What are dividend index funds? Let's take each word in reverse order. First, they're funds -- either mutual funds or exchange-traded funds (ETFs). Second, they attempt to track an index that consists of multiple stocks. Third, their focus is on stocks that pay dividends.
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Just as dividend stocks aren't ideally suited for every type of investor, dividend index funds won't appeal to everyone. However, if you're primarily interested in obtaining steady income rather than high growth from your investments, these funds could be just what you're looking for. And, there's no stock-picking required.
8 top dividend index funds to buy
Here are eight dividend index funds listed in alphabetical order that have relatively low expense ratios but varying dividend yields and risk levels.
| Fund | Dividend Yield | Expense Ratio | Risk Level |
|---|---|---|---|
| Invesco S&P 500 High Dividend Low Volatility ETF (NYSEMKT:SPHD) | 3.89% | 0.30% | Average |
| iShares Core High Dividend ETF (NYSEMKT:HDV) | 3.57% | 0.08% | Below Average |
| ProShares S&P 500 Aristocrats ETF (NYSEMKT:NOBL) | 1.94% | 0.35% | Below Average |
| Schwab U.S. Dividend Equity ETF (NYSEMKT:SCHD) | 3.39% | 0.06% | Below Average |
| Vanguard High Dividend Yield ETF (NYSEMKT:VYM) | 3.00% | 0.06% | Below Average |
| Vanguard Dividend Appreciation Index ETF (NYSEMKT:VIG) | 1.96% | 0.06% | Below Average |
| iShares Core Dividend Growth ETF (NYSEMKT:DGRO) | 2.34% | 0.08% | Below Average |
| Vanguard Real Estate ETF (NYSEMKT:VNQ) | 3.91% | 0.12% | Average |
1. Invesco S&P 500 High Dividend Low Volatility ETF
This ETF tracks the S&P 500 Low Volatility High Dividend Index. As the name indicates, it targets dividend stocks that historically haven't been very volatile but also provide high dividend yields. The ETF includes 51 stocks, with its highest allocation to utility stocks and consumer staples stocks.
2. iShares Core High Dividend ETF
The iShares Core High Dividend ETF attempts to track an index that consists of 75 U.S. stocks that pay relatively high dividends. Its top holdings include several energy stocks and big pharmaceutical stocks.
3. ProShares S&P 500 Aristocrats ETF
This is the only ETF that exclusively tracks the performance of Dividend Aristocrats -- S&P 500 members that have increased their dividends for at least 25 consecutive years. As you might expect, these stocks tend to have lower risk levels. This ETF currently owns 64 Dividend Aristocrat stocks.
4. Schwab U.S. Dividend Equity ETF
The Schwab U.S. Dividend Equity ETF seeks to track the total return of the Dow Jones U.S. Dividend 100 Index. This index focuses on U.S. stocks with high dividend yields and a strong track record of consistently paying dividends. Financial stocks make up more than 20% of the ETF's holdings.
5. Vanguard High Dividend Yield ETF
This ETF attempts to track the performance of the FTSE High Dividend Yield Index. The index includes only U.S. stocks with high dividend yields but excludes real estate investment trusts (REITs). The Vanguard High Dividend Yield ETF currently owns more than 400 stocks, with financial stocks representing nearly 20% of its assets.
6. Vanguard Dividend Appreciation Fund Index ETF
The Vanguard Dividend Appreciation Fund Index ETF tracks the NASDAQ US Dividend Achievers Select Index, which consists of 289 companies that have increased their dividend over long periods of time. The idea is to include companies that have a long track record of dividend growth, which speaks to superior capital management.
7. iShares Core Dividend Growth ETF
Similar to Vanguard's Dividend Appreciation ETF, the iShares Core Dividend Growth ETF seeks to replicate the performance of companies that have consistently increased their dividend. This ETF tracks the Morningstar US Dividend Growth Index, which is nearly 50% larger than the NASDAQ US Dividend Achievers Select Index. With more than 400 holdings, the opportunity set is slightly larger here compared to Vanguard's fund.
8. Vanguard Real Estate ETF
The real estate world also has the potential to generate meaningful income through dividends. The Vanguard Real Estate ETF invests in REITs as well as in companies that invest in office buildings, hotels, and a variety of other properties. This ETF tracks the MSCI US Investable Market Real Estate 25/50 Index, which consists of about 175 companies.
What to look for in dividend index funds
A good first step is to determine your overall asset allocation, and, as a follow-up, determine how much you have to invest in stocks and/or equity index funds. Once you've done the pre-work, you can visit any of the major online discount brokerages, such as Vanguard, Fidelity, or Charles Schwab, all of which offer free (or very low-cost) ETF trading.
Here are three top considerations when selecting dividend index funds to buy:
- Dividend yield: Dividend payouts as a percentage of the fund's price.
- Expense ratio: The percentage of fund assets used for operating costs.
- Risk level: How risky the fund is.
To some extent, there's a trade-off between dividend yield and risk level. Generally speaking, higher yields are associated with higher risk, but higher expense ratios don't necessarily translate to higher dividend yields or lower risk levels.
Additionally, it's important to remember that dividend yield alone does not act as a perfect indicator of future performance. By focusing only on companies that pay dividends, you're leaving out a large number of companies, such as big tech, that derive their growth from price appreciation.
Make sure that you construct a diversified portfolio that covers a wide population of underlying firms with different capital strategies.
Dividend index funds are meant for the long term
Given the significant volatility we've seen throughout financial markets during the first months of 2022, it's important to keep in mind that dividend index funds are meant to be held for the long run.
First, the longer you hold your index funds, the better performance you're likely to see. Longer holding periods lend themselves to more compounding, which enables your money to grow at a rapid pace in later years.
Second, short-term market movements tend to be unreliable when it comes to successful investing. As we've seen this year, short-term market swings can be erratic in both direction and magnitude. However, longer-term investment horizons have reliably trended upward, especially when it comes to dividend-paying blue chip stocks.
Finally, longer holding periods also make your portfolio more tax-efficient. If you keep your dividend index funds for longer than a designated holding period, you'll be eligible for qualified dividends, which are taxed at a lower capital gains rate when earned.
If you do choose to allocate a portion of your portfolio to dividend index funds, know that short-term price movements are entirely normal. A long-term focus has historically been a preferable strategy.
Related index fund topics
Why invest in dividend index funds?
Dividend index funds will be most attractive to income-seeking investors. The top funds provide solid dividend yields and diversification across a wide range of stocks, which can be less risky than buying a smaller number of individual dividend stocks. Consider dividend index funds as part of a broadly diversified portfolio that considers your overall risk tolerance and return expectations.
Sam Swenson, CFA, CPA has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends ProShares Trust - ProShares S&p 500 Dividend Aristocrats ETF, Vanguard Specialized Funds - Vanguard Dividend Appreciation ETF, Vanguard Specialized Funds - Vanguard Real Estate ETF, and Vanguard Whitehall Funds - Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.
