When you think about investing in the stock market, you usually imagine looking for a stock that you can buy low and sell high. But there’s another way to invest: by buying high dividend stocks, or a dividend ETF that holds those stocks, which give you the opportunity for a regular income from dividend payouts.
Both dividend stocks and dividend ETFs have enjoyed a certain amount of popularity for a long time, especially among retirees who want a regular income and investors looking for low-risk options, but the unique pressures of COVID-19 seem to have increased their appeal. Could dividend ETFs be having their moment in the spotlight?
What Is an ETF?
ETF stands for exchange-traded fund. It contains a number of different stocks and equities that trade on the stock market, so you’re effectively investing in numerous stocks with a single investment. An ETF can be traded like a stock itself, and you can track its changing price throughout the day.
Some ETFs track an index by holding stocks in the same ratio as the index. These are known as passively-managed ETFs. A passively-managed ETF attempts to mirror the composition and performance of the index it tracks. The Fund’s returns may diverge from that of the Index due to costs and expenses incurred by the Fund or its holdings may deviate from a precise correlation with the Index. This is a risk known as a tracking error. The index typically uses proprietary methodology and criteria to exclude or include certain securities. The ETF’s performance may be adversely affected by a general decline in the market segments relating to its Index.
An actively-managed ETF is an exchange-traded fund that relies on an adviser or portfolio manager for choosing investments and making portfolio allocation decisions. The portfolio manager uses strategies and proprietary processes to manage the fund in seeking to achieve its investment objective and typically aims to outperform a benchmark.
What Is a Dividend ETF?
Dividend ETFs are constructed specifically to include stocks that pay dividends to investors, either through cash payouts or by reinvesting the dividend back into the fund. Most dividend ETFs track stocks that have the potential to deliver above-market yields, higher than average liquidity, and lower risk.
Dividend ETFs set their own date to pay dividends rather than following the schedule of the dividend stock. However, a dividend ETF isn’t the same as a fixed-income ETF. Fixed-income ETFs track fixed-income securities, which are like a loan made by the investor to the issuer of the security, and payments come from interest on the loan, not dividends.
In theory, a fixed-income ETF pays a predictable amount, unlike dividend ETFs where the amount you receive can vary depending on the performance of the dividend stocks. But there’s still a risk that the borrower could default on the loan.
Why Invest In a Dividend ETF?
Dividend ETFs are popular income investments for people who are seeking a regular income as well as the possibility of long-term growth. Some dividend ETFs tend to have lower risk, thanks to their broad diversification and market exposure, and typically have a lower expense ratio than managed funds. People also appreciate that dividend ETFs offer more control over their money, and perceive them as offering a way to address the effects of inflation because the payouts are made regularly.
That said, dividend payments aren’t guaranteed and may not continually increase. The price of dividend ETFs tends to grow more slowly than other ETFs, and if it falls drastically, you could end up losing more money than you gain. You also need to pay tax on dividends in the year they are distributed, whether you take them in cash or reinvest them, which can be off-putting for some investors.
Dividend ETFs Are Seeing a Surge In Popularity
Data from the last couple of years have shown a significant jump in the number of people investing in dividend ETFs. 2020 saw a record $504 billion in dividend ETF flows, but 2021 has already eclipsed that, with CFRA Research reporting flows of over $800 billion by the beginning of December 2021 and David Botset, Head of Strategy at Charles Schwab, predicting that the year’s total will exceed $1 trillion.
Analysts are clear about tracing this trend back to the COVID-19. Record numbers of people took early retirement during the pandemic, partly due to fears over the infection and partly from a lockdown-inspired realization that they wanted a better work-life balance. This rapidly expanding retiree community turned to dividend ETFs, seeking a source of income.
Dividend ETFs are even more appealing in the current economic climate; with interest rates so low, it’s hard to earn a decent return on savings accounts or other income investments. “Dividend ETFs are even more appealing in the current economic climate; with interest rates so low, it’s hard to earn a decent return on savings accounts or other income investments. “You’ve got a huge number of individuals that need income, that is transitioning to retirement,” Botset said, “and in a low-interest-rate environment it’s challenging to find that income.”
What to Look For In a Dividend ETF
If you’re tempted by low-interest rates, diversification, and the prospect of a steady payout, there are some things you should know to investigate before jumping to buy a dividend ETF.
Dividend Payout Frequency
Typically, income funds like dividend ETFs payout every quarter, but some pay monthly and a few pay weekly. Monthly or weekly payouts can be more convenient for managing cash flow, and if you reinvest your dividends, monthly dividend stocks can bring greater total returns.
Most dividend ETFs track stocks that have low volatility but high yields. Today’s high payments might not be sustainable over the long term, and the highest yield stocks tend to suffer most in a declining market.
Future Growth Opportunity
Some investors prefer an ETF that delivers low payments at the moment but could grow to provide higher yields as well as capital appreciation in the future. Of course, there are no guarantees.
Level of Risk
Some high dividends ETFs include higher-risk stocks that could pay larger dividends, but also could lose money. It’s important to read the fund’s strategy in choosing stocks to be sure you’re comfortable with the level of risk involved.
Some dividend ETFs, mainly those that invest in domestic stocks, pay qualified dividends which are taxed like long-term capital gains at a lower rate than ordinary income. Non-qualified dividends, typically paid by international dividend ETFs, are taxed at ordinary income rates.
Investing In a Dividend ETF With SoFi
SoFi, the FinTech platform, offers two weekly dividends ETFs, WKLY and TGIF. Both of these funds payout once a week — TGIF on Fridays, as you’d guess from the name.
TGIF is an actively-managed ETF, which is unusual for dividend ETFs, investing in US-denominated investment-grade and high-yield fixed-income securities. The ETF is diversified across more than 100 bonds in multiple industries and capital structures, but the high-yield holdings are considered speculative and thus have a higher risk than investment-grade securities.
If you prefer a lower-risk dividend ETF, you could try WKLY. WKLY is a non-diversified, global ETF that tracks the SoFi Sustainable Dividend Index. The index is comprised of equity securities of publicly traded, large- and mid-capitalization U.S. and non-U.S. companies in developed markets. To be eligible for inclusion in the Index, companies in a selected universe must meet certain eligibility requirements in an attempt to find the most consistent dividend-paying stocks around the world. WKLY selects securities that maintained payments for at least the previous 12 months, are predicted to continue to do so for the next 12 months, and meet other conditions to help reduce the risk of low payouts.
For investors who are recently retired, or looking for regular returns at any stage in life, SoFi’s TGIF or WKLY weekly dividend ETFs could be an attractive option.
Before investing you should carefully consider the Fund’s investment objectives, risks, charges, and expenses. This and other information is in the prospectus. A prospectus may be obtained by visiting sofi.com/invest/etfs. Please read the prospectus carefully before you invest.
Investments involve risk. Principal loss is possible. There is no guarantee the Funds’ investment strategy will be successful and you can lose money on your investment in the Funds. The Funds are new and have a limited operating history to evaluate. Shares may trade at a premium or discount to their NAV in the secondary market. Brokerage commissions will reduce returns.
Risks Specific to WKLY
The Fund is non-diversified and its investments may be concentrated in an industry or sector to the extent the index is concentrated meaning it may invest a greater percentage of its assets than a diversified fund. As a result, a decline in the value or an adverse event could cause the Fund’s overall value to decline to a greater degree. There is no guarantee that issuers of the securities held by the Fund will declare dividends or increase over time. Although the Fund intends to maintain a consistent weekly income distribution, depending upon the timing of the receipt and payment of dividends from the Fund’s underlying holdings, the amount of the Fund’s weekly income distribution may fluctuate and the Fund’s NAV will fluctuate accordingly.
Investments in securities of non-U.S. issuers involve certain risks not involved in domestic investments and may experience more rapid and extreme changes in value. Financial markets in certain foreign countries may not be as efficient or liquid as financial markets in the U.S., and therefore, the prices of non-U.S. securities can be more volatile. In addition, the Fund will be subject to risks associated with adverse political, global health crises and economic developments including sanctions in foreign countries. Generally, there may be less readily available or reliable information about non-U.S. issuers due to less rigorous disclosure or accounting standards and regulatory practices.
Risks Specific to TGIF
High-yield securities (also known as “junk” bonds) carry a greater degree of risk and are more volatile than investment-grade securities and are considered speculative. The Fund’s investments in high-yield securities expose it to a substantial degree of credit risk. The value of the Fund’s investments in fixed-income securities will fluctuate with changes in interest rates. Typically, a rise in interest rates causes a decline in the value of fixed income securities owned indirectly by the Fund.
Investments in foreign securities may involve risks such as social and political instability, market illiquidity, exchange-rate fluctuations, a high level of volatility, and limited regulation. Investing in emerging markets involves different and greater risks, as these countries are substantially smaller, less liquid, and more volatile than securities markets in more developed markets. The Fund’s investment in Privately placed securities generally is less liquid than publicly traded securities and the Fund may not always be able to sell such securities without experiencing delays in finding buyers or reducing the sale price for such securities.
SoFi ETFs are distributed by Foreside Fund Services, LLC