What You Need to Know Before Investing in Exchange-Traded Funds (ETFs)
Even if you feel comfortable investing in Exchange-Traded Funds (ETFs), it’s wise to revisit the basics of how ETFs work and how they can be used.
Here are the essential things to know about ETFs before investing:
- ETFs are a hybrid between stocks and mutual funds.
- ETFs trade throughout the day like stocks, while mutual funds trade at the end of the day when the net asset value of the underlying assets can be determined.
- Like mutual funds, shareholders of ETFs do not directly own the underlying assets of the fund. Instead, they own shares of the ETF itself. This means they are buying shares of the underlying assets.
- Like index funds, ETFs are typically passively managed and track a benchmark index.
- Typically, the expense ratios of ETFs are lower than those of mutual funds.
- There is no minimum initial investment amount in ETFs, whereas mutual funds often require an initial investment of $1,000 or more.
Taxes on ETFs and Best Account Types for ETFs
One of the biggest benefits of ETFs comes from their low turnover ratio. A low turnover ratio means there is less buying and selling of the underlying assets throughout any given year. When an ETF has less turnover, the taxes are generally lower. This happens because the relatively low selling of underlying assets means there is less capital gain passed on to shareholders of the ETF.
The low capital gains make ETFs smart investments for taxable accounts. However, investors looking for the best ETFs for income should be aware of the taxes that can arise from dividends.
Note that dividends from ETFs can be taxed. This is the case even if those distributions are received in cash or reinvested to purchase more shares of the fund. Also, for tax-exempt and tax-advantaged accounts, such as IRAs or 401(k)s or insurance accounts, the dividend distributions are not taxed to the investor while held in the account. Instead, the investor will pay income tax on withdrawals during the tax year in which the distribution (withdrawal) occurs.
Tip: If you buy and hold income-generating ETFs, you may want to consider holding them in a tax-exempt account like a Traditional IRA or Roth IRA.
Best ETFs for Your Portfolio
In this list of the best ETFs for income, we include funds with a variety of objectives and styles. In other words, these funds are not always those that pay the highest dividends. For example, a high dividend fund may have a higher yield than income from stocks that offer capital appreciation, which tend to hold shares of growing dividends.
To find the best ETFs for you, you should consider the following factors: current yield (or SEC 30-day yield), expense ratio, and investment objective.
Then, without any particular order, here are the top 10 ETFs for income:
- Vanguard High Dividend Yield (VYM): This fund tracks the FTSE High Dividend Yield Index. The fund represents approximately 400 stocks that generate a high income yield. The SEC yield for VYM is 3.77%; the expense ratio is 0.06% or $6 per $10,000 invested.
- Vanguard
Dividend Appreciation (VIG): Investors looking to maintain a basket of stocks from companies with a history of increasing dividends may consider purchasing a fund like the Vanguard Dividend Appreciation Fund. This fund tracks the Nasdaq U.S. Dividend Achievers Select Index, which covers approximately 182 dividend-paying stocks. The SEC yield for VIG is 1.98%, and the expense ratio is 0.06%. - iShares Select Dividend Index (DVY): BlackRock’s DVY tracks an index that includes about 90 stocks with a record of paying dividends over the past five years. The SEC yield is approximately 4.61%, and expenses are 0.39%.
- iShares Core High Dividend (HDV): HDV provides exposure to around 75 U.S. stocks that pay dividends. According to the parent company BlackRock, all have been “screened for financial health.” The SEC yield is about 4.67%, and the expense ratio is low at 0.08%.
- Invesco Zacks Multi-Asset Income (CVY): If you don’t mind paying higher expenses for higher yields, you might like what you see in this fund. The fund tracks the Zacks Multi-Asset Index, which consists of 149 stocks. The SEC yield for CVY is around 6.43%, and the expense ratio is 0.97%.
- Invesco KBW High Dividend Yield Financial Portfolio (KBWD): This fund
Source: https://www.thebalancemoney.com/best-dividend-etfs-4139756
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