The best dividend growth ETF to invest $1,000 in right now

Looking for income? Veteran investors know that dividend stocks offer something that bonds simply cannot. This is income growth that at least keeps pace with inflation. And given enough time, most of these names will also offer respectable capital appreciation.

The question is what actions? Investors may also wonder if an exchange-traded fund would be an easier and better choice because it allows them to own a basket of stocks. An ETF would really be a better choice for most people starting out with less experience and a relatively small amount of money, say $1,000. But which fund?

Spoiler alert (partial): Investors’ favorite ETF Vanguard Dividend Appreciation (VIG 0.84%) i didn’t make my list and neither did he ETF ProShares S&P 500 Dividend Aristocrats (NOBLE 0.79%).

Don’t misread the message and don’t panic if you already own the Vanguard fund in question! Don’t face financial ruin by owning the world’s most popular dividend growth ETF. Ditto for the ProShares exchange-traded fund I mentioned above.

However, there is a case to buy instead iShares Core Dividend Growth ETF (DGRO 0.78%)which gives investors a piece of some smaller companies with higher growth potential without adding too much risk of poor dividend growth that you might normally expect from such stocks.

Similar, but quite differenth

Contrary to common assumption, not all ETFs in the same category are built the same. The aforementioned Vanguard Dividend Appreciation ETF mirrors the S&P US Dividend Growers Index, for example. This is a basket of stocks of companies that have increased their dividend payments every year for at least 10 years, excluding the 25% of these names with the highest yields, in an attempt to remove yield traps that have a high return due to a decline in share price. This index also largely excludes real estate investment trusts — or REITs — which are large income-producing investments in their own right, but also very different from conventional stocks.

The ProShares S&P 500 Dividend Aristocrats ETF reflects the collective performance of all Dividend Aristocrats® in the market. (The term Dividend Aristocrats® is a registered trademark of Standard & Poor’s Financial Services LLC.) They are constituents of the S&P 500 with a track record of no less than 25 uninterrupted years of annual payout increases, although most have increased their payouts by much longer. .

So how is the iShares Core Dividend Growth ETF different from any of these other options? First, it is based on the Morningstar US Dividend Growth Index.

Although superficially similar to the S&P US Dividend Growers Index, the Morningstar Index is different in several key ways. Inclusion in this index requires only five consecutive years of annual dividend growth, but also a dividend payout ratio of Less over 75%. The thinking is that companies should invest enough of their earnings to support continued earnings growth. If they pass on more than three-quarters of their bottom line to shareholders, there may not be enough reinvestment in the business to sustain the profit growth needed to support rising dividend payouts, it believes.

It’s worth adding that Morningstar’s Dividend Grower Index is not limited to large-cap stocks, as the S&P US Dividend Growers Index effectively is and as the Dividend Aristocrat® formally requires.

It also includes smaller companies with higher growth. This is always a plus for investors, but especially now. If we’re headed for a period of lethargic economic growth in the shadow of pending rate cuts, these smaller names could fare much better than larger companies. You see, smaller, more nimble companies are generally better equipped to navigate challenging and turbulent environments. They are particularly well-positioned to perform right now, after years of lagging behind large-cap tech names.

And the small differences between these seemingly similar ETFs already have a big impact on their performance.

The things that matter

These can be any exchange-traded funds that invest in dividend-paying stocks. Each prioritizes dividend growth. However, they are not nearly the same.

One of these differences is their yield, although the difference is not a huge one.

DGRO dividend yield data by YCharts

The trailing dividend yields of all three of these ETFs are pretty close, ranging from 1.7% to 2.2% as I write this. So there is no runaway winner based on yield.

Investors will want to look deeper into the stocks the funds hold.

These exchange-traded funds have different rules and end up with very, very different holdings. The top positions of the Dividend Aristocrats® ETF right now are The Clorox Company, Stanley Black & Deckerand a company called Kenvuewhich separated a year ago from Johnson & Johnson.

The Vanguard Dividend Appreciation ETF’s largest market-cap-weighted holdings are currently Apple, Broadcomand Microsoft. This underlying index is clearly overweighted with tech names that have driven the market higher over the past few years!

The main constituents of the iShares Core Dividend Growth ETF? JPMorganJohnson & Johnson and drug manufacturer Abbviealthough the notable differences don’t stop there.

The iShares fund holds a lot of small caps that the other two ETFs simply don’t.

That’s how this particular fund offers about the same return (or more) as any of the other ETFs, while offering the potential for greater value-based capital appreciation. As noted above, given enough time, small-cap stocks can and do frequently outperform larger-cap stocks, increasing the net gains of this fund’s stocks. This ultimately translates into a chance for a better overall net return than with either alternative.

VIG Total Return Level data by YCharts

Don’t sell the others, but DGRO is the litter choice right now

Nothing stays the same. The economic context and market environment change in ways that favor certain types of actions over others. Companies may come and go. Investors’ goals are also changing. Maybe you’d prefer to collect a little more income right now in exchange for a little less satisfactory price appreciation. The nickels and dimes add up.

If your goal is to strike a reasonable balance between solid dividend growth right from the start — with better-than-average stocks capable of outperforming blue chips with longer-lived dividend pedigrees — an ETF based on Morningstar US Slightly less demanding dividend. The growth index is actually the smarter move.

Again, though, don’t panic if you own one of the other two funds discussed here. Both are also solid dividend growth ETFs and certainly worth sticking with for now if trading them would also create an unwanted, taxable capital gain.