Key Points
Higher yields often come with greater risks.
Check for a consistent history of dividend growth over the long term.
High-paying dividends tend to depend on stable economic conditions.
Exchange-traded funds (ETFs) that pay monthly dividends are gaining popularity among income-focused investors, who are drawn primarily to attractive yields ranging from 8% to 13%. As the name suggests, these ETFs distribute income monthly, providing a consistent cash flow. However, it's worth considering whether such high dividends are a mirage.
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Understanding high-yield monthly dividend ETFs
Elevated payouts are typically achieved through various investment strategies. Here are two examples:
- Preferred stocks and bonds: Some ETFs invest in preferred stocks or high-yield bonds, both of which can offer higher yields than common stocks. For example, Global X SuperDividend ETF (NYSEMKT: SDIV) invests in a diversified portfolio of high-yield stocks and real estate investment trusts (REITs) and has recently yielded 8.5% or more. With an expense ratio of around 0.58%, SDIV is an attractive option.
- Covered call writing: Covered call writing involves an investor holding a long position in an asset and selling call options on that asset. While this generates income from the option premium, it can cap upside gains if the holding's value increases dramatically.
Are high dividends sustainable?
Plenty of strong dividend-paying ETFs exist, including those that pay out monthly. Before betting on high-monthly dividend ETFs, though, it's important to be realistic about what you can expect. Here are four factors that can pull dividends down.
- Company earnings: Ultimately, companies must generate sufficient earnings to cover dividend payments, and while you can invest in companies you believe in, you can't control every challenge those companies may face. Let's say the driving force behind a company is a charismatic CEO, and that CEO dies. You can't be sure who will replace them, or whether that person's leadership style and policies will produce the same results as their predecessor's.
- Cash flow issues: Companies that rely on borrowing or selling assets to maintain high dividends may face cash flow problems. It's natural to investigate an individual company's cash flow situation before investing. It's a bit easier to overlook the cash-flow issues of a handful of companies when they're folded into an otherwise attractive ETF.
- Market conditions: Economic downturns or sector-specific challenges can negatively impact profits and lead to dividend cuts. While you may spot some potential challenges a mile away, others can sneak up on you.
- Dividend policy changes: Companies can -- and do -- alter their dividend policies based on strategic corporate decisions or financial health. This change could potentially reduce or even eliminate payouts.
The bottom line is this: Including a high-yield monthly dividend ETF in your portfolio can be a smart way to diversify. However, whether it's dividend-paying stocks, bonds, or an ETF, it's up to you to conduct thorough due diligence. In this case, due diligence means understanding the ETF's underlying strategy and associated risks and determining whether it aligns with your financial goals and risk tolerance.
Dana George has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.