Investing is like building a strong foundation for your financial future. It involves strategically choosing investments that not only contribute to wealth growth but also can provide regular income. There are certain investments like Dividend Exchange-Traded Funds (ETFs) that aim to satisfy the purpose. In this article, learn about Dividend ETFs, their pros and cons, how they differ from other ETFs and more.
What Is a Dividend ETF?
A dividend ETF is a type of ETF that invests in a selection of stocks that can offer dividends. These funds are passively managed as they track a particular index. The underlying index is tracked to include companies with a proven history of consistent dividend payouts.
Dividend ETFs can also invest in blue-chip companies as they are less risky compared to other companies. Hence, these are mostly preferred by risk-averse investors looking for investment options with regular income and low risk. However, investors must check the history of the underlying stocks in the fund.
Let us consider an example to understand the working of Dividend ETFs better. Suppose there is an ETF called ABC ETF that tracks a global index of large, established companies renowned for consistently paying high dividends. This fund might include a diversified range of sectors, such as technology, healthcare, and consumer goods, ensuring a balanced exposure to various industries. As a passively managed fund, ABC ETF aims to mirror the performance of its dividend-focused index, providing investors with an opportunity to benefit from both stock appreciation and regular income.
Advantages of Dividend ETFs
- Stable income stream: Dividend ETFs offer investors a reliable income stream through regular dividend payments from the underlying stocks.
- Diversification: These ETFs typically invest in a diversified basket of dividend-paying stocks, spreading risk across various sectors and companies.
- Blue-chip exposure: Many dividend ETFs focus on blue-chip stocks, which are shares in large, well-established companies with a history of financial stability.
- Cost efficiency: As these ETFs are passively managed, they have lower expense ratios than actively managed funds.
Disadvantages of Dividend ETFs
- Market risk: Dividend ETFs are susceptible to market fluctuations. If the stock market experiences a downturn, the value of the underlying stocks in the ETF may decrease, impacting the fund’s overall performance.
- Lack of control: Like other mutual funds or ETFs, investors can’t select the underlying securities.
- Average income: The payout dividend yield on these funds is an average of all underlying stocks. If any stocks in the fund reduce the dividends, the average yield will also reduce.
Taxation on Dividend ETFs
Previously, dividends generated from ETFs faced taxation by the issuing company, attracting a 15% Dividend Distribution Tax (DDT) excluding applicable cess. However, as of the financial year 2020-21, the taxation structure has changed. Dividends earned from ETFs are taxed based on the individual investor’s applicable income tax slab rates.
How To Choose a Dividend ETF?
When selecting a Dividend ETF, several crucial factors should be considered as follows:
- Dividend yield: Assess the ETF’s historical dividend yield to gauge the income potential. A high dividend ETF may offer more income.
- Dividend growth: Examine the ETF’s track record for consistent dividend growth. A history of increasing dividends suggests financial strength and stability in the underlying companies.
- Underlying index: Understand the methodology of the ETF’s underlying index. Ensure it aligns with your investment objectives and includes companies with a reliable dividends-paying history.
- Sector exposure: Evaluate the ETF’s sector allocation. Diversification is crucial to mitigate risk, and an even distribution across sectors can contribute to a balanced portfolio.
- Distribution frequency: Determine the ETF’s distribution frequency. Some ETFs pay dividends monthly, quarterly, or annually. Choose a frequency that aligns with your income needs.
By carefully evaluating these factors, you can make informed decisions when selecting a Dividend ETF that suits your unique investment objectives and preferences.
Also Read More About ETF Terminologies
Dividend ETFs vs Other ETFs
| Aspect | Dividend ETFs | Other ETFs |
| Underlying Assets | Primarily invest in dividend-paying stocks. | Include a broad range of assets like stocks, bonds, commodities, or a combination, depending on the fund’s strategy. |
| Investor Preference | Suited for income-focused investors, especially those prioritising regular cash flow. | Attract investors seeking diversified exposure to specific markets, sectors, or asset classes, focusing on capital appreciation. |
Conclusion
Dividend ETFs make it easy for you to invest in lots of companies simultaneously, spreading your money for safety. They’re like a basket, holding pieces of many companies that can offer you a share of their profits. So, if you want a steady income and a safer way to grow your money, Dividend ETFs can be a smart choice for you. Start your journey with Dividend ETFs and see how they can make your money work harder for you.
To get started with Dividend ETFs, open a Demat Account for free on Angel One. Happy Investing!
FAQs
Is a Demat Account mandatory to invest in ETFs?
Yes. You need to have a Demat Account to buy or sell ETFs as they are traded on stock exchanges, and the process of buying and selling them is similar to individual stocks.
Should we invest in ETFs for the long term or the short term?
Though ETFs are chosen for long-term investments, the decision depends on your investment objective, risk tolerance and investment horizon.
Stocks or ETFs: Which is better?
Though both stocks and ETFs are popular investments, the choice depends on preferences and risk appetite. Individual stocks offer the potential for higher returns but with increased risk. ETFs provide diversification, simplicity, and lower risk, making them suitable for a hands-off approach to market exposure.
How to find the best dividend ETF?
To find the best dividend ETF, check the historical performance of the fund, assess the fund’s objective, consider expense ratios, and ensure it aligns with investment goals. Look for consistency in dividend payments, a robust track record, and a diversified portfolio.
Do all ETFs pay dividends?
Not all ETFs pay dividends in India. Some ETFs reinvest dividends back into the scheme, while some ETFs, like Liquid ETFs, credit them to the investor’s account. Check the scheme’s details before investing.
