Forget Dividend ETFs… This is Better

Marc Lichtenfeld By Marc Lichtenfeld
Chief Income Strategist, The Oxford Club

Dividend Investing

Ever since I became the Editor of The Ultimate Income Letter and the Investment Director for Wealthy Retirement, and especially since my book, Get Rich with Dividends, became a best seller, several people in the money management industry have approached me about creating an exchange-traded fund (ETF) based on my 10-11-12 System.

For those of you who aren’t familiar with the 10-11-12 System that I write about in the book, it’s designed to generate 11% yields or 12% average annual total returns over a 10-year period. The key component to the system is investing in stocks that raise their dividend every year.

This is a strategy an ETF struggles to recreate…

Why ETFs Can’t Deliver the Goods

As Wall Street has jumped on the dividend bandwagon, it’s come up with various ETFs and mutual funds to tantalize yield-hungry investors.

The problem is: Those opportunities don’t deliver consistently higher dividends or decent starting yields that investors need if they’re going to make real money over the long term.

For example, the Vanguard Dividend Appreciation ETF (NYSE: VIG) is supposed to track the performance of a benchmark index that measures the investment return of stocks that have a record of raising their dividends over time.

Hey, that sounds exactly like what we’re looking for, doesn’t it?

But hold your horses… The ETF only has a yield of 2.09% – which isn’t going to get any investor excited.  We need investments with a yield that’s going to outpace inflation.

So, a 2.09% dividend yield just isn’t going to cut it.

Plus, while its payout has generally increased each year, it’s all over the place quarter-to-quarter. For investors who rely on the dividend for income, that inconsistency can cause problems.

For example, in December 2011, the ETF paid a dividend of $0.33 per share.  In March 2012, it decreased to $0.27. In June it rose to $0.32.

That’s just a little too sporadic.

VIG ETF Dividend Increases


Now, let’s compare that to a Perpetual Dividend Raiser – a company that has a track record of raising its dividend every year. And let’s look at one that matches the criteria for my 10-11-12 System, Intel (Nasdaq: INTC).

Intel Dividend Increases


While VIG’s chart does move higher, it’s filled with periods of lower dividends. On the other hand, Intel has never decreased its dividend. There were some quarters where it remained flat. But it’s consistently increased year after year.

Further Failures of Dividend ETFs

The Powershares High-Yield Equity Dividend Achievers (NYSE: PEY) seeks to replicate results of the Dividend Achievers 50 Index.  A Dividend Achiever is a company with at least a 10-year track record of raising its dividends.

These companies are basically junior Dividend Aristocrats in the making (a dividend aristocrat is a company that has raised its dividend every year for 25 years).

Again, it sounds like something we as dividend investors are looking for…

But here’s the interesting conundrum: The PEY is paying the same dividend as when it first started in 2004. And the dividend is actually lower than it was as recently as December 2011.

Now you’re probably asking yourself: “How is it that an ETF made of companies that continually raise their dividends isn’t increasing its own dividend?”

It’s because of changes in the underlying Dividend Achievers index.

If a company is dropped from the index, the ETF also must remove the stock from its holdings. In the past year, the Powershares High-Yield ETF turned over 35% of its portfolio due to alterations to the index.

Of course, that can greatly impact (and reduce) the ETF’s dividend payment.

Why I’m a Dividend Zealot

So, now you can see why I’m not interested in creating an ETF. It’s just too inefficient.

I can have a greater impact advocating dividend growth here in Wealthy Retirement, as well as in other venues.

But you may be wondering why I’m such a dividend growth zealot.

Well, it’s for two reasons:

  1. For investors who reinvest dividends, the annually raised dividends turbocharge the already powerful tool of compounding.
  2. For investors relying on the income, it’s one of the only ways to stay ahead of inflation. Other than Treasury Inflation Protected Securities (TIPS), bonds aren’t going to do it, as they pay investors the same coupon every time for the life of the bond. And by the way, a 10-year TIPS is paying 1.6%.  So… Thanks, but no thanks.

When you invest in a stock like Intel, you start off with a 3.4% yield. Over the past 10 years, it’s raised its dividend an average of 25.6% per year. It’s also raised its dividend by a total of 43% in three of the last seven quarters.

But let’s be conservative and assume Intel’s dividend growth slows… For argument’s sake, let’s say the dividend growth rate is cut in half to 12.8% per year over the next 10 years.

At that rate, an investor who buys $10,000 worth of stock today and reinvests the dividend would wind up with $31,104 – assuming Intel tracks the market’s historic average… I actually think Intel will outperform the market. But remember, we’re being conservative here.

Investors that want the income today would enjoy a yield of 9.9% in 10 years. And that average annual 12.8% increase in the dividend will be more than enough to offset inflation.

I have no interest in creating a “Me too!” product for the financial industry.  I’d rather help individuals take control of and secure their retirement with a strategy that’s worked for decades.

ETFs can be cost-effective tools for gaining broad market exposure. But if you’re looking for dividend growth, the best way to do it is by owning a portfolio of Perpetual Dividend Raisers.