The best dividend ETFs can lead to high yields and add stability to your portfolio

The best dividend ETFs will practice “passive” fund management, in contrast to the “active” management that conventional mutual funds or some new ETFs provide at much higher costs.

As a result of low turnover, you won’t incur the regular capital gains taxes generated by the yearly distributions most conventional mutual funds pay out to unitholders.

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Canadian ETFs are some of the best on the market

Canadian ETFs are great way for investors to own a wide range of stocks with a single investment. Canadian exchange traded funds that hold Canadian stocks are also eligible for the Canadian dividend tax credit, although this only applies to Canadian ETFs that pay dividends.

So investors who are Canadian taxpayers, and who hold Canadian dividend ETFs, get a special bonus. Their dividends are eligible for the dividend tax credit in Canada. This dividend tax credit—which is available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.

This means that dividend income will be taxed at a lower rate than the same amount of interest income is taxed at. Investors in the highest tax bracket pay tax of around 29% on dividends, compared to 50% on interest income. At the same time, those investors in the highest tax bracket pay tax on capital gains at a rate of about 25%.

The best dividend ETF: 9 ways to find and invest in these profitable investments

1. Look for ETFs that hold companies with records of long-term success and a long history of paying dividends. These companies are the most likely to keep paying and increasing their dividends.
2. The current financial health of each company in the ETF. If a company is doing well, has done so consistently, and shows signs of growth, these factors are indicative of stocks that will keep paying a dividend.
3. Know the economic stability of countries when investing in international ETFs. It’s also worth mentioning that foreign leaders may not be your ally when it comes to passing legislation that can affect your investments.
4. How does the company manage its relationships with investors? If there is a favourable relationship, and the company fits the other qualifications listed above, it may be a good dividend-paying stock to invest in.
5. Know how broad the ETF is, so you can determine its volatility. The broader the ETF, the less volatility it may have. A sector-based ETF, like one that tracks resource stocks, may be more volatile.
6. Note the competition. Look for ETFs with companies with a strong hold on a growing market and a unique product or service that cuts its competition.
7. Know the liquidity of ETFs you invest in.
8. Determine if the ETFs you buy will include capital gains
9. Consider buying ETFs in a lump sum rather than periodic small amounts to cut down on brokerage fees.

When a high dividend yield means danger

A high dividend yield may be a danger sign. It may mean investors are selling and pushing the price down. A falling share price makes a stock’s yield goes up (because you still use the latest dividend payment as the numerator to calculate yield—but the denominator, the price, has dropped). But when a stock does cut or halt its dividend, its yield collapses—and usually so does its share price.

The best dividend ETF: High dividend paying stocks can be a big part of long-term investment gains

If you stick with top quality high dividend paying stocks, the income you earn can supply a significant percentage of your total return—as much as a third of your gains. And at the same time, dividends are more dependable than capital gains as a source of investment income.

Good dividend stocks are a valuable component of any sound investment portfolio. But note, though, that when it comes to investment safety, a long history of steady dividends is more important than a current high dividend yield.

Investing for the best dividend ETF requires a long-term mindset

Investors should take a long-term view of investing when deciding on Canadian exchange traded funds. They are units you will hold on to for a long time. Buying and selling them too quickly will generally result in minimal capital gains.

What do you consider the best dividend ETF in your portfolio? Share your thoughts with us in the comments.

This article was first published in October 2015 and is regularly updated.