These 4 dividend ETFs are a retiree’s best friend

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In today’s environment of low interest rates, retirees seeking income from their investments are increasingly turning to stock dividends. This can be dangerous, as dividends are never guaranteed payments, and dividends that are too high often end up becoming yield traps where income eventually evaporates.

Because of the additional risks associated with seeking dividends for income, many retirees are turning to dividend-focused ETFs rather than individual stocks in order to spread those risks. Such a decision can more easily provide a more diversified portfolio, thereby reducing the investor’s impact of reducing a company’s dividends. With that benefit in mind, these four dividend-paying ETFs could be a retiree’s best friend in this quest for some sort of income in today’s environment.

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1. A fairly broad index of companies that have increased their dividends

The Vanguard Dividend Appreciation Index ETF (NYSEMKT: VIG) try to follow the NASDAQ US Select Dividend Achievers Index. This index is made up of companies with at least 10 years of not only payment history, but also an increase in their dividends. Dividend growth over time is an important metric, as it provides one of the few opportunities for an investor’s income growth to fight inflation.

The index (and therefore the fund) only looks at companies with a dividend growth rate of at least 10 years. With this restriction, it means that at this point the fund should only own companies that have been successful in keeping their streak alive during the COVID-19 pandemic. This bodes well for their ability to continue to generate liquidity even in times of economic uncertainty.

While the ETF’s yield of around 1.6% may be lower than most dividend aficionados would like, it still beats the S&P 500yield of the order of 1.3%. Combined with the fact that the Vanguard Dividend Appreciation Index ETF specifically searches for companies with a track record of increasing dividends, it gives investors the opportunity to see a higher stream of income which may also grow faster.

2. Dividend producers with reasonable payout ratios

The IShares Core Dividend Growth ETF (NYSEMKT: DGRO) follows the Morningstar U.S. Dividend Growth Index. The particularity of this index is that it seeks not only a history of at least five years of dividend growth, but also a dividend payout ratio equal to or less than 75% of earnings.

A payout ratio of 75% corresponds to the upper limit of the Goldilocks zone for dividend distributions. With the exception of specialty businesses like real estate investment trusts, when a company’s payout greatly exceeds this level, it can undermine the company’s flexibility when things go wrong.

As a result, the iShares Core Dividend Growth ETF potentially adds a layer of robustness that comes from seeking only the best sustained dividends among companies with decent growth histories. What’s more, with a yield of just over 2%, this ETF even manages to outperform 30-year Treasuries in terms of current payment amounts.

3. An industry long known for generating cash

Real estate has a strong history of generating money for its owners. This story is so ingrained that there is in fact a special type of corporation known as a real estate investment trust. Companies of this type can deduct their dividend payments from their corporate tax if they pay at least 90% of their income in the form of dividends to their shareholders.

So between the reputation of the industry and the advantage of the corporate structure, there is reason to ask why the Vanguard Real Estate Index ETF (NYSEMKT: VNQ) made this list? With a yield of around 2.3% and an asset base with a strong incentive to pay cash to their owners, there is good structural reason to believe that it can continue to generate a reasonable income stream.

Additionally, since real estate is often viewed as a reasonable hedge against inflation, it is possible that dividends will increase over time, helping to preserve the purchasing power of these cash flows.

4. If income matters more than growth

In many cases, higher returns are indicative of higher risk to the underlying business’s cash flow. In other cases, a higher return represents a cash cow type industry that generates a lot of cash but the growth prospects may be a bit limited. For the Global X MLP & Energy Infrastructure ETF (NYSEMKT: MLPX), investments fall largely in the latter camp.

The Global X MLP & Energy Infrastructure ETF invests primarily in mid-market energy companies such as pipelines. Even with the growth of renewables, the Energy Information Agency predicts that demand for oil and natural gas will remain strong for decades to come. Strong demand – but little growth – leads to an asset class that looks likely to generate liquidity for its shareholders.

With a yield of 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 limited long-term prospects, however, there’s good reason to believe investors won’t see much in terms of revenue growth. When it comes to investing, there is usually still no free lunch, and therefore higher current income seems like a reasonable trade-off for those less clear long-term growth prospects.

Money to cover your retirement

As an income-seeking retiree, these four dividend-focused ETFs just might become your best financial friends. Remember, dividends are never guaranteed payments. Therefore, be sure to view your dividend income as an aid in replenishing the money you spend from more secure sources, rather than the direct source of that spending money itself.

Used correctly, dividends can play a key role in your retirement funding plans. So start now and give yourself a decent chance to fund the retirement you are hoping to live.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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