overall average yield will fall.
- Price Risk: A decline in stock prices due to market conditions may outweigh dividend yields and creates a negative return for the fund.
Factors to Consider While Choosing a Dividend ETF?
The following are the factors to consider while choosing a dividend ETF –
Dividend Yield
You must check the overall portfolio’s dividend yield as it helps to estimate the income you can expect from the portfolio. It is essential to understand that future dividends are not guaranteed, but a dividend yield can help to estimate the potential returns from the portfolio.
Investment Objective
Dividend ETFs are suitable for investors looking for regular income from their portfolio. Therefore, while selecting the fund, you must check the underlying index of the fund. This helps to align your investment objective with the fund objective to enjoy significant returns.
Costs
Not all ETFs perform the same way, even though they track the same index. Due to tracking errors, the performance of each fund fluctuates. Therefore, before investing in these funds, you must consider the fees, liquidity of the fund and its tracking error.
Risks
Like any other funds, dividend ETFs are also subject to market risks. To invest in these funds, understanding risk is essential. Adverse developments in the market or sector in which the fund has invested will impact the returns.
Taxation
The capital gains from dividend ETF can be either short-term or long-term, depending on the holding period.
The short term capital gains (STCG) are taxable at 15% if the holding period is less than three years. While long term capital gains(LTCG) are taxable at 10% for gains above INR 1lakh if the holding period is more than three years.
Additionally, dividend income is taxable in the hands of investors at 10% TDS if the dividend income is more than INR 5000. It is taxable under the head ‘Income from Other Sources‘.
Dividend ETF Vs Other ETFs
Generally, Exchange Traded Funds (ETFs) allow investors to diversify within a given benchmark index. This means that investors will gain broad exposure to many stocks within a given index. Also, investors can sell short, buy on margin, and purchase low, as ETFs have no minimum deposit requirements. Furthermore, these funds have lower expense ratios than other mutual funds.
Investors prefer investing in ETFs because they are easy to buy and sell, like stocks on a stock exchange. Also, these funds provide diversification, broad market exposure and low-cost investing.
On the other hand, investing in dividend ETFs offers only one investing strategy. The portfolio invests in a group of stocks with high dividend yield or blue chip companies. These funds provide investors with regular dividends.However, there are many other types of ETFs that investors can research and add to their overall investment portfolio. Some common ETFs are Gold ETFs, Index ETFs, Bond ETFs, Sector ETFs, Commodity ETFs and so on. Moreover, investors can access any ETFs through their brokers or simply purchase them like a stock on their own through a Demat account.
Frequently Asked Questions
It is better to reinvest dividends rather than getting cash. Dividend reinvestment plan should be considered in order to take advantage of the power of compounding. As long as a company continues to prosper and your portfolio is well-balanced, reinvesting dividends is preferable to receiving cash. Reinvesting dividends in mutual fund investments is always recommended. As this increases the amount invested and provides superior returns to dividend distribution options.
Reinvesting the dividend is a good strategy as it is very cheap. One need not incur extra costs of investing if they opt for dividend reinvestment. Once one opts for reinvestment, it gets automatically processed every time one receives a dividend. Every time the dividend is reinvested, the average cost of investing goes down. This will help in boosting returns.
Yes, ETFs are equity mutual funds and hence are exposed to market volatility. Though ETFs mimic the underlying index, the portfolio is exposed to fluctuations. Thus, a long-term investment horizon will help you average out the market volatility. Therefore, you’ll be able to generate greater returns in the long-term than in the short-term.
Yes, ETFs pay dividends. ETFs must distribute any dividends they earn on shares held in the fund portfolio. Consequently, ETFs pay dividends if any of the stocks they hold pay dividends.
Buying a dividend ETF is a good idea when you are looking for regular income and are a risk-averse investor.
ETFs pay dividends with cash or extra ETF shares.
Most ETFs offer quarterly dividend payments; however, some also offer monthly dividend returns. Therefore, investors looking for a monthly income stream can consider dividend ETFs as one of their investment options.
Furthermore, it is important to look at the track record of the stocks that the ETF invests in. Also, some dividend ETFs have a high expense ratio. Hence it is important to consider ETFs with the lowest expense ratio or no-load mutual funds. No-load mutual funds are the ones that one can buy and sell without any commission or charges.
Dividend ETFs are suitable for risk-averse investors looking for a regular income. Also, beginners can consider investing in dividend ETFs as they may lack the knowledge and time to understand the market.
Exchange Traded Funds (ETFs) are passively managed investment options. The fund manager focuses on identifying, buying and selling the units in the portfolio. They employ diverse investment strategies to generate significant returns for their investors. Also, dividend ETFs provide regular income for their investors.
On the other hand, stocks are the most volatile type of investment. An individual must have good knowledge and understanding of the stock market while investing. Also, one should be able to take buy and sell decisions before it’s too late.
ETFs are a good diversification tool that helps in reducing volatility in the investment portfolio and mitigate risk. The choice of ETFs or stocks completely depends on the investor’s profile, willingness and understating of risk, etc. ETFs, offer advantages over stocks when the returns from the stocks in a sector have a narrow dispersion around the mean. Also, ETF investments are advantageous when an investor is unable to gain an advantage through knowledge of the company. Stocks can generate significant returns; however, they also have a significant amount of risk attached to them. Higher the risk, the higher the returns.
Therefore, ETFs and stocks suit different types of investors, which is a personal investment style that dictates.
ETFs offer a fresh alternative to bond and stock investments. ETFs, combine well-known benefits of stocks and bonds diversification, tax efficiency and lower costs. Additionally, ETFs require lower minimum investments.
ETFs are ideal for long-term investment, provided that one invests in the right ETFs. They are not suitable for an investor looking at fast buy-and-sell for the stocks. Over the long term, ETFs have the potential to generate significant returns. Therefore, the longer one stays greater the potential to generate higher returns.
Furthermore, dividend ETFs provide an additional regular source of income over the long term. Additionally, they offer good portfolio diversification, high portfolio turnover and segmented investing strategies at lower fees.
ETFs suit almost any investor. Long-term investors looking to save for retirement can also invest in ETFs. The longer the time horizon, the greater the opportunity for growth. Also, post-retirement, one can invest in ETFs to help offset inflation and have a regular source of income (through dividend ETFs).
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