Dividend-focused ETFs are tempting when you hold them up against
the insanely low yields on benchmark U.S. government debt. But that
doesn't mean dividend ETFs are a good idea.
They might not even be a better idea than buying, say, a 10-year
U.S. Treasury bond.
But first, some of the reasons why Treasurys currently look like
such a bad idea …
Ten-year U.S. Treasury notes are at historical lows. Just look
at debt slated to mature in 2022, which are yielding a positively
wimpy 1.65 percent. I don't know that I'd lend money to the federal
government for such a skimpy return.
And that explains why ETFs promising dividend yields are all the
Take the iShares High Dividend Equity Fund (NYSEArca:HDV), which
launched March 29 of last year, and currently has more than $2
billion in assets, making it one of 2011's most successful ETF
launches. With a yield of 4.13 percent, that isn't too
But HDV is just the tip of the dividend-crazed iceberg, with ETF
sponsors marketing such funds to steer investors away from the
currently not-so-tempting Treasurys market.
FlexShares recently filed paperwork laying out plans for no less
than six dividend ETFs-three focusing on the U.S., the other three
global in focus. Each trio is distinguished in terms of volatility,
an investment strategy that might as well scream, "Volatility kills
dividend yield!" I wish them well, but really?
There's no denying dividend ETFs are sporting some
mouth-watering yields-at least compared to Treasurys. For example,
the PowerShares High Yield Equity Dividend Achievers fund
(NYSEArca:PEY) is yielding 4.88 percent, the highest in its
segment, according to IndexUniverse's ETF analytics tool.
So why would I give my money to the U.S. government, when ETFs
like PEY can get me three times the yield?
What's That Dividend Really Doing?
Well, because what goes up must come down.
And with dividend ETFs, when the share price goes up, that hefty
dividend yield everyone's raving about gets less attractive each
time the share prices of the underlying holdings go up. So the
later you come to the party, the less of a party it will be.
Which brings up another aspect of dividend ETFs that some
yield-hungry investors may be overlooking:Equities are a lot more
volatile than bonds. A falling stock price could readily wipe out
even the sexiest yield on a dividend.
Hypothetically, if you fast-forward several months, PEY may not
be yielding nearly as much, even if for now it looks attractive
next to 10-year debt.
It seems that an ETF like PEY-again, with a yield of 4.88
percent-has a bit more wiggle room than a 10-year Treasury bond,
since there's not likely to move down too much more when yield is
already at 1.65 percent. That's even more true when-accounting for
inflation-that 10-year Treasury bond is actually yielding -0.64
Ten-year government debt didn't always yield so abysmally. The
current Treasurys market is just a window of how extreme a decline
in yields can get. It took a lot of buying interest to drive bond
yields that far into the dirt.
Worse yet, stocks are not bonds, and thinking you could replace
the income portion of your portfolio with dividend-paying stocks in
an ETF wrapper just might be the height of folly.
So what's the takeaway here?
Beware the Wall Street marketing machine, and know exactly what
you're getting into. Because when it comes to yield, while there's
no such thing as a free lunch, there is such a thing as overpaying
for your meal.
At the time this article was written, the author had no
positions in the securities mentioned. Contact Hannah Tool at
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