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In the past few years, interest rates in the U.S. and other developed countries have been at, or near all-time lows. In this scenario, investors seeking current income have eventually shifted their focus to dividend paying stocks.
With low yields from traditional sources of income, this trend is expected to continue in the rest of fiscal 2012 and into the future as well. This is especially true given the highly accommodative policies from the Fed and the ECB, and the high likelihood that these programs will continue for many years to come.
Dividend paying stocks also play a defensive role and provide steady and stable returns to the investor when the market is not heading in a positive direction (Can You Beat These High Dividend ETFs?). Dividend paying exchange traded funds (ETFs) can also offer this attributes while simultaneously offering investors a more spread out and thus less risky security profile.
In the ETF space, there are some products which can provide outsized returns to the income investor. This holds true especially for the products that have achieved noteworthy dividend rates.
In fact, investors will find that some ETFs have a similar profile to the S&P 500 but pay out higher rates of current income. Thanks to this, there is no shortage of choices for investors in this low rate environment that can still generate a decent level of current income (Three Excellent Dividend ETFs for Safety and Income).
Our top recommendation for the investors with low risk tolerance, seeking exposure to dividend ETFs, is the Vanguard Dividend Appreciation ETF (VIG - ETF report). Currently, the fund receives a top position and a Zacks #1 ETF Rank or ‘Strong Buy’. Thus, we expect this ETF to outperform its peers that have a similar (low) level of risk.
About Zacks ETF Rank
The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook for the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of the investors.
The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of five ranks within each risk bucket. Thus, the Zacks Rank reflects the expected return of an ETF relative to other ETFs with similar level of risk.
For investors seeking to apply this methodology to their portfolio in the U.S. dividend market, we have taken a closer look at the top ranked VIG below:
Vanguard Dividend Appreciation ETF (VIG)
Investors seeking more stability in their portfolios along with high levels of current income can invest in Vanguard Dividend Appreciation ETF. VIG tracks the performance of the Dividend Achievers Select Index which holds a total of 133 stocks.
It looks to focus on U.S. common stocks that have a history of increasing dividends for at least ten consecutive years, thereby providing steady and stable returns to the investor (Four Vanguard ETFs for Long-Term Investors).
This produces a fund that pays out a solid dividend yield of roughly 2.1% a year, a good level considering the focus of VIG. This is because VIG zeroes in on companies that are high quality dividend payers rather than those that have purely high yields.
High yielders can be considered riskier which could make them less appropriate for income starved investors that have a low risk tolerance. With that being said, investors should note that VIG’s yield is higher than the average S&P dividend yield of 1.94% meaning that it is a quality destination for income in addition to a low risk choice in the space (Three Impressive Small Cap Dividend ETFs).
With a focus on companies that have increased their payouts for ten successive years, the fund appears to be more tilted towards Consumer Discretionary (14.5%), Consumer Staples (25.6%), Industrials (21.1%) and Energy (10.2%) (Top Three Consumer Staples ETFs). These four are the only sectors in the list which receive double-digit allocation.
Large cap companies dominate the market cap holdings of the fund with a small portion relegated to mid caps and small caps. With an exposure to companies with a history of consistent dividend growth, VIG does not appear to be concentrated among its individual holdings, as the top 10 make up just 39.2% of the total asset allocated. This suggests that company-specific risk is low in the fund and the top 10 holdings don’t dominate the returns of the fund.
From an individual holdings perspective, Wal-Mart Stores Inc. and Coca-Cola Co receive equal weightings of 4.5% of the total while Pepsi Co gets the third position with 4.2% of the total. Among others, the fund does not allocate more than 3.9% to any one company, suggesting wide diversification.
This dividend ETF charges an expense ratio of 13 basis points on an annual basis making it a low cost option in the segment, while volume and AUM levels also suggest a tight bid ask spread. The product’s index also has decent valuation metrics as a whole, making VIG an interesting pick for investors looking for a top ranked dividend choice in today’s market.
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