A high dividend ETF can offer lower-risk, higher-return opportunities—but only if the high yield is not a danger sign

The dividend yield is the percentage you get when you divide the current yearly dividend payment by the share or unit price of an investment. It’s an indicator we pay especially close attention to when we select stocks, or ETFs, to recommend in our investment newsletters.

However, a high dividend yield—either with a stock or a dividend ETF—can be misleading in some cases.

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A high-dividend ETF can provide you with a third or more of your overall returns

ETFs trade on stock exchanges, just like stocks. The best exchange-traded funds offer well-diversified, tax-efficient portfolios with exceptionally low management fees. They are also very liquid.

Dividend stocks make cash payouts that serve as a way for companies to share the wealth they’ve accumulated. These payouts are drawn from earnings and cash flow and paid to the shareholders of the company, which includes dividend ETFs. Typically, dividends are paid quarterly, although they may be paid annually or even monthly as well.

Dividends can provide Successful Investors with as much as a third of their total return over long periods, and you can even retire on dividends.

Investors use ETFs in a variety of ways, and some investors working to create a portfolio work only with ETFs and no other type of investments.  This can also include high dividend ETFs.

A high dividend ETF: Is the yield solid or misleading?

You can’t fake a record of dividends. That’s why we place a high value on a sustained history of dividend payments. And when you’re looking for income-producing stocks or ETFs, a high dividend yield should be one of your key investment considerations.

At the same time, dividends can give you a false sense of security. That’s because many investors have a tendency to think that all investment income is almost as safe and predictable as bank interest.

The fact is that investment income can dry up suddenly. Money-losing companies are sometimes unable to keep paying a long-standing dividend, and they sometimes spring the bad news on their shareholders with little or no warning.

To expand on that: a high dividend yield may be a danger sign. It may mean insiders are selling and pushing the price down. A falling share price makes a stock’s yield go up; that’s because the denominator, the price, has dropped while the latest dividend payment, the numerator, has stayed the same. When a stock then cuts or halts its dividend, its yield collapses.

8 tips for finding and investing in the best high dividend ETFs

• Examine the current financial health of the companies in the ETF. If they are doing well, have done so consistently, and show signs of growth, these factors are indicative of stocks that will keep paying dividends.
• 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.
• How do the companies held by the ETF manage their relationships with investors? If there is a favourable relationship, and the company fits the other qualifications listed here, it may be a good dividend-paying stock for the ETF to invest in.
• Know the economic stability of constituent 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.
• Note the competition. Look for ETFs with companies that have a strong hold on a growing market and a unique product or service that reduces the competition they face.
• Know how broad the ETF is, so you can determine its volatility. The more diversified the ETF, the less volatility it may have. A sector-based ETF, like one that tracks primarily resource stocks, may be more volatile.
• Know the liquidity of the ETFs you invest in.
• Consider buying ETFs in a lump sum rather than periodic small amounts to cut down on brokerage fees.

Dividends can be a big part of your long-term investment gains

To sum up, good dividend stocks and ETFs are a valuable component of any sound Successful Investor portfolio.

If you stick with top-quality high dividend yield 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.

Note, though, that when it comes to investment safety, a long history of steady dividends is more important than a current high dividend yield.

We think very highly of stocks that have been paying dividends for five or more years. Many of these stocks will fit in well with our three-part Successful Investor philosophy.

High dividend yield ETFs can be controversial, depending on the reliability of the dividends they collect from their stock holdings. What else do you look out for when choosing from these ETFs?

How much do you count on dividends as a part of your income? Is it a nice supplement, or do you count on it as key part of your income?