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These 3 Dividend ETFs Are a Retiree's Best Friend

Motley Fool - Sun Oct 30, 2022

With inflation still clocking in around 40 year highs, more retirees are looking for ways to boost their incomes. Dividends stocks look tempting, as a strong dividend-paying company can potentially boost what it offers to its shareholders faster than inflation.

The flip side, unfortunately, is that dividends are never guaranteed payments. When a company is forced to cut its dividend, its share price often drops along with it. That's a double gut punch. After all, not only do you lose the income, but you also lose a bunch of the capital that you otherwise could have used to buy other dividend paying stocks with more solid foundations.

That risk is what makes dividend-focused ETFs a worthwhile tool for your consideration. With a broad enough base of companies in the ETF, the loss of any one company's dividend won't have quite as dramatic an effect as it would have had in a more concentrated portfolio. With that in mind, these three dividend ETFs could very well turn out to be a retiree's best friend.

growing plants on rising stacks of coins.

Image source: Getty Images

No. 1: Vanguard's Dividend Appreciation ETF

In typical Vanguard style, the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) offers investors an index-like investing experience at a low overhead price. The Vanguard Dividend Appreciation ETF clocks in with a very modest 0.06% expense ratio, which means investors get the vast majority of the total returns the underlying stocks offer.

The ETF attempts to track the S&P US Dividend Growers Index. That index includes U.S.-based companies with at least 10 consecutive years of dividend increases, as they are not Real Estate Investment Trusts. Within that universe, companies can be included unless they are in the highest 25% yielding companies (15% if the company is already a member of the index).

While it may seem strange to ignore the highest-yielding companies in a dividend focused index, it actually makes sense from the perspective of investors looking for dividend growth over time. A company with too high a yield often can't generate sufficient cash to invest for its future growth. In addition, dividends that look too juicy to be true are often yield traps -- payments that are likely to get cut for being unsustainable.

With that perspective, the Vanguard Dividend Appreciation ETF's willingness to cut out the highest yielding companies gives reason to believe its payouts could be maintained or even grow over time. That's an important factor for retirees to consider when it comes to seeking out income from their portfolios.

No. 2: Vanguard's Real Estate Index ETF

Real estate has long been considered a great way to earn passive income. Investing via an ETF rather than as a direct landlord has the added advantage of being completely hands off from an investor's perspective. Of course, there's the trade-off that you are paying for the management of the real estate companies owned by the ETF. Still, when it comes to the Vanguard Real Estate Index ETF (NYSEMKT: VNQ), you're not paying much overhead above that, as the fund has a mere 0.12% expense ratio.

The Vanguard Real Estate Index ETF attempts to track the MSCI US Investable Market Real Estate 25/50 Index, which includes at equity-focused (as opposed to mortgage-focused) real estate investments. That means the ETF owns a bunch of companies that act as landlords, either to people's homes or businesses.

The big advantage of real estate in inflationary times is that many of the big costs -- notably mortgages -- tend to remain fixed, while the revenues from rents tend to increase. That gives reason to believe that many real estate-focused companies could increase their dividends in response to inflation. With its low expense ratio, investors in the Vanguard Real Estate Index ETF will probably see the vast majority of any dividend increases that the underlying companies offer.

No. 3: Vanguard's High Dividend Yield ETF

For retirees not interested in real estate but seeking out a fairly high current yield relative to the market, the Vanguard High Dividend Yield ETF (NYSEMKT: VYM) may be worth considering. With a low 0.06% expense ratio, investors get virtually all the income and other returns that the underlying companies offer their shareholders.

As for those underlying companies, the Vanguard High Dividend Yield ETF tracks the FTSE High Dividend Yield Index. That index looks for companies that pay higher yields than the market in general. In today's market, that works out to a yield of around 3.4%. While not a huge yield on a historical basis, it is about twice the S&P 500's current yield of about 1.7%.

In addition, while past performance is no guarantee of future returns, the Vanguard High Yield Dividend ETF has held up remarkably well, given the general market challenges we've seen in 2022. Year to date, it has managed a negative-4.6% total return, which holds up well when compared with a 20%-plus decline in the overall market.

Of course, that outperformance in a down market may well translate to underperformance in a rising one. After all, companies that pay high dividends tend to be slower growth ones, and as a result, they will generally not be expected to provide much in the way of capital appreciation. Still, especially in a rough market, there's nothing wrong with accepting a bit more current income in exchange for the likelihood of less in gains over time.

Get started now

If you're looking for income from your portfolio, now is a great time to check out any of these dividend-focused ETFs. While none of them can guarantee you a given income, each of them is built in ways to give you a decent likelihood of seeing a reasonable income stream from the dividend stocks they hold.

Still, to get any dividend income from your investments, you need to be a shareholder before that investment goes ex-dividend and hold on through that ex-dividend day. The sooner you invest, the better your chances of seeing that income stream get started quickly. So get started now, and get ready to watch as your dividends start arriving.

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Chuck Saletta has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Dividend Appreciation ETF, Vanguard High Dividend Yield ETF, and Vanguard Real Estate ETF. The Motley Fool has a disclosure policy.

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