Should You Invest in Dividend Stocks or Dividend ETFs?

Original post

I’m a huge advocate of dividend growth investing for three main reasons.

  1. If you’re collecting dividend income, dividend growth ensures you’ll keep up with, and hopefully beat, inflation.
  2. If you’re reinvesting dividends, the growth of the dividend will accelerate your ability to build wealth.
  3. Dividend-growers outperform the market.

Some investors are intimidated by the idea of trying to find dividend growth stocks on their own or are nervous about the risks of investing in just a few. They would rather invest in an ETF that pays dividends.

So which is better: individual dividend-paying stocks or dividend-paying ETFs?

Let’s take a look.

There are nearly 200 ETFs that are considered dividend ETFs. They cover a wide range of investing strategies, from First Trust Morningstar Dividend Leaders (NYSE: FDL), which invests in large cap stocks that have sustainable dividends, to WisdomTree International SmallCap Dividend Fund (NYSE: DLS), which has a large concentration in Japan.

Then there are dividend ETFs that fill a niche, such as leveraged ETFs, country- or region-specific ETFs, and some that specialize in high- or low-volatility stocks.

I have no quarrel with ETFs in general. They’re an excellent way to own a diversified group of stocks. But for investors looking for dividend growth, they often fall short…

Way short.

Let’s look at a few of the most popular dividend growth ETFs and see if they live up to their billing.

The Vanguard Dividend Appreciation ETF (NYSE: VIG) is one of the largest ETFs as far as assets under management. It has a yield of just 2%. The ETF does a surprisingly good job of increasing the dividend every year.

I say “surprisingly” because most mutual funds and ETFs that label themselves as dividend growth-focused actually do a very poor job of raising their dividends every year.

However, the Vanguard Dividend Appreciation ETF’s dividend is hardly consistent on a quarterly basis.

This ETF has boosted the dividend every year since 2010 (though it cut the dividend in 2009). However, the dividend is not consistent.

For investors who care only about yearly increases, that may not matter. But for others who rely on the quarterly dividend check, it could be an issue.

Unlike an individual dividend-growing company that typically keeps its dividend stable each quarter until it increases the payout, this ETF offers no guarantees for what investors will get from quarter to quarter.

Additionally, the ETF’s portfolio is weighted. Its largest holdings are Microsoft (Nasdaq: MSFT) and Walmart (NYSE: WMT) at 4.57% and 4.41% respectively. That’s nearly twice the size of its 10th-largest holding, Nike (NYSE: NKE) at 2.33%.

The next-largest dividend growth ETF, the iSharesCore Dividend Growth ETF (Nasdaq: DGRO), has a similar story. Its 2.4% yield is not impressive either. The ETF has raised the dividend every year despite existing only since 2014, but its payout varies widely from quarter to quarter.

Compare that with what I call a Perpetual Dividend Raiser – a company that raises its dividend every year, like Helmerich & Payne (NYSE: HP). This stock, which is currently recommended in TheOxford Income Letter, has raised its dividend every year since 1972.

Since at least 1980 (as far back as our data goes), the dividend never fell from quarter to quarter. It always remained either at the same distribution level or went up. Shareholders could feel secure that there would not be a bad surprise waiting for them in their mailbox or brokerage account in the form of a dividend cut.

There are 131 companies – the Dividend Aristocrats – that have raised their dividends every year for at least 25 years. There are another 205 stocks whose dividends have increased annually for at least 10 years (the Dividend Achievers) and 528 more companies who have raised their dividends each year for at least five years.

The overwhelming majority of them pay consistent quarterly dividends that don’t vary.

There are lots of stocks to choose from where you can get dividend growth and more consistent quarterly distributions. Also, if you choose the right dividend stocks, you can see increases in the dividend payments of 10% or more each year.

That will be tough to achieve with an ETF. Both ETFs mentioned above raised their dividends by about 6% per year for the past three years on average.

Lastly, the CEO of a dividend growth company must answer to shareholders. After 46 straight years of annual dividend increases, if Helmerich & Payne does not boost the dividend, the CEO will likely be looking for empty boxes to pack up his office, whereas if an ETF does not raise its dividend, the investment manager will very likely not suffer any consequences, particularly if it’s a fund that follows an index.

The company CEO is going to do everything they can to continue to raise the dividend. The ETF manager not only won’t do everything they can to ensure the dividend is stable or raised but also is likely not able to do anything about the dividend.

Dividend growth ETFs are useful for someone who has no interest in selecting stocks themselves and would prefer a money manager do it for them, or for someone who would prefer that their money is invested in a way that follows an index.

I prefer the individual stock route. An investor has more control over which stocks and how much of them will be in their portfolio, and they should be able to obtain a higher level of dividend growth as well.

Good investing,

Marc

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