The Dark Side Of Payout ETFs
August 29, 2012
What’s That Dividend Really Doing?
Well, because what goes up must come down.
And with dividend ETFs, when the share price goes up, that hefty dividend yield everyone’s raving about gets less attractive each time the share prices of the underlying holdings go up. So the later you come to the party, the less of a party it will be.
Which brings up another aspect of dividend ETFs that some yield-hungry investors may be overlooking: Equities are a lot more volatile than bonds. A falling stock price could readily wipe out even the sexiest yield on a dividend.
Hypothetically, if you fast-forward several months, PEY may not be yielding nearly as much, even if for now it looks attractive next to 10-year debt.
It seems that an ETF like PEY—again, with a yield of 4.88 percent—has a bit more wiggle room than a 10-year Treasury bond, since there’s not likely to move down too much more when yield is already at 1.65 percent. That’s even more true when—accounting for inflation—that 10-year Treasury bond is actually yielding -0.64 percent. Ouch.
Ten-year government debt didn’t always yield so abysmally. The current Treasurys market is just a window of how extreme a decline in yields can get. It took a lot of buying interest to drive bond yields that far into the dirt.
Worse yet, stocks are not bonds, and thinking you could replace the income portion of your portfolio with dividend-paying stocks in an ETF wrapper just might be the height of folly.
So what’s the takeaway here?
Beware the Wall Street marketing machine, and know exactly what you’re getting into. Because when it comes to yield, while there’s no such thing as a free lunch, there is such a thing as overpaying for your meal.
At the time this article was written, the author had no positions in the securities mentioned. Contact Hannah Tool at email@example.com.