Investing in dividend-paying stocks can be a powerful wealth-creating strategy. Over the last 50 years, the average dividend payer in the S&P 500 outperformed dividend non-payers by more than two-to-one (9.2% annualized total return to 4.3%), according to data from Ned Davis Research and Hartford Funds.
However, digging a bit deeper into the data of dividend stocks shows that dividend growers delivered the best returns (10.2% annualized) while cutters and eliminators produced poor returns (-0.9% annualized). Given this data, investors should buy ETFs focused on dividend growth and steer clear of those filled with companies at high risk of dividend reductions.
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Here’s one dividend ETF investors should avoid and one they should buy hand over fist.
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The Global X SuperDividend U.S. ETF(NYSEMKT: DIV) invests in the 50 highest-yielding dividend stocks in the U.S. On the one hand, this dividend ETF offers fairly broad exposure to high-yielding dividend stocks, making it an enticing investment for those seeking passive income. It holds companies across all stock market sectors, led by energy at 20%. Over the last 12 months, the fund has delivered a nearly 7% distribution yield to investors. That’s several times higher than the S&P 500‘s dividend yield (around 1.2%). It also pays monthly dividends, which adds to its appeal.
However, ultra-high-yielding dividend stocks are at a much higher risk of dividend cuts than lower-yielding companies. For example, chemicals producer LyondellBasell had the highest dividend yield in the S&P 500 until it cut its payout by 50% earlier this year. Meanwhile, several of the fund’s holdings pay variable dividends due to the volatility of their earnings, including Cal-Maine Foods, a leading egg producer. Cal-Maine Foods’ dividend has fallen in each of the past three quarters. Meanwhile, there have been quite a few quarters over the past several years when the company didn’t pay a dividend.
The fund’s focus on yield above all else hasn’t paid off for investors over the years. The GlobalX SuperDividend U.S. ETF has only delivered a low-to-mid single-digit annualized total return over the past one-, three-, five-, and 10-year periods, as well as since its inception in 2013 (3.9%). The value of the fund’s holdings has steadily declined, offsetting a meaningful portion of the income received. This unappealing return is why income investors should avoid this dividend ETF.
The Schwab U.S. Dividend Equity ETF(NYSEMKT: SCHD) aims to invest in the 100 highest-quality, high-yielding dividend stocks. It tracks an index (Dow Jones U.S. Dividend 100 Index) that screens companies based on several dividend-quality characteristics, including dividend yield, five-year dividend growth rate, and financial strength.
As a result, it holds high-yielding dividend growth stocks. Its average holding has a current dividend yield of more than 3% and has grown its payout at an annualized rate of more than 8% over the last five years (faster than the S&P 500’s 5% dividend growth rate). The fund’s top holding, Lockheed Martin, has increased its dividend for 23 straight years.
The Schwab U.S. Dividend Equity ETF‘s focus on dividend growers has paid off for investors over the years. It has delivered a more than 11% annualized total return over the last one-, three-, five-, and 10-year periods, as well as since its inception in 2011 (13.3% annualized). The fund’s compelling yield (3.3% annualized over the last 12 months) and robust total return potential make it a top ETF to buy.
It can be tempting to buy a stock or ETF based solely on its yield. However, this strategy hasn’t historically paid off, as the highest-yielding stocks are at greater risk of cutting their payouts and delivering poor investment returns. That’s why investors should avoid the GlobalX SuperDividend ETF, which focuses on yield above all else, and load up on the more dividend growth-focused Schwab U.S. Dividend Equity ETF.
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Matt DiLallo has positions in Schwab U.S. Dividend Equity ETF. The Motley Fool has positions in and recommends Cal-Maine Foods. The Motley Fool recommends Lockheed Martin. The Motley Fool has a disclosure policy.
