In today's low interest rate environment, retirees looking for income from their investments are increasingly looking toward stock dividends. That can be dangerous, as dividends are never guaranteed payments, and dividends that are too high often end up as yield traps where the income ultimately evaporates.
Because of the extra risks associated with looking to dividends for income, many retirees look to dividend-focused ETFs instead of individual stocks in order to spread out those risks. Such a move can more easily provide a better diversified portfolio, thus reducing the impact to the investor of any one company's dividend cut. With that benefit in mind, these four dividend ETFs could be a retiree's best friend in that quest to get some sort of income in today's environment.
1. A fairly broad index of companies that have increased their dividends
The Vanguard Dividend Appreciation Index ETF (NYSEMKT: VIG) attempts to track the NASDAQ US Select Dividend Achievers Index. That index is made up of companies with at least a 10-year history of not only paying, but of also increasing their dividends. Dividend growth over time is an important measure, as it provides one of the few opportunities for an investor's income to grow to combat inflation.
The index (and thus, the fund) only looks at companies with at least a 10-year dividend growth rate. With that restriction, it means that at this point, the fund should only hold companies that managed to keep their streaks alive during the COVID-19 pandemic. That bodes well for their ability to continue to generate cash even during uncertain economic times.
Although the ETF's yield of around 1.6% may be lower than most dividend aficionados would like, it still beats the overall S&P 500‘s yield of around 1.3%. When combined with the fact that the Vanguard Dividend Appreciation Index ETF specifically seeks out companies with a history of increasing dividends, it provides a possibility for investors to see a higher income stream that may grow faster, as well.
2. Dividend growers with reasonable payout ratios
The iShares Core Dividend Growth ETF (NYSEMKT: DGRO) follows the Morningstar US Dividend Growth Index. What's special about this index is that it not only looks for at least a five-year history of growing dividends, but also a dividend payout ratio at or below 75% of earnings.
A 75% payout ratio is about the upper limit of the Goldilocks zone of dividend payouts. Except for specialized businesses like real estate investment trusts, when a business's payout gets much above that level, it can sap the company's flexibility for when things go wrong.
As a result, the iShares Core Dividend Growth ETF potentially adds a layer of robustness that comes from seeking out only those better-supported dividends among companies with decent growth histories. In addition, with a yield just above 2%, this ETF manages to top even 30-year Treasuries in terms of current payout amounts.
3. An industry with a long reputation of generating cash
Real estate has a solid history of generating cash for its owners. That history is so entrenched that there's actually a special corporation type known as a real estate investment trust. Companies of that type can deduct their dividend payments from their corporate income taxes if they pay out at least 90% of their income in the form of dividends to their shareholders.
So between the industry reputation and the corporate structure benefit, is there any wonder why the Vanguard Real Estate Index ETF (NYSEMKT: VNQ) makes this list? With a yield of around 2.3% and an asset base that has a strong incentive to pay cash to their owners, there's good structural reason to believe it can continue to deliver a reasonable income stream.
In addition, since real estate is often considered a reasonable inflation hedge, the opportunity is there for dividends to increase over time, helping preserve the purchasing power of those cash flows.
4. If income matters more than growth
In many cases, higher yields are a signal of higher risks to the underlying business's cash flows. In other cases, a higher yield represents a cash-cow type of industry that generates a bunch of cash but whose growth prospects may be a bit limited. For the Global X MLP & Energy Infrastructure ETF (NYSEMKT: MLPX), the investments largely fall in that latter camp.
The Global X MLP & Energy Infrastructure ETF invests primarily in midstream energy companies like pipelines. Even with the growth of renewables, the Energy Information Agency projects demand for petroleum and natural gas to remain strong for decades to come. Strong demand — but not much in the way of growth — leads to an asset class that looks likely to generate cash for its shareholders.
With a yield around 6.1%, the Global X MLP & Energy Infrastructure ETF provides a higher current income stream than any of the other ETFs on this list. With long-term prospects limited, however, there's good reason to believe investors won't see much in the way of income growth. When it comes to investing, there's generally still no such thing as a free lunch, and as a result that higher current income seems like a reasonable trade-off for those less clear long-term growth prospects.
Money to help cover your retirement
As a retiree looking for income, these four dividend-focused ETFs just may become your financial best friends. Just remember that dividends are never guaranteed payments. As a result, be sure you look to your dividend income as help to replenish the cash you spend down from higher-certainty sources, rather than as the direct source of that spending cash itself.
Used properly, dividends can play a key role in your retirement funding plans. So get started now, and give yourself a decent shot at funding the retirement you hope to live.
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Chuck Saletta has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Vanguard Dividend Appreciation ETF and Vanguard REIT ETF. The Motley Fool has a disclosure policy.