This is a guest contribution written by Ben Reynolds at Sure Dividend. Sure Dividend uses The 8 Rules of Dividend Investing to build high-quality dividend growth portfolios.

Regular readers of Smart Money Today are very familiar with good ETFs over the next decade, and ETF investing in general.

Dividend investing has slowly returned to popularity. The idea that your investments should actually pay you is not new. With more and more baby boomers retiring, dividend investing’s popularity will likely continue.

Many dividend investors are looking for income now. To this end, they look for high yield dividend stocks and ETFs.

Not surprisingly, there are a wide variety of high yield dividend ETFs that meet this demand.

The number and type of ETFs focused on dividend investing has grown significantly over the last decade.

This article takes a look specifically at high dividend focused ETFs for investors looking to add greater current or future income potential to their portfolios.

High Yield Dividend ETFs

A list of the most popular (based on AUM) high dividend ETfs is below:

iShares High Dividend Equity (HDV) with a 3.5% dividend yield

PowerShares S&P 500 High Dividend (SPHD) with a 3.4% dividend yield

Vanguard High Dividend Yield (VYM) with a 3.1% dividend yield

Note: AUM stands for Assets Under Management

Total returns (including dividends) over the last 3 years for these 3 stocks are shown below. For comparison, the S&P 500 had total returns of 33.1% over the same time period:

HDV: 30.5% Total returns over the last 3 years

VYM: 32.9% Total returns over the last 3 years

SPHD: 49.7% Total returns over the last 3 years

Note: Total return data from ETF Replay

Clearly, the SPHD has performed significantly better than its peers (and the market) over the last several years. Past performance is certainly no guarantee of future success, but it is interesting to see why the ETF performed better.

Here’s how SPHD is constructed (according to its prospectus):

The highest 75 yielding stocks in the S&P 500 are found The 50 lowest volatility stocks out of these 75 are selected These 50 stocks are weighted based on their dividend yields

For comparison, the portfolio construction rules of the other 2 ETFs are shown below.

HDV’s investment style is much less transparent. Here’s a quote from the fund’s prospectus:

“The Fund seeks to track the investment results of the Morningstar® Dividend Yield Focus Index (the “Underlying Index”), which offers exposure to high quality U.S.-domiciled companies that have had strong financial health and an ability to sustain above average dividend payouts.”

Unfortunately, the exact methodology that Morningstar uses to create its Morningstar Dividend Yield Focus Index is proprietary. This means we don’t know the exact factors that go into the strategy. The strategy has not worked particularly well over the last 3 years, as it has underperformed the S&P 500 (whatever the exact strategy may be).

VYM’s stated goal is to track the performance of the FTSE High Dividend Yield Index. I could not locate the exact methodology of the FTSE High Dividend Yield Index. It appears to invest in the top 50% or so of high dividend stocks in (or around the same market cap size) the S&P 500.

Not only has SPHD outperformed significantly over the last 3 years, it is also the most transparent in its methodology. The ETF uses a very simple ranking system to find high yielding stocks. It uses volatility as a proxy for risk to weed out the ‘riskiest’ 25 of high yielding stocks in its universe. What’s left is a high yielding portfolio that at least attempts to reduce risk.

Looking at HDV’s yield, it must take a somewhat similar approach. HDV holds 79 stocks, but is far from equally weighted. HDV’s top 10 holdings account for over 50% of the ETFs total holdings by dollar value. For comparison, SPHD’s top 10 holdings hold just 27.5% of the fund’s value.

Vanguard’s VYM is very widely diversified. It holds 428 different stocks. With that said, the Top 10 holdings account for 32% of total holdings by dollar value.

Last but not least, one should consider ETF fees. The expense ratios for these 3 ETFs are listed below:

HDV has an expense ratio of 0.12%

VYM has an expense ratio of 0.09%

SPHD has an expense ratio of 0.35%

Both HDV and VYM are very cheap. SPHD is still relatively inexpensive with an expense ratio of 0.35%. To put that into perspective, every $1,000 invested in SPHD costs $3.50 a year in management fees.

Final Thoughts

When considering high dividend yield ETFs, I believe SPHD stands out due to its clear investment methodology, focus on only 50 stocks (instead of 100’s), high dividend yield, and excellent historical performance.

There is more to dividend investing than just yield; much more. For those interested in more than only high yielding dividend ETFs, see my article on the best dividend ETFs.

When evaluating dividend ETFs, there is no one factor that should be examined. Rather, a mix of information should be gathered and compared before making an investment. Several key dividend ETF investing questions to ask are below:

Is the investment methodology straightforward?

Does it match what I’m looking for?

Is the expense ratio reasonably low?

How long has the fund been around?

How big is the fund (how much AUM)?

What is the turnover ratio?

How good/bad is historical performance?

The investment methodology should line up with what you want the fund to do. As an example, don’t expect a dividend growth fund to give you high current income.

The lower the expense ratio, the better – always. Similarly, a lower turnover ratio implies greater efficiency as management does not have to continuously trade the portfolio, which will run up the expense ratio.

Larger funds that have been around a long time are likely to continue to exist. ETFs can close, forcing you to liquidate your holdings.

Looking at historical performance is not perfect. If a fund has significantly outperformed or underperformed, it’s important to have an idea why to see if the performance is likely to continue.