Summary
Dividend ETFs invest in a group of dividend-paying companies and can provide investors with dividend income and growth potential.
They can provide passive income, but dividends are not guaranteed and may change over time.
Dividend ETFs are suitable for retired, income-focused, conservative and beginner investors, depending on their goals and risk level.
What Is a Dividend ETF?
A Dividend ETF is a fund that invests in a group of companies that pay dividends. Instead of buying these stocks individually, investors buy units of the ETF. The ETF collects dividends from the companies it holds and may pass this income to its investors as distributions. Dividend ETFs can therefore provide both dividend income and potential growth in the ETF’s value.
How Dividend ETFs Work
A Dividend ETF is a type of investment fund that collects investments from individuals and utilises them to invest in a basket of dividend-generating stocks. If the corporations generate dividends, the ETF earns from such dividends and may redistribute profits to shareholders based on the investment policy of the ETF and the income generated.
Do ETFs Pay Dividends
There are some ETFs that pay dividends or distributions, but it is not guaranteed. An ETF that invests in dividend-paying stocks can receive dividends from those companies and distribute the income to its investors, depending on the ETF’s structure and distribution policy.
Types of Dividend ETFs Investors Should Know
There are a few types of dividend ETFs that are listed below.
- High Dividend Yield ETFs: Investing in companies that generally offer higher dividend payments. They are mainly suitable for investors looking for income.
- Dividend Growth ETFs: Focusing on companies that have a history of increasing their dividend payments over time.
- Sector-specific Dividend ETFs: Investing in dividend-paying companies from a particular sector, such as banking, energy or healthcare.
- International Dividend ETFs: Investing in dividend-paying companies from countries outside the investor’s home market, helping provide global exposure.
- Option Income ETFs: Using options strategies along with stock investments to generate additional income. These ETFs may provide regular distributions but can have different growth potential.
Who Should Invest in Dividend ETFs?
The investors who are suitable for dividend ETFs are given below.
- Retired investors: Investors who have retired may use dividend income as an additional source of regular cash flow.
- Income-focused investors: Investors looking for regular income from their investments may consider dividend ETFs.
- Conservative investors: Those who prefer established, dividend-paying companies may find these ETFs suitable, although they still carry market risk.
- Beginners: Dividend ETFs can provide exposure to several dividend-paying companies through a single investment, making them easier to manage.
Dividend ETFs vs Growth ETFs
The key differences between dividend and growth ETFs are given below.
| Basis | Dividend ETFs | Growth ETFs |
| Primary Aim | Investing with the primary focus on dividend-paying companies for dividend and growth | Investing mostly in growth potential companies for long-term wealth creation |
| Dividend Income | Provide higher or stable dividend income | Provide lower dividends as most of the income is reinvested for growth |
| Return | Earned from both dividend and rising price | Earned from market value |
| Suitable for | Investors seeking income with growth potential | Investors seeking long-term wealth creation |
Benefits and Risks of Dividend ETFs
The benefits of dividend ETFs are given below.
- Stable income: They can provide income through dividends paid by the companies in the ETF.
- Growth potential: Along with dividends, investors may benefit if the ETF’s value increases.
- Easy investing: Investors can buy and sell ETF units through the stock exchange like shares.
The risks of dividend ETFs are given below.
- Market volatility risk: The ETF’s value may fall when the stock market declines.
- Dividend cuts: Some companies may reduce or stop their dividend payments.
- Sector-specific: Some dividend ETFs may focus heavily on certain sectors, increasing sector-specific risk.
Are Dividend ETFs Suitable for Passive Income?
Dividend ETFs are ideal for passive investors since they comprise dividend-paying stocks that yield passive income for investors. However, this passive income cannot be guaranteed since companies are at liberty to cut back or even suspend dividend payouts. Additionally, the passive income can also depend on the composition of the ETF and other factors in the market.
Popular Dividend ETFs to Consider
Some of the popular dividend ETFs are mentioned below.
- Schwab US Dividend Equity ETF (SCHD): SCHD is a passively managed ETF that tracks the Dow Jones U.S. Dividend 100 Index. It provides investors exposure to a portfolio of U.S. companies selected using dividend-related criteria.
- Vanguard Dividend Appreciation ETF (VIG): This ETF focuses on companies with a record of increasing their dividends over time. It is designed to follow the S&P U.S. Dividend Growers Index and emphasises dividend growth rather than simply high yields.
- Vanguard High Dividend Yield ETF (VYM): This ETF tracks the FTSE High Dividend Yield Index and focuses on U.S. companies with above-average dividend yields. It offers investors a simple way to gain exposure to a broad group of high-dividend stocks.
- iShares Core Dividend Growth ETF (DGRO): DGRO invests in U.S. stocks with a history of growing their dividends. According to iShares, it aims to provide a low-cost way to pursue both income and long-term growth.
How to Choose the Right Dividend ETF
Before investing in a dividend ETF, investors must evaluate certain factors. They are listed below.
- Yield: Investors must check how much dividend income the ETF pays. However, a very high dividend yield does not always mean the ETF is a better investment.
- Growth: They must evaluate whether the companies in the ETF have regularly increased their dividends over time. This can help investors understand the ETF’s potential for growing income.
- Holdings: Investors must review which companies and sectors the ETF invests in. Investing across different companies can help reduce the impact of problems in a single company or sector.
- Risks and Strategies: They must understand whether the ETF focuses on high dividend income or companies that grow their dividends. Also, consider risks such as falling share prices and possible dividend cuts.
- Expense Ratio: They should check the annual fee charged for managing the ETF. A lower expense ratio means less of your investment returns are reduced by fees.
Taxation of Dividend ETFs in India
Dividends declared, distributed, or paid on or after 1 April 2020 are treated as “Income from Other Sources” for tax purposes. The amount received is taxable in the investor’s hands at the applicable income-tax slab rate. Earlier, dividends declared, distributed, or paid before this date were generally exempt from tax for shareholders under Section 10(34) of the Income-tax Act, 1961, as the company was required to pay the Dividend Distribution Tax (DDT).
How to Invest in Dividend ETFs
The steps to invest in a dividend ETF are as follows.
- Select the ETF: Investors must thoroughly compare dividend yield, expense ratio, holdings and past performance before selecting an ETF.
- Open a Demat Account: They must open a demat account and trading account to facilitate buying ETFs listed on the stock exchange.
- Place Order: Next, simply search for the selected ETF on the trading platform and place an order for the desired number of units.
- Monitor: They must review or monitor their investment, its dividend distributions, and overall performance regularly.
Real-World Examples and Practical Use Cases
Let’s understand with the help of an example.
Suppose an investor wants to earn income from dividend-paying companies but does not want to buy and manage many individual stocks. They could invest in a dividend ETF such as Schwab U.S. Dividend Equity ETF (SCHD), which tracks the Dow Jones U.S. Dividend 100 Index.
For example, if the ETF holds several dividend-paying companies and those companies distribute dividends, the ETF receives that income and passes distributions to its investors, subject to the fund’s distribution policy. This allows the investor to gain exposure to several dividend-paying companies through a single ETF.
Final Thoughts
Dividend ETFs can be a simple way to invest in several dividend-paying companies through a single investment. They help investors earn dividend income while also offering the possibility of capital growth. However, investors should not choose an ETF only because it offers a high dividend. It is important to evaluate its holdings, costs, strategy and risks before investing. Dividend ETFs can be useful for income-focused investors, but they should match the investor’s financial goals and risk tolerance.
FAQs
There is no single best dividend ETF for everyone. The right choice depends on factors such as dividend yield, dividend growth, expense ratio, holdings and investment goals.
Nippon India ETF Nifty Dividend Opportunities 50 and Mirae Asset BSE 500 Dividend Leaders 50 ETF focus on dividend-paying companies.
A dividend ETF is an exchange-traded fund that invests mainly in companies that pay dividends. It allows investors to gain exposure to multiple dividend-paying companies through one ETF
The amount of investment needed depends on the ETF’s dividend yield and the income it distributes. For example, at a 5% annual yield, an investment of about ₹20 lakh would generate ₹1 lakh before taxes, assuming the yield remains unchanged.
