5 Dirt-Cheap Index Funds That Invest in Dividend Stocks

Schwab U.S. Dividend Equity

• Type: High Dividend
• Market value: $7.4 billion
• Dividend yield: 2.5%
• Expenses: 0.07%

The Schwab U.S. Dividend Equity (SCHD (opens in new tab), $51.10) is the cheapest dividend-focused ETF on the market, according to ETFdb.com data. The 0.07% expense ratio means that for every $10,000, Schwab is taking just $7.

Here’s a look at the benefit of cheap index funds. Let’s say SCHD and a mutual fund charging the category average 1.05% both generated the exact same 7% annual return over a period of 30 years. That higher-priced mutual fund would return $55,461, while SCHD would’ve returned $74,540. Not only would the mutual fund gobble up more in fees ($8,961 to $698 for SCHD), but that would also drag on performance via the opportunity cost of having less to reinvest ($11,970 in opportunity cost to just $884 for SCHD).

As for the fund itself, Schwab U.S. Dividend Equity tracks the Dow Jones U.S. Dividend 100 Index, which is composed of high-yielding stocks that consistently pay out dividends and boast fundamental strength compared to peer stocks. This results in a portfolio of mostly blue-chip, large-cap stocks – “who’s who” dividend payers such as Microsoft (MSFT (opens in new tab)), Boeing (BA (opens in new tab)) and Pfizer (PFE (opens in new tab)).

That low payout ratio and sturdy holdings list help earned SCHD its place on the Kiplinger ETF 20 list of the market’s best exchange-traded funds.

Vanguard Dividend Appreciation

• Type: Dividend growth
• Market value: $27.8 billion
• Dividend yield: 1.8%
• Expenses: 0.08%
• Vanguard Dividend Appreciation (VIG (opens in new tab), $103.96) isn’t a particularly powerful yielder. In fact, at the moment, VIG delivers just a little more income than the S&P 500 (1.7%).

But high current yield isn’t really the point of Vanguard Dividend Appreciation. It’s all about dividend growth – and what dividend growth means to investors.

VIG tracks the stocks in the Nasdaq US Dividend Achievers Select Index, made up of companies that have improved their regular payouts on an annual basis for at least 10 years. Unsurprisingly, this index fund holds many of the same stocks SCHD does, such as Microsoft and Johnson & Johnson (JNJ (opens in new tab)), but the top 10 holdings include a few different faces, too, such as medical device company Medtronic (MDT (opens in new tab)) and railroad operator Union Pacific (UNP (opens in new tab)).

The case for dividend growth is twofold. For one, a focus on companies that reliably improve their payouts should lead to higher yields on initial cost over time – while VIG might pay out 1.8% today, in theory, it should pay more on an annual basis every year the fund is held. Also, many analysts and market theorists consider dividend growth to be a signal of a company’s financial health, and thus the fact that all of these companies have improved their distributions for at least a decade indicates a level of quality that other stocks don’t have.

iShares International Dividend Growth

• Type: International dividend growth
• Market value: $52.3 million
• Dividend yield: 2.4%
• Expenses: 0.22%

The iShares International Dividend Growth (IGRO (opens in new tab), $58.75) ETF subscribes to the same theory as VIG, but provides international exposure for investors who want geographic diversification, too.

IGRO is a robust portfolio of roughly 430 holdings across developed-market countries such as the United Kingdom, Canada, Switzerland and Taiwan. And like the previous funds, iShares International Dividend Growth is chock full of big blue chips such as pharma outfit Roche Holding (RHHBY (opens in new tab)), electronics conglomerate Samsung (SSNLF (opens in new tab)) and foods giant Nestle (NSRGY (opens in new tab)).

The bar to clear for dividend growth is small, at just five consecutive years to qualify for inclusion in the tracking index. However, the Morningstar Global ex-US Dividend Growth Index also requires component companies to have “a significant margin to continue growing dividends.”

The expense ratio of 0.22% is considerably cheaper than the category average 0.36%, too.

iShares Core U.S. REIT ETF

• Type: Real estate investment trust (REIT)
• Market value: $405.5 million
• Dividend yield: 3.6%
• Expenses: 0.08%

Real estate investment trusts were created by Congress in 1960 to better allow regular investors access to invest in real estate. Specifically, REITs own and operate real estate, and in exchange for certain tax benefits, they’re required to pay out at least 90% of their taxable income as dividends to shareholders. These distributions often are more generous than the average stock, making REITs a beloved source of dividend income.

The iShares Core U.S. REIT ETF (USRT (opens in new tab), $45.10) is one of the cheapest ways to invest in this space, and one of the most diversified REIT index funds as well. USRT holds nearly 160 REITs, spanning categories such as retail, residential, office, industrial, healthcare and hotels.

The fund is a little top-heavy, with large REITs such as Simon Property Group (SPG (opens in new tab), 6.3%), Prologis (PLD (opens in new tab), 4.2%) and Equinix (EQIX (opens in new tab), 4.1%) accounting for large chunks of the ETF’s performance. Still, it’s diversified enough across specialty to help mitigate at least some risk.

USRT also shows the income power of REITs, yielding 3.6% at the moment – more than double S&P 500-tracking ETFs.

Global X U.S. Preferred ETF

• Type: Preferred
• Market value: $26.5 million
• SEC yield: 5.9%*
• Expenses: 0.23%

Preferred stocks are a different breed than the areas discussed so far. The other funds have dealt in common stocks – shares that represent ownership in the company, typically come with voting rights and allow investors to partake in growth.

Preferreds, however, are viewed as hybrids, boasting features of both common stocks and bonds. On the one hand, preferred stocks do represent ownership in the company, just like a stock. However, they pay out a fixed dividend that’s more similar to bonds’ coupon payments, and they also tend to trade in a range around an initial par value, like bonds. But while they tend to not appreciate like stocks, they often pay out large dividends between 5% and 8%, giving them appeal among investors looking for income and stability.

The Global X U.S. Preferred ETF (PFFD (opens in new tab), $24.10) is the cheapest option among index funds that invest in preferred stocks. Its 0.23% expense ratio is nearly half the U.S. preferred category average. PFFD also is among the youngest preferred funds on the market, launched in September 2017 at a dirt-cheap price to undercut the established competition.

Global X’s ETF holds more than 200 preferred stocks, mostly from financial companies (75.7%) – par for the course among preferred-stock funds. Real estate (6.4%), utilities (6%) and telecoms (3.9%) are among other represented industries. And at the moment, its nearly 6% yield is a little better than popular rivals such as the iShares U.S. Preferred Stock ETF (PFF (opens in new tab)) and PowerShares Preferred Portfolio (PGX (opens in new tab)).

*SEC yield reflects the interest earned after deducting fund expenses for the most recent 30-day period and is a standard measure for bond and preferred-stock funds.