We explain why the SDY ETF may be right for your portfolio

Interest rates are low, making it difficult to get adequate investment income. Many investors have been turning to dividend ETFs, like the SPDR S&P Dividend ETF (SDY). This has become especially popular since the tax rates on qualified dividends were lowered.

The problem lies in the risk that must be taken to get this income. Many investors are moving from lower risk investments, such as CDs at the bank or bond funds, into stocks that pay dividends. Many do not realize the risk of these dividend ETFs.

The SDY ETF is a great example. This high quality ETF selects 50 dividend-paying stocks from the S&P 1500 Composite Index that have increased dividends for at least 20 consecutive years. The S&P 1500 Composite Index is made up of the popular S&P 500 Index, the S&P MidCap 400 Index, and the S&P SmallCap 600 Index. Unlike many competing indexes, S&P increases the quality of the stocks in this index by requiring each company to have at least four consecutive quarters of positive as-reported earnings.

What could go wrong with a portfolio of stocks that must have at least 20 years of increasing dividends and at least four quarters of positive earning?

The answer is plenty. Here is what we call a drawdown chart of the SDY ETF. This chart shows how much the ETF fell during different downturns since its inception in 2005.

Source: Zephyr StyleADVISORTM

As we can see from this chart, SDY ETF fell almost 50% from its high during the worst downturn since 2005. It fell for a total of 21 months and took another 25 months to fully recover. It took almost four years to get back what was lost.

For the investors who made it through this downturn, they continued to get paid the dividends, but we will assume that many people who switched from conservative investments to this dividend ETF did not survive the ride back to the top.

We classify SDY ETF as a rising dividend ETF because of the requirement for each company to have an increasing dividend for some period of time. You can read about our favorite rising dividend ETF in our free report. We like these types of dividend ETFs, but one issue is the low dividend yield, which is currently sitting at a relatively low 2.29%. You can imagine that any company able to increase its dividend yearly over the last 20 volatile years is going to be in demand. This high demand drives up the price, which lowers the effective dividend yield.

Successful investing is about learning the art of portfolio design. By combining funds together you can often achieve the same results with less risk.

Increase your retirement income!  Download our FREE Report, Dividend Income Builder Program PLUS MY Exclusive Dividend ETF Portfolio To Help You Retire Successfully now!

We like to combine rising dividend ETFs like SDY with Utility ETFs like the Vanguard Utility ETF (VPU). VPU does not have the growth potential of a rising dividend ETF, and suffers more during rising interest rates. However, making a simple 50% SDY and 50% VPU portfolio increases the dividend total to 3.04% while lowering the risk.

If the risk is still too high, then you can combine these two funds with a short-term bond fund like Vanguard Short-Term Bond ETF (BSV). There is a small loss in the dividend tax advantage as bond ETFs do not pay qualified dividends, but making a simple portfolio of 34% SDY, 33% VPU, and 33% BSV gets almost the same payout at 2.27%. The SDY ETF has about half of the total drawdown.

Here is the drawdown chart for all of the portfolio combinations:

Source: Zephyr StyleADVISORTM

With low interest rates, dividend ETFs are gaining popularity. With a little understanding on how to put these portfolios together, you should be able to create a portfolio that meets your needs. To learn more about the art of dividend ETF portfolio building, download our free report:

Increase your retirement income!  Download our FREE Report, Dividend Income Builder Program PLUS MY Exclusive Dividend ETF Portfolio To Help You Retire Successfully now!

Remonsy ETF Network  exists to enhance your life-long investing success by providing independent and authoritative investment advice you can trust.  Landmark academic financial studies, proprietary in-depth research and over a quarter century of real world financial advisory experience during good times and bad provide the foundation for our time-tested, proven investing guidance. And most important, we work only for you: We dont hold or manage your money. We dont earn trading commissions. And we dont take money from investment companies.