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The best dividend ETFs aren’t necessarily the ones with the highest yields. This is because extremely high yields can indicate underlying financial weakness within a business. Investors should consider other factors, such as dividend history, performance history and expense ratio. 

In this article, we explain how dividend-paying ETFs work and how to choose the best ones for you. We also provide a list of top dividend ETFs. 

What Is a Dividend ETF? 

A dividend ETF is a type of exchange-traded fund that focuses on investing in a diversified portfolio of stocks that pay dividends. The goal is to generate a stream of income for investors through the dividends paid by the companies held within the ETF. 

Dividend ETFs may hold stocks of companies with a history of consistently paying and increasing their dividends over time, or they may focus on high dividend-paying companies across various sectors and industries, such as real estate, utilities, energy and financials. 

Dividend-paying ETFs can be appealing to investors seeking a combination of income and potential long-term growth. They are particularly popular among investors who are looking for reliable income streams, such as retirees, or those who prefer a more conservative investment approach compared to growth ETFs. 

How Do Dividend ETFs Work? 

Many dividend ETFs are designed to passively track the performance of an underlying index, such the S&P 500 Dividend Aristocrats, the Dow Jones Select Dividend Index or the FTSE High Dividend Yield Index. This means that the ETF's portfolio will closely mirror the composition of the chosen index. Some dividend ETFs, such as factor ETFs, may combine elements of active and passive strategies. 

Dividend ETFs make money for shareholders through income distributions and capital appreciation: 

• Income distribution: The dividends received from the underlying stocks are collected by the ETF manager and then distributed to the ETF shareholders on a regular basis, typically quarterly or annually. 

• Capital appreciation: In addition to the dividend income, investors may also benefit from potential capital appreciation of the ETF's underlying stocks, which can contribute to overall returns. 

How to Choose Dividend ETFs: 10 Factors to Consider 

When choosing dividend ETFs, there are several key factors to consider, including dividend yield, dividend history, performance history, expense ratio, assets under management and more. Investors should consider these factors and how they align with their financial goals, risk tolerance and time horizon. 

Here are 10 factors to consider before you choose a dividend ETF: 

1. Dividend yield: The dividend yield is a crucial factor to consider, as it indicates the income you can expect to receive from the ETF's holdings. However, a higher yield doesn't always mean a better investment. Extremely high yields might be a sign of underlying issues with the companies' financial health. 

2. Dividend history: Look at the ETF's track record of dividend payments and its underlying companies' histories of consistent dividend payments. A long history of reliable dividends can be a positive indicator of a stable investment. 

3. Performance history: Review the ETF's historical performance in different market conditions. While past performance is not a guarantee of future results, it can provide insights into how the ETF has performed relative to its benchmark. 

4. Expense ratio: The expense ratio represents the annual cost of owning the ETF, expressed as a percentage of your investment. Lower expense ratios are generally preferable, as they reduce the impact of fees on your overall returns. 

5. Assets under management: Higher AUM generally translates to higher trading volume, which also indicates better liquidity, which can result in narrower bid/ask spreads and lower transaction costs. 

6. Index or strategy: Understand the index or investment strategy that the ETF is designed to track. Different strategies might focus on high-yield dividend stocks, dividend growth or other approaches. Choose the strategy that matches your investment objectives. 

7. Underlying holdings: Examine the companies held within the ETF's portfolio. Ensure they align with your investment goals and risk tolerance. A well-diversified portfolio across different sectors and industries can help mitigate risks. 

8. Issuer reputation: Consider the reputation and credibility of the ETF issuer. Established and reputable ETF issuers often have a history of managing funds effectively. 

9. Distribution frequency: Some dividend ETFs distribute dividends quarterly, while others do so annually. Choose a distribution frequency that aligns with your income needs and preferences. 

10. Investment objective and time horizon: Determine your purpose for holding the ETF, such as current income or long-term growth, and how long you plan to hold it. This, along with current economic and market conditions, will influence the risk profile of the dividend ETF that suits your needs.

10 Best Dividend ETFs for 2023 by AUM 

A good place to start researching and choosing the best dividend ETFs is with the top funds as measured by assets under management, which is a key factor in ETF selection. Investors may then dig deeper to check other metrics, such as dividend yield, expense ratio and performance history. 

List of Top Dividend ETFs by Assets Under Management

Data as of August 24, 2023, except 30-day SEC yield as of July 31, 2023.

How to Invest in Dividend ETFs in 9 Simple Steps 

Investing in dividend ETFs is relatively straightforward and follows a process similar to investing in other types of exchange-traded funds. Here's a step-by-step guide on how to invest in dividend ETFs: 

1. Educate yourself: Before you start investing, take the time to educate yourself about dividend ETFs, their benefits, risks and how they align with your investment goals. Understand the factors to consider when selecting an ETF, as previously outlined in this article. 

2. Choose an online brokerage account: To invest in ETFs, you'll need a brokerage account. Choose a reputable online brokerage that offers a wide range of ETFs with competitive commission rates and user-friendly interfaces. Examples of popular online brokerages include Vanguard, Fidelity, Charles Schwab and E*TRADE. 

3. Open an account: Follow the brokerage's account opening process. This typically involves providing personal information, verifying your identity and funding your account. Types of investment accounts include a traditional brokerage account, a joint brokerage account or an individual retirement account (IRA). 

4. Research ETFs: Once your account is set up, you can use an ETF screener and search for dividend ETFs that match your investment criteria. You can filter by factors such as performance history, expense ratio and assets under management. You may then analyze other data, such as yield and trading volume.  

5. Select ETFs: Choose one or more dividend ETFs that align with your investment goals and risk tolerance. Consider factors like dividend yield, dividend history, sector allocation and overall investment strategy. 

6. Choose to receive income or reinvest dividends: Choose whether you want to receive dividends in the form of a cash payment or if you want to automatically reinvest dividends. This means that the dividends you receive from the ETF are used to purchase additional shares, compounding your investment over time. 

7. Place an order: Once you've selected the ETFs you want to invest in, place an order through your brokerage's trading platform. You can place a market order (buy at the current market price) or a limit order (set a specific price at which you're willing to buy). 

8. Consider dollar-cost averaging: If you're uncertain about market timing, consider using a strategy called dollar-cost averaging. This involves investing a fixed amount of money at regular intervals (e.g., monthly) regardless of market conditions, potentially reducing the impact of market volatility. 

9. Monitor your investments: After you've invested, regularly monitor the performance of your dividend ETFs and the companies within their portfolios. Review your investment strategy periodically to ensure it still aligns with your financial goals. 

Bottom Line on Investing in a Dividend ETF 

It's important to note that while dividend ETFs can provide income and diversification benefits, they are not risk-free. The value of the ETF can still fluctuate based on economic and market conditions, and there's no guarantee that companies will continue to pay dividends in the future. It's important to do thorough research, diversify your portfolio, and consider your risk tolerance and time horizon before making investment decisions.  

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