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Dividend Stocks vs Dividend ETF’s – The Debate About Fees

July 03, 2013
I know it’s somewhat rare for an investor to be using both dividend stocks and ETF’s. I must be the exception then and I certainly think more should try it. It should not be a choice between the 2 but rather how much mony to invest in ETF’s you should add to complement your dividend portfolio. There are several asset classes that are important enough to be part of your portfolio (bonds, international stocks, etc) but difficult to buy outright. I’ll certainly discuss this in more details eventually.

Today though, I wanted to take on a debate that continues regarding the comparison between owning a dividend portfolio and a dividend ETF. Clearly, there are benefits and downsides to each method and some have argued that it should be a clear choice. I’d disagree 100% on that. There are some aspects that are very subjective (such as being able to select your own stocks, have more control over what type of yield and growth you’re aiming for, etc. I think those are certainly benefits of buying the stocks directly when you know what you’re looking for. I would not get too excited about those though. It’s never enough to look at yield for example. If a dividend portfolio is able to yield more than an ETF such as VIG (Vanguard Dividend Appreciation ETF), it does not make that portfolio superior. If that was all there was, we’d all jump on ETF’s such as BKLN (Bank Loans) and GII (Global Infratructure) that pay 4% or more in yields. It’s about more than yield. There is usually a tradeoff between dividend yield, price and dividend growth. Looking only at yield can often lead to issues. Owning a 4% dividend portfolio is obviously not bad but it does mean that it might have less dividend growth and price appreciation than a 2-3% portfolio.

The Fees Debate

I’ve often seen debates about the fees aspect. When you’re holding on to ETF’s, you certainly have low brokerage fees but you pay management fees through the ETF’s that can add up to 0.20% per year. The argument is that if you own a $50,000 portfolio, you’ll end up paying $100 in fees which is cheaper than the brokerage fees you might incur on your dividend portfolio. As much as I agree that ETF’s should be part of almost any portfolio, that argument is flawed. The fact is that while it’s close when you start off, as years go by, the difference becomes more significant.

If 10 years later, the portfolio is now 3 times bigger, you will basically have the same brokerage fees (same number of stocks) but those management fees in the ETF’s grow as assets increase so they would be 3 times more important. That is significant and it’s certainly a knock on ETF’s, when you compare with buying stocks.

You Do Get Additional Value Though

I’m sure you’ve seen several comparisons between active managers (that try to beat the market) and on average they fall short (way short). I’m not even talking about guys like you and I, but rather about professional money managers.

By building a dividend porfolio, you are effectively performing active management. You are trying to select which stocks will do better than the overall index or market. Odds are that you’ll fall short on that mission. It’s sad but true. By how much is hard to say. But those buying an index ETF know how far off they’ll be (more or less)… by selecting dividend stocks you are betting that you’ll do better.

I’m not saying you won’t succeed, but I do think that this part of the argument is too rarely mentioned when looking at the fees involved in the construction of an income portfolio.


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