With today’s economic ups and downs, finding a reliable income source is more crucial than ever. For many traders, the idea of earning a regular income from investments is incredibly appealing, especially as everyday costs keep climbing due to inflation. Dividend ETFs offer a practical solution and also make it easy to invest in multiple dividend-paying stocks all at once. In this article, we’ll look into why dividend ETFs are becoming a popular choice and how to pick the best one for your needs.
Understanding Dividend ETFs
Let’s start with the basics. Exchange-traded funds (ETFs) are like a big basket of different investments that you can buy a piece of. When you invest in an ETF, you own units in that basket but not the individual items inside it. A dividend ETF is a special kind of ETF that pays you dividends regularly, usually every six months or once a year. These dividends come from the profits of the companies within the ETF’s portfolio.
Dividend ETFs offer several perks over picking individual stocks or going with traditional mutual funds. They are cost-effective and make it easy to spread your money across many investments. Unlike mutual funds, which can be tricky to trade, ETFs are bought and sold on stock exchanges, just like regular stocks. Dividend ETFs can also help you earn passive income and you can benefit from any increase in the value of the assets they hold.
The Growing Popularity of Dividend ETFs
In May 2023, more than $970 million was invested in dividend ETFs, the highest amount in six years! This surge shows that more and more people are seeing the value in index funds Australia. The crazy inflation rates, like the 6.1% we saw in Australia in 2022, have pushed investors to find stable income sources, and dividend ETFs have become a go-to choice.
Types of Dividend ETFs
There are two main types of dividend ETFs: passive and active. Passive ETFs aim to replicate the performance of a market index. For example, an ETF that tracks the ASX 200 will include stocks from the 200 largest companies listed on the ASX. These tend to have lower fees.
Active ETFs, on the other hand, have a fund manager who tweaks the portfolio to try and beat the market. While this can lead to higher returns, it also means higher fees. Basically, you’re paying a little extra for expert advice.
Australian dividend ETFs focus on companies listed on the ASX, known for their generous dividend payouts. For instance, in 2024, the average dividend yield for Australian large-cap stocks in the ASX 200 was 5.69%, which is pretty high compared to other markets.
Choosing the Best Dividend ETFs
When you’re looking to invest in dividend ETFs, it’s crucial to evaluate various factors that can significantly impact your returns. Keep these things in mind:
Management Fees
These are the costs charged by the ETF provider for managing the fund. Lower fees are preferable because they allow you to keep more of your returns. Over time, even small differences in management fees can add up and significantly affect your overall returns.
The Vanguard Australian Shares High Yield ETF (VHY) charges a management fee of just 0.25% per year. This low fee structure ensures that a larger portion of the dividends and capital gains generated by the ETF goes directly into your pocket rather than to the fund manager. In comparison, ETFs with higher fees can eat into your returns, especially if the market experiences lower growth periods.
Dividend Yield
This represents the annual dividend income as a percentage of the ETF’s price. A higher yield generally indicates a better return on your investment, particularly for income-focused investors.
So what to look for? A dividend yield above 5% is typically considered good. This yield can provide a steady income stream, which is especially beneficial for retirees or those looking to supplement their income.
High yields can be particularly attractive, but they also often come with higher risk, as they may be associated with sectors or companies with more volatile earnings.
Diversification
This involves spreading your investment across various sectors and companies to reduce risk. A well-diversified ETF can protect your investment from significant losses if one sector underperforms.
Diversification matters because it helps mitigate the risk of investing in a single sector or company. By holding a range of assets, the poor performance of some investments can be balanced by better performance in others.
The BetaShares Equity Yield Maximiser Fund (YMAX) provides diversification by including 20 of the biggest blue-chip stocks on the ASX. These stocks are from various sectors, ensuring that the ETF isn’t overly reliant on any single industry. Such diversification can provide stability and steady income, even in volatile markets.
Historical Performance
Evaluating an ETF’s past performance can give you insights into its potential future returns. While past performance is not always indicative of future results, it can help you understand how the ETF has navigated different market conditions.
Look at the ETF’s annual returns over multiple years, volatility, and performance during market downturns.
The Russell Investments High Dividend Australian Shares ETF (RDV) has a five-year return of 5.54%. This historical performance indicates that the ETF has been able to provide a steady return over a significant period, making it a potentially reliable choice for long-term investors seeking income.
Liquidity
This refers to how easily you can buy or sell an ETF without affecting its price. High liquidity ensures that you can quickly enter or exit a position, which is particularly important in volatile markets.
An ETF with high liquidity means there are many buyers and sellers in the market. This reduces the risk of having to sell at a lower price due to lack of demand.
Tax Efficiency
This refers to how the dividends and capital gains from the ETF are taxed. In Australia, many companies pay fully or partially franked dividends, which can lower your tax bill.
Fully franked dividends come with a tax credit for the corporate tax already paid by the company. This means you can offset this credit against your personal tax liability, effectively reducing the tax you pay on your dividend income.
Investing in ETFs that include Australian companies paying franked dividends can be tax-efficient. For instance, if an ETF holds shares in companies that pay fully franked dividends, the dividends you receive could come with tax credits. This can be especially beneficial for investors in higher tax brackets, as it reduces the effective tax rate on dividend income.
Australia’s Best Dividend ETFs
Here, we delve into some of the best dividend ETFs available on the Australian market, providing a detailed analysis of their performance, strategy, and suitability for different investment goals.
Vanguard Australian Shares High Yield ETF (ASX: VHY)
- Index: FTSE ASFA Australia High Dividend Yield Index
- Assets under Management: $3.71 Billion
- Dividend Yield: 5.48%
- Distributions: Quarterly
- Total Return (5 Years): 9.69%
The Vanguard Australian Shares High Yield ETF (VHY) is a prominent choice among Australian investors due to its broad diversification and focus on high-yielding stocks. VHY tracks the FTSE ASFA Australia High Dividend Yield Index, which is composed of companies that are expected to pay above-average dividends.
With a management fee of just 0.25%, investors can retain more of their returns compared to higher-cost funds.
VHY’s strategy focuses on high dividend yields, which can provide a steady income stream. The ETF’s quarterly distributions make it suitable for investors seeking regular income.
The ETF is best for investors looking for a low-cost, diversified ETF with a solid track record of high dividend yields.
SPDR® S&P®/ASX 200 Resources Fund (ASX: OZR)
- Index: S&P/ASX 200 Resources Index
- Assets under Management: $166.34 Million
- Dividend Yield: 4.68%
- Distributions: Semi-annual
- Total Return (5 Years): 10.58%
The SPDR® S&P®/ASX 200 Resources Fund (OZR) focuses on the resource sector, which is known for high dividends. It tracks the S&P/ASX 200 Resources Index, and its strategy involves investing in leading resource companies. These companies often benefit from global demand for raw materials, resulting in substantial profits and high dividends.
The fund is more suitable for investors seeking exposure to the resource sector and high dividend yields. The semi-annual distributions provide less frequent but substantial income.
BetaShares Equity Yield Maximiser Fund (ASX: YMAX)
- Benchmark Index: Actively Managed
- Assets under Management: $489.03 Million
- Dividend Yield: 8%
- Distributions: Quarterly
- Total Return (5 Years): 6.79%
The BetaShares Equity Yield Maximiser Fund (YMAX) employs a covered call strategy to enhance its yield. Unlike index-tracking ETFs, YMAX is actively managed to maximize income through dividends and option premiums.
YMAX offers an impressive dividend yield of 8.8%, boosted by the covered call strategy. YMAX’s covered call strategy involves writing call options on the stocks held in the fund. This generates additional income from option premiums, enhancing the overall yield but potentially capping the capital appreciation.
Investing in Dividend ETFs
Open a Brokerage Account
The first step in investing in dividend ETFs is to open a brokerage account. Choose a brokerage platform that offers a wide variety of ETFs and has competitive fees. Look for platforms that provide robust research tools, easy-to-use interfaces, and good customer support.
You also need to decide between a standard brokerage account, retirement account, or other types of accounts based on your investment goals and tax considerations. It is important to be aware of the fee structure, including trading fees, account maintenance fees, and any other charges that might apply.
Popular brokerage platforms in Australia include CommSec, IG Markets, and SelfWealth. Each platform has its own fee structure and range of offerings, so compare them to find the best fit for your needs.
Research ETFs
Once you have a brokerage account, the next step is to research the available dividend ETFs. Use the criteria that we personally use to evaluate and select the best ones for your investment goals:
- Management Fees: Lower fees mean higher net returns. Compare the expense ratios of different ETFs.
- Dividend Yield: Look for ETFs with high and sustainable dividend yields. Generally, a yield above 5% is considered good.
- Diversification: Ensure the ETF provides exposure to a wide range of dividend-paying stocks across different sectors.
- Historical Performance: Check the ETF’s past performance to understand its returns and stability over time.
- Liquidity: Higher liquidity means you can easily buy or sell the ETF without significantly affecting its price.
- Tax Efficiency: Look for ETFs that pass on franking credits, which can reduce your tax burden.
Researching Vanguard Australian Shares High Yield ETF (ASX: VHY) might reveal that it has a management fee of 0.25%, a dividend yield of 5.8%, and a strong track record, which makes it one of our favourite.
Place an Order
After selecting your preferred ETF, you need to place an order through your brokerage account. A market order buys the ETF at the current market price. This type of order is executed immediately but doesn’t guarantee the price. A limit order on the other hand buys the ETF at a specific price or better. This provides price control but might not be executed immediately if the market price doesn’t reach your specified limit.
For example, if you decide to buy units of the SPDR® S&P®/ASX 200 Resources Fund (ASX: OZR), you can place a market order to purchase at the current price or a limit order to buy only if the price drops to a certain level.
Monitor Your Investment
Regularly monitoring your ETF investments is crucial to ensure they align with your financial goals. Here’s how to keep track:
- Performance Review: Periodically review the performance of your ETFs. Look at price changes, dividend payouts, and overall returns.
- Rebalance Portfolio: Adjust your holdings if necessary to maintain your desired asset allocation. This might involve selling some units of an ETF and buying others.
- Stay Informed: Keep up with market news and developments that might affect your investments. This includes changes in interest rates, economic indicators, and company earnings reports.
Down the Lane
Dividend ETFs are a fantastic tool for anyone looking to earn regular income and diversify their investments. By understanding the different types of dividend ETFs and carefully selecting the ones that fit your goals, you can boost your income while also managing risk. With the right approach, dividend ETFs can be a valuable addition to your portfolio, offering a blend of income and growth in today’s unpredictable economic environment.
Investing in dividend ETFs is a straightforward way to generate income, particularly in an inflationary climate where maintaining purchasing power is critical. With careful selection and regular monitoring, dividend ETFs can offer a reliable and rewarding investment strategy.