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Should I buy a dividend ETF?

Dividend ETFs are a type of Exchange Traded Funds that invest in stocks with a potential to offer a high dividend. These are passively managed funds and track a particular index. An individual doesn’t need to worry about managing the funds themselves. Dividend ETFs best suit investors who are looking for high yields and more stability from their investment portfolios.

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.

Is it better to buy an ETF or stocks?

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 investments. 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 mitigating risk. The choice of ETFs or stocks completely depends on the investors profile, their 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 have a significant amount of risk attached to them as well. Higher the risk, higher the returns.

Therefore, ETFs and stocks suit different types of investors, and it is a personal investment style that dictates.

What are the disadvantages of ETFs?

Exchange Traded Funds have the following disadvantages:

  • Demat account is required
  • Stock exchange-based transactions
  • Market returns
  • Large-cap portfolio

Demat account required: To invest in ETFs one requires a demat account. And one has to pay a certain fee every year to maintain a demat account.

Stock exchange-based transactions: All ETF transactions are facilitated by stock exchange (except NFO). Hence to redeem their units, investors will have to sell it on the stock exchange. And the liquidity of the ETF will depend on the volume of the transactions on the stock exchange.

Market returns: ETFs replicate an index. Hence the returns are limited to the market returns. On the other hand, actively managed funds strive to generate excess returns over the benchmark.

Large cap portfolio: In India, most of the ETFs track major indexes like Nifty and Sensex which are large-cap indexes. There are very few investment choices in mid and small-cap ETFs. Mid and small-cap companies tend to outperform large caps in a bullish market.

Are ETFs good for the long term?

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 is 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 is the opportunity for growth. Also, post-retirement, one can invest in ETFs to help them offset inflation and have a regular source of income (through dividend ETFs).

Is it better to reinvest dividends or get cash?

When an investment pays a dividend, an investor has two options to choose from. The investor can either choose to use the cash as a source of extra income or invest the same back. Having an extra source of income is appealing; however, reinvesting the same will pay off in the long term.

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.

One can always opt for taking cash when the underlying asset performing poorly or one needs an additional source of income. Also, when the reinvestment leads to an unbalanced portfolio, one can consider taking cash instead of reinvesting the dividend. Additionally, one can take cash when they plan to diversify their portfolio by investing the same in a different asset class. Otherwise, it is wise to reinvest dividends rather than taking cash.

Published on October 27, 2020