Perhaps the most important elements to dividend investing are identifying the companies that shown lengthy commitments to paying dividends and the ability to continually sustain and grow those payouts.
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Historical data indicate that while dividend stocks outperform over long holding periods, dividend growth stocks really outperform, particularly when investors reinvest those payouts. Plenty of exchange traded funds are dedicated to dividend consistency and growth in some form, including the SPDR S&P Dividend ETF (SDY).
SDY is one of the four largest U.S. dividend ETFs with over $13 billion in assets under management. More important than that superficial metric is what SDY attempts to do and how it does it. SDY aims to deliver steadily rising dividends by tracking the S&P High Yield Dividend Aristocrats Index, which mandates member firms have dividend increase streaks of at least 20 years.
Although SDY tracks a high-yield index, the ETF's dividend yield of 2.47 percent certainly does not qualify as alarming. Plus, focusing solely on yield can spell trouble for dividend investors.
Investors may be drawn to high dividend yields, but its important to remember there is no guarantee that those yields will be sustained in todays volatile environment. Last year nearly 500 US firms cut their dividends, approaching the number of firms who made cuts in 2008, the year that the US economy fell in to a deep recession. This year, the cuts keep coming. In February, ConocoPhillips cut its dividend payment by two-thirds as the fall in oil prices had a material effect on its cash flow from operations, said State Street Vice President David Mazza in a recent note.
SDY allocates just 3.1 percent of its weight to energy stocks, insulating the ETF from that sector's negative dividend actions. On the high-yield sector front, utilities and telecom names combine for just 17 percent of SDY's lineup.
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Another critical element with dividend growth stocks is that these stocks perform notably less poorly during bear markets. According to State Street data, the average drawdown for the S&P 500 during its worst 15 months is almost 7.6 percent but the average drawdown for SDY's underlying index during those months was less than 5.8 percent.
Dividend ETFs with robust exposure to rate-sensitive, income-generating asset classes and sectors, such as real estate investment trusts (REITs) and utilities have made a comeback this year. On a related note, SDY's largest sector weight is 22.6 percent to financial services. Knowing SDY's dividend increase streak requirement, that can be seen as a sign that SDY's financial names are of a higher quality ilk.
If and when the Fed decides to continue on its gradual path to rate increases, history has shown that dividend growers have performed better in a rising rate environment than their high yielding competitors, adds Mazza.
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