ETFs that track high-dividend-paying stocks have been some of the best performing funds this year, strongly outpacing the S&P 500 and many of the large-cap growth funds that were in favor last year. Dividend funds and ETFs are attractive to investors in search of higher yields in this low interest environment, and they also tend to be defensive, which is appealing in volatile markets.
If you want to capitalize on the dividend trend, here are three crucial things to remember:
1. Focus on ETFs with strong recent returns
While some dividend funds have had strong recent returns not all dividend funds have done well lately. Many dividend ETFs trounced the S&P 500 in the first four months of the yeariShares Select Dividend (DVY) gained 10.0% compared to just 1.7% for the indexbut others like PowerShares International Dividend Achievers (PID) , haven’t done as well (PID was up just 2.2% in the first quarter). So don’t buy just any dividend ETF; invest in the ETFs that have strongest recent returns.
2. Take risk into account
Some dividend funds are riskier than others: they may invest in more volatile areas of the market, like small caps or emerging markets, or they may have more concentrated portfolios. WisdomTree Small-Cap Dividend (DES) , for example, invests in small- and micro-cap stocks, and it’s often been more volatile than iShares Select Dividend, which invests in large- and mid-cap stocks.
And it’s important to remember that dividend funds are stock funds. Even though these funds may have good yields, they aren’t a substitute for bond funds.
3. Look beyond a fund’s name
Many dividend ETFs have similar names, which leads investors to assume that these funds own the same stocks. But that’s not the case. When you look past the funds’ names, you’ll find that they are different enough to provide good diversification.