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Summary Dividend income is a great way to increase cash flow while not having to liquidate positions and taking money out of the market. Historically, dividend-paying companies have outperformed non-dividend-paying companies thus this strategy may boost overall portfolio return. Companies that make up dividend-paying ETFs can vary from traditional broad market ETFs, so splitting your portfolio up can help diversify your holdings. For a majority of investors, regular “stock picking” is not of interest to them. The shear amount of work and patience involved in the process tends to push the masses towards passive management, where the debate between mutual funds and ETFs begins. Without a doubt, there has been a lot of movement into ETFs due to their lower-fee structure as well as their overall net-of-fees performance compared to mutual funds. Over the past few months, I’ve begun to do a deeper dive on the value of high dividend yield ETFs to see if they are truly worth the hype. Many of the most successful investors preach the importance of investing in companies that pay steady dividends. It’s easy to understand the appeal of such companies; the ability to return cash to shareholders shows that the company is, usually, being managed well and investors can generally expect a stream of cash to supplement any unrealized gains in their shares. I’m of the personal opinion that, to some degree, companies pay dividends to keep shareholders from selling their shares. In other words, giving investors a bit of cash to pad their pockets may deviate them from selling their position when they are in need of cash – something that tends to occur increasingly during economic downturns. Of course, these dividends come at the cost of less capital appreciation, but many investors like the little bonus they see in their investment account. If you are someone who believes you should just spend the interest, not the principal, then high-dividend ETFs should peak your interest. In addition, corporations have been distributing record amounts of dividends back to shareholders recently, showcasing a need for investors to broaden their exposure. Concept of High-Dividend ETFs As the name implies, these types of funds typically offer higher payout yields compared to the average ETF. They tend to come in all shapes and sizes, so it’s important to understand that many of these funds are outside of your investment objectives. For example, most individual investors would not have the risk tolerance for the UBS ETRACS Monthly Pay 2X Leveraged Mortgage REIT ETN (NYSEARCA: MORL ), which has a current dividend yield of over 30% and is considered one of the highest yielding ETFs out there unless they were looking for specific exposure the real estate market. There are, however, some more general high-yield ETFs that are of interest to someone looking to mix up their investments which maintaining their overall asset allocation. For example, someone may want to have 50% of their funds invested in U.S. Equities. Instead of having that portion of your portfolio in something like the PowerShares QQQ Trust ETF (NASDAQ: QQQ ), you could split up your U.S. Equity exposure and invest some of that money in a higher yielding ETF like the Global X Super Dividend U.S. ETF (NYSEARCA: DIV ). Of course, the industry makeup of these two funds are vastly different – QQQ is highly focused in the technology sector while DIV has more exposure to Utilities and Real Estate, but this could actually prove to help with overall diversification for your investment in a particular economy like U.S. Equities. One of the reasons I have tried to increase my exposure to dividend-paying stocks and ETFs is because, according to a study by BlackRock, they have outperformed non-dividend paying companies over the long-term. As you will see below, this is the case both in bull markets and bear markets. Risks One negative view has surfaced regarding dividend ETFs recently. An article on Bloomberg showcased that for the first time ever, dividend ETFs are projected to have an outflow of capital for the year. Although there are many reasons for this phenomenon, including investors choosing to change their investment mix to other markets that may not be as much dividend-paying as growth-oriented, it is a trend that needs to be watched to ensure there isn’t significant downward pressure on the actual price of these ETFs. As always, it is important when using ETFs in your portfolio to review and understand the underlying investments (i.e. companies) that are held in the portfolio. As long as dividend-paying companies continue to perform well and corporations continue to pay and grow their dividend, there shouldn’t be any significant risk to these funds. Portfolio Strategy For an investor looking to produce some extra income, and potentially even diversify their portfolio more, high-yielding ETFs are a great product to help you achieve this goal. What I would recommend, especially at the beginning, would be to structure your portfolio in a way that only half of a given asset allocation is invested in a high-yield ETF to begin with. Similar concept to my example above, let’s say you currently have a portfolio of 30% Fixed Income, 40% U.S. Equities, and 30% International Equities. I would recommend keeping 15% of your Fixed Income investments the same and the other 15% I would find a high-yield bond ETF to keep the same exposure to fixed income, but with more income; keep in mind that, especially true with fixed income, higher yield is typically higher risk investments. Similarly, I would take 20% of your U.S. Equity allocation and invest in a high-yield U.S. Equity ETF, like DIV I mentioned above. Finally, I would take 15% of the funds I have in International Equities and find a similar type of non-North American ETF that offers a high-yield. One such example would be the FlexShares International Quality Dividend Index ETF (NYSEARCA: IQDF ). Something like the Arrow Dow Jones Global Yield ETF (NYSEARCA: GYLD ) may work as well, keeping in mind that as a “Global” ETF it would still have exposure to the U.S. market so you need to be careful to ensure your overall portfolio allocations are still intact. As always, if this type of investment is of interest to you I highly recommend speaking to a licensed financial professional to see which funds match your overall risk and return objectives. Scalper1 News
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