Investments that generate income, have the potential for strong growth, and offer protection against stock market downturns: It's this compelling combination of attributes that has made dividend stocks so popular with investors these days.
If you don't have any dividend payers in your core investing portfolio right now, that's easy enough to remedy. With the help of one of Wall Street's hottest innovations -- exchange-traded funds, or ETFs -- putting together a great dividend-stock portfolio is a snap.
What Kind of Dividend is Right for You?
ETFs let investors buy all the investments they like in a single package. Rather than having to search through dozens or even hundreds of attractive dividend stocks, you simply need to find the right ETF to add a wide array of stocks you like to your portfolio.
There are three basic types of dividend ETFs. Picking the type that makes the most sense for your portfolio comes down to your priorities. Specifically:
- Do you need to max out your income potential right now?
- Or can you afford to take a longer-term approach?
1. I want the money right now.
If you're like many investors, you want as much income as you can get. High-yield dividend ETFs seek out the stocks that give their shareholders the biggest payouts available. For instance, the Vanguard High Dividend Yield ETF (VYM) lives up to its name by choosing stocks with top payouts, including AT&T (T), Frontier Communications (FTR), and Pitney Bowes (PBI).
High-yield dividend ETFs obviously have the benefit of generous income. But some stocks with high yields are vulnerable to potential problems in the near future, which could both hurt their share price and lead to dividend cuts. So don't assume that a high-yielding dividend ETF is a completely safe bet.
2. I want investments that will continue to generate income for years to come.
Some dividend ETFs aren't as concerned about current yield. Instead, they look for companies with established track records of consistently raising dividend payouts over time, leading to healthy dividend growth for long-term shareholders.
For instance, the SPDR Dividend ETF (SDY) invests in members of S&P's exclusive Dividend Aristocrats list. Companies only become aristocrats by establishing a streak of at least 25 years of annual dividend increases. Even though some of the stocks on the list have relatively low yields, their demonstrated ability to produce higher payouts year in and year out, even through tough times, makes them very strong investments.
3. I'm willing to take a bit of risk for a higher payout in a niche sector.
Finally, some dividend ETFs focus on particular types of dividend stocks. Look at the Market Vectors Mortgage REIT ETF (MORT) and you'll find nothing but mortgage REITs, a real-estate investment that gives you exposure to some of the highest-yielding companies in the market.
Mortgage REITs aren't for the meek, however. These companies borrow heavily to make their bets on mortgage-backed securities, and that abundant leverage makes them highly sensitive to interest rate changes. If rates start to rise, REITs' dividend yields could fall sharply.
In addition, there's been some talk recently of putting restrictions on mortgage REITs, as well as offering the borrowers on whom mortgage REITs' profits depend a chance to refinance their home loans more cheaply. Either of those outcomes could hurt mortgage REIT investors. But for now, with many REITs yielding 15% or more, investors are willing to take that chance.
Motley Fool contributor Dan Caplinger looks everywhere for stocks that pay him back. You can follow him on Twitter here. He doesn't own shares of the stocks mentioned in this article. Motley Fool newsletter services have recommended buying shares of AT&T.