Those who are looking to invest in an income-producing asset would do well to look into the realm of dividend ETFs. An ETF is an exchange traded fund, which is a financial instrument that is much like a mutual fund in that it is a basket of stocks that fall within a given investment category.
ETFs are unlike mutual funds in that they are openly traded on exchanges and are a bit more liquid.
Dividend ETFs are intended to provide an income stream for those who choose to invest in them. These ETFs tend to follow a dividend index or another strategy that is based upon dividend income. One option would be related to dividend yield.
These ETFs would search for higher yields so that investors are able to get more income today. There are also funds that are tied to dividend growth. The intention of a dividend growth strategy is to have income that grows over time.
Dividend growth stocks tend to increase their dividend payout on an annual basis. Many times, this is at the expense of current yield and dividend income. The hope with this strategy is that dividend income will grow enough to exceed inflation.
The dividend income can take one of two tracks. Many dividend ETFs will pay cash directly into your brokerage account. You could then withdraw these funds to pay for living expenses, a vacation or just about anything else you need or want to spend money on.
The other option that is sometimes available is the reinvestment of dividends. Some brokerages will allow for automatic reinvestment, which allows the holder of the ETF to periodically buy additional shares at the current market value.
Other brokerages will allow account holders to pool dividends for a future purchase of another security. Some dividend ETFs will pay out on a quarterly basis, while others will pay out every month.
The tax rate that a dividend ETF will incur can vary based upon a few factors. Qualified dividend income for those who are in the 10 or 15 percent tax bracket are currently not subject to the federal income tax.
Any dividend ETFs that are held in a sheltered retirement account are likewise not taxed until they are withdrawn, usually after the age of 59.5. Unqualified dividend income does not receive the same level of beneficial tax treatment.
There are some possible negative impacts that can come with investing in dividend ETFs. The economy tends to run in cycles, and when a cycle hits a downturn in a given industry, dividend cuts can happen.
Occasionally, a company will suspend its dividend altogether. This will hurt the revenue stream that dividend ETFs are supposed to provide for investors.
Additionally, there is the possibility that dividend payments will lag behind the annual inflation rate. This circumstance would lead to decreased purchasing power over time.
When it comes to spreading your investment dollars across a range of companies that pay dividends, one of the best options is a dividend ETF. These financial instruments can provide the income that you need to improve your standard of living.
If the ETF invests in companies that grow their dividends, the income is likely to grow in excess of the rate of inflation over time.