Inflation Is Red Hot. How to Protect Your Portfolio and Grow Income.

Before that upgrade, says Jared Woodard of BofA Global Research, the research committee wasn’t down on dividends but thought “there were better places to put new capital to work.”

“Today, we’re in a mid-to-late cycle moment, the Federal Reserve may be hiking interest rates, [and] we may see inflation sticking around longer than people thought,” says Woodard, who leads the research committee. “A growth stock, for example, is just not your friend in a period of high inflation and rising interest rates.”

In a Jan. 11 research note, Woodard wrote that “dividend growth has consistently outpaced inflation since 1950,” even during times when inflation spiked, as it did in the 1970s and into the 1980s.

“With a dividend ETF,” he says, “you’ll get paid, and your dividends can grow over time and outpace inflation.”

Separate from BofA’s call, Barron’s had

Morningstar

compile a list of these ETFs, and in the accompanying table, we included the 10 biggest ones by assets under management as of Dec. 31.

Based on the net inflows for these funds, investors have taken a shine to dividend ETFs at the right time. Dividend ETFs last year had estimated net inflows of nearly $49 billion, up from about $8 billion a year earlier, according to Morningstar.

The $31 billion

Schwab US Dividend Equity
ETF (ticker: SCHD) raked in nearly $10 billion of cash on a net basis last year, more than any other dividend ETF, according to Morningstar. All of the funds listed in the table had net inflows last year, though to varying degrees.

Although there are plenty of dividend ETFs to choose from, investors need to do their homework.

“First and foremost, it’s important to realize that no two dividend ETFs are created alike,” says Ben Johnson, director of global ETF research at Morningstar. “It’s really important to dig into the details, specifically the details outlined in these funds’ index methodologies.”

Among the things that investors should examine, says Johnson, are the pool of stocks a fund draws from, how those stocks are selected from that pool, how the holdings are weighted, and how an index is rebalanced.

Nevertheless, rising dividends have traditionally been a sound hedge against inflation, and dividend ETFs, with their relatively low expense ratios, can make sense.

S&P 500 index
dividends per share and earnings per share have moved together historically, with the former up 7.7% a year on average and the latter up 6.9% since 1946, according to BofA Global Research. Dividends have grown at an annual clip of 5.6% since 1950, ahead of 3.5% for inflation.

Broadly speaking, dividend ETFs tend to fall into two categories: those that look for higher-yielding stocks and those that emphasize stocks with dividend growth.

Among the largest dividend ETFs, “investors have generally shown a preference for growers—for those ETFs that look to own stocks that have a history of paying and growing their dividends and are likely to continue to do so,” says Johnson.

With assets of about $70 billion as of Dec. 31, the

Vanguard Dividend Appreciation
ETF (VIG) is the largest fund in this group. It aims to track the performance of the S&P Dividend Growers Index.

The fund’s top holdings at the end of 2021 included

Microsoft

(MSFT), which sports a relatively low yield of 0.8% but has increased its dividend at about a double-digit clip in recent years;

UnitedHealth Group

(UNH), which yields 1.2%;

Johnson & Johnson

(JNJ), 2.5%; and

Home Depot

(HD), 1.8%. UnitedHealth and Home Depot put through double-digit dividend increases last year, as well, while Johnson & Johnson’s was about 5%.

In contrast, the

Vanguard High Dividend Yield
ETF (VYM) seeks to track the FTSE High Dividend Yield Index. It consists of stocks “that pay dividends that generally are higher than average,” according to the fund’s summary prospectus, but it does try to mitigate the inherent risk of higher-yielding stocks in part by looking for higher-quality companies.

The fund’s 12-month yield is 2.78%, considerably higher than 1.67% for the Vanguard Dividend Appreciation ETF, according to Morningstar. Although these two Vanguard funds take a different approach, there was some overlap in their recent top holdings, including

JPMorgan Chase

(JPM), Home Depot, and Johnson & Johnson.

Woodard points out that sector weightings can vary markedly among these ETFs. For example, the Schwab US Dividend Equity ETF’s biggest sector weightings were financials and information technology, both at more than 20% as of Dec. 31. In contrast, the

SPDR S&P Dividend

ETF’s (SDY) lowest weighting was technology, at 3%; the largest were consumer staples (16.43%) followed by industrials (15.21%).

The dividend ETF strategy isn’t foolproof. BofA cites the possibility of companies holding on to their “cash buffers amid rising uncertainty around Covid, persistent inflationary pressure, and the impact of the Fed hikes on the growth outlook” as possible headwinds.

Still, these funds can make a lot of sense in this environment, says Woodard, while reminding investors to do their due diligence: “It’s really worth looking under the hood.”

Write to Lawrence C. Strauss at [email protected]