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Picking dividend earning ETFs

Lesson in Course: ETFs and mutual funds (beginner, 8min )

Building out an income or dividend portfolio creates a steady flow of cash. What are some good examples of dividends ETFs and how do we compare them?

Adding a few dividend-paying ETFs to our portfolio is a great way to take advantage of dividend stocks without the requirements of analyzing individual companies. There are a few industries that consistently pay great dividends. These industries, or sectors, include Utilities, REITs, and Telecoms. Let's take a look at the sectors below and briefly compare 3 ETFs in each sector. 

We'll compare expense ratio and yield. The best options are the ones with the highest dividends and lowest expense.

Double tap for an example

An ETF with an expense ratio of 0.10% and a yield of 4% means that for every $100 invested, we will pay $0.10 towards management fees but will also generate $4 worth of dividends. We will compare different ETFs by taking yield and subtracting the cost of management to calculate how much the fund generates. The fund generates $3.90 for every $100 invested after fees.

 

Utilities

Utility companies provide basic amenities such as water, sanitation, electricity, and natural gas. The companies are essential for the public infrastructure and are often heavily regulated by the government for price protection. These companies can pay dividends because they operate under a cost-plus model. The cost-plus model is a direct markup paid by consumers on the cost of providing a good or service. For example, if it costs the company $20 to provide us electricity, the company may charge $30, a $10 markup. If costs rise to $30, our bill would be $40, ensuring profitability for the company.

ETFs

The following yields shown are based on 2020

XLU - XLU has an expense ratio of 0.13%, is diversified with 29 companies, and pays out a yield of 3.36%.

VPU - VPU has an expense ratio of 0.10%, is diversified with 69 companies, and pays out a yield of 3.10%.

FUTY - FUTY has an expense ratio of 0.08%, is diversified with 66 companies, and pays out a yield of 3.12%.

XLU stands out because the fund generates $3.20 compared to $3.00 for VPU and $3.04 for FUTY for every $100 invested. Compared to the other two, the fund, XLU is less diversified—while 29 companies provide good diversification, we can pick FUTY if we want additional diversification.

REITs

REITs provide good exposure to the housing market without owning a house and are required to distribute 90% of their earnings via dividends. The real estate companies secure stable and long-term cash flow from rents and leases and distribute them back to the shareholders. Note, the dividends REITs issue is taxed differently. Read about ordinary dividends.

ETFs

The following yields shown are based on 2020

RWR - RWR has an expense ratio of 0.25%, is diversified with 94 companies, and pays a yield of 4.54%.

VNQ - VNQ has an expense ratio of 0.12%, is diversified with 184 companies, and pays out a yield of 4.25%.

FREL - FREL has an expense ratio of 0.08%, is diversified with 181 companies, and pays out a yield of 4.01%.

RWR generates the most for us with $4.19 compared to $4.13 from VNQ and $3.93 from FREL for every $100 invested. The difference between the diversification benefits between 90 companies compared to 180 companies isn't substantial.

Telecommunications

Telecoms are large entrenched businesses because the cost to run lines and communication across the country is so high; startups cannot get the money to compete. As a result, telecom companies have very little competition, make a lot of money through multiple bundled services, and pay stable yielding dividends.

ETFs

The following yields shown are based on 2020

XLC - XLC has an expense ratio of 0.13%, is diversified with 27 companies, and pays out a yield of 1.01%.

VOX - VOX has an expense ratio of 0.10%, is diversified with 114 companies, and pays out a yield of 1.11%.

FCOM - FCOM has an expense ratio of 0.08%, is diversified with 105 companies, and pays out a yield of 1.04%.

VOX generates the most providing us $1.01 compared to $0.88 from XLC and $0.96 from FCOM for every $100 invested. VOX also has the most diversity built into the fund.

It's pretty noticeable that the yield for Telecoms is much lower than the other two sectors. An important consideration to add telecoms even with lower yields is the larger growth potential of the share prices. Innovations such as 5G wireless networks can drive significant growth in the sector compared to the other two.

https://www.etf.com/ is a good resource to use to look up expense ratios, holdings, and yields of any ETF.

Adding REITs to our portfolio not only provides us great income generation but also gives us exposure to the real estate market if we don't currently own property ourselves. Our portfolio benefits more from diversification if we include at least a fund from each of the sectors above.

The ETFs mentioned are among the most popular and this lesson is intended to illustrate how to compare different yield-bearing ETFs. None of these represent our personal endorsements, and at Archimedes, we always encourage you to do your own due diligence. If you know of better ETFs, I would love to include them—shoot me a note at Simon@getmedes.com!

Glossary

What is Cost-plus?

The cost-plus model is a direct markup paid by consumers on the cost of providing a good or service. For example, if it costs the company $20 to provide us electricity, the company may charge $30, a $10 markup. If costs rise to $30, our bill would be $40, ensuring profitability for the company.

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