Collecting dividends from stocks is a great way to generate income without trimming a position. Exchange-traded funds (ETFs) that pay dividends can help you take your diversified income-investing game to the next level.
Sure, an ETF might not be as exciting as a hidden gem stock with market-beating potential. However, the hands-off approach of generating income from a passive investment vehicle like an ETF can be an excellent choice for folks looking for a tool to help them reach their financial goals.
Here's why these Fool.com contributors picked the Vanguard Energy ETF (NYSEMKT: VDE) , the JPMorgan Equity Premium Income ETF (NYSEMKT: JEPI) , and the SPDR S&P Dividend ETF (NYSEMKT: SDY) as three top dividend-paying ETFs for income investors to buy now.
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Managing risk and generating income from the oil patch
Daniel Foelber (Vanguard Energy ETF): The energy sector is known for its volatility and sensitivity to oil and gas prices. Whereas when investors think about safe stocks that can generate a lifetime of passive income, they probably think of stodgy consumer-facing companies like Coca-Cola or Procter & Gamble .
Yet the top holdings in the Vanguard Energy ETF are highly reliable dividend stocks. A whopping 35.6% of the ETF is invested in ExxonMobil and Chevron . ExxonMobil has 42 consecutive years of dividend raises compared to a 37-year streak for Chevron . Meaning that through all the downturns that have occurred since 1987, investors have been able to count on both companies to raise their payouts.
Besides their impressive dividend streaks, both companies have solid yields as well: 3.1% for ExxonMobil and 4.3% for Chevron. The fund as a whole yields 3.3%, which is considerably higher than the S&P 500 (SNPINDEX: ^GSPC) yield of just 1.3%.
Data by YCharts.
As for the rest of the holdings, dozens of oil and gas exploration and production companies including ConocoPhillips and EOG Resources make up 26.9% of the fund, midstream and downstream companies have a 23.6% weighting, and oil field services companies make up 10.1%. By including a diversified portfolio of 112 holdings, the fund reduces the risk of companies cutting their dividends during a downturn.
The Vanguard Energy ETF is a good buy for investors looking for an above-market yield and who are confident in the future of the oil and gas industry.
But it's worth mentioning that many companies, including ExxonMobil, Chevron, and Occidental Petroleum , are investing in low-carbon solutions like carbon capture and storage, hydrogen, biofuels, and more as a way to diversify their revenue streams and adjust for an energy transition that includes fewer fossil fuels and more renewables.
With a mere 0.1% expense ratio, the Vanguard Energy ETF is a low-cost way to get a basket of dividend-paying oil and gas stocks to power your passive income stream.
An ETF that currently yields 7%
Lee Samaha (JPMorgan Equity Premium Income ETF): There are many ways to buy into high-yield ETFs, but this fund's strategy offers something different. The reality is that every mechanical-based strategy will result in an unintentional style or sector bias.
In other words, if you are buying stocks focused on one key metric -- in this case, dividend yield -- your portfolio will likely be overweight with stocks in sectors that tend to pay high yields. Similarly, you might find yourself loading up on stocks with dividends that could prove unsustainable.
This ETF offers an equities-based strategy (giving investors upside exposure to the equities market) with a monthly distribution and a current yield of over 7%. The fund differentiates itself by allocating up to 80% of its assets to equities and up to 20% to structured products that sell out-of-the-money call options on the S&P 500.
Data by YCharts.
I've discussed the latter in more detail elsewhere; it allows the ETF to pick up premiums when the S&P 500 declines or moves to a level less than the strike price. It acts to reduce the volatility in the overall portfolio.
The crucial point is that the equity part of the portfolio isn't allocated based on dividends, allowing the asset manager to avoid the unintentional bias discussed above. For instance, the manager can invest in sectors with low dividend yield such as technology or biotech and is not compelled to buy equities in sectors with high dividend yields such as energy and utilities.
In this way, the ETF captures the upside potential of these sectors and the benefits of diversification while also delivering low-volatility returns to investors through a monthly distribution.
An excellent low-cost option for generating steady passive income
Scott Levine (SPDR S&P Dividend ETF): There's no shortage of strategies on building a well-diversified portfolio. But one tactic that is hard to deny is finding quality stocks that provide steady streams of passive income -- especially those that can last for a lifetime. For this reason, the SPDR S&P Dividend ETF, with its 2.3% yield, is an ideal option for income investors.
According to State Street, the manager of the SPDR S&P Dividend ETF, the goal of the fund is to track the performance of an index of stocks included in the S&P 1500 that have the highest dividend yields and have raised their payouts for at least 20 consecutive years. To raise a dividend, uninterrupted, for more than two decades is no small feat, so the 133 stocks included in the ETF can generally be recognized as representative of high-quality companies that have rewarding shareholders inherent in their companies' cultures.
Data by YCharts.
While consumer staples and industrials each represent 18% of the fund's holdings, it's not readily apparent by looking at the highest-weighted stocks. With a 2.6% weighting, Realty Income , a real estate investment trust (REIT), is the largest position. the utility Southern Company and energy stalwart Chevron make up the next two largest holdings with weightings of 1.9% and 1.8%, respectively.
For those who worry that they would have to pay exorbitant fees to gain access to such a high-quality income investment, their fears should be assuaged by the fact that the ETF has a modest expense ratio of 0.35%.
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Daniel Foelber has no position in any of the stocks mentioned. Lee Samaha has no position in any of the stocks mentioned. Scott Levine has positions in Realty Income. The Motley Fool has positions in and recommends Chevron, EOG Resources, and Realty Income. The Motley Fool recommends Occidental Petroleum. The Motley Fool has a disclosure policy .
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