Income Investing Funds
Dividend ETFs
For investors seeking a simplified path to generating passive income, dividend funds offer an excellent solution. Instead of hand-picking individual stocks, you can buy a professionally managed portfolio in a single transaction. Specifically, dividend ETFs (Exchange-Traded Funds) have surged in popularity due to their low costs, tax efficiency, and easy tradability on the stock market. They provide instant diversification across dozens or even hundreds of income-paying companies.
Here we will take a deep dive to learn more about dividend ETFs and their dividend mutual fund counterparts, helping you choose the best fit for your goals. To see how funds fit into a complete strategy, explore our guide on dividend investing and income.
Diversified Dividend Income, Simplified
Income Investment Funds
Careful evaluation is important, but a dividend fund can be a useful vehicle for generating dividend income. Investing for dividends through mutual funds or ETFs is an appealing choice for many investors. The primary benefit of investing in funds is that they offer diversification at a much lower cost than buying individual securities.
Basket of Dividend Stocks
Dividend ETFs are invested in dividend-paying stocks, or they may track a dividend index like the Dow Jones U.S. Select Dividend Index, or a specific category of stocks like the ProShares S&P 500 Dividend Aristocrats Index. You will usually find that these funds track more mature and established companies that pay a consistent dividend and offer a steady stream of income to investors.
Key Consideration: Expense Ratio
Perhaps the most important difference between dividend ETFs is their expense ratios. The expense ratio is the amount investors pay to cover the fund’s annual operating expenses. It is calculated annually and is found in the fund’s prospectus and shareholder report
Dividend Diversification
A dividend ETF is one of the easiest ways to achieve instant diversification. Instead of researching and buying dozens of individual stocks, you purchase a single ETF, which holds a broad basket of income-paying companies. This automatically spreads your investment risk across various sectors and industries. If one company in the fund performs poorly or cuts its dividend, the impact on your overall portfolio and income stream is significantly cushioned by the other holdings.
Active vs. Passive Management
The stocks within a dividend ETF are managed in one of two ways: passively or actively.
Most dividend ETFs are passively managed, meaning the fund automatically tracks a specific dividend-focused index, like the NASDAQ US Dividend Achievers Select Index. The fund only buys or sells stocks to continue mirroring the holdings of that index. This rules-based, automated approach results in lower management fees, also known as the expense ratio.
In contrast, an actively managed dividend ETF has a fund manager or team making strategic decisions to buy and sell stocks, aiming to outperform the market. This hands-on approach leads to higher fees.
Ultimately, the key advantage of using a dividend ETF is its simplicity.
Dividend Mutual Funds and ETFs
The Easiest Way to Earn Dividend Income
Whether the fund is actively or passively managed, all the complex decision-making and portfolio adjustments are handled by the fund manager. This includes researching companies, timing trades, and rebalancing the portfolio according to the fund’s strategy. As an investor, you are freed from the difficult task of picking individual securities, allowing you to own a diversified, professionally managed portfolio with a single purchase.