Dividend ETFs vs. Bond Funds: Which Is Right for Retirees

Dividend ETFs and bond funds can each play an important role in a retirement income strategy. Jack_the_sparow/Shutterstock

As investors near retirement or continue moving through their golden years, many seek regular streams of income to meet their immediate needs and hedge against inflation, as well as longevity risk. But investors still need to rely on some form of capital appreciation.

Two types of assets may provide both: dividend exchange-traded funds (ETFs) and bond funds. Each can offer investors regular income, as well as capital appreciation to strengthen their nest eggs well into multi-decade retirements.

But which is right for you? To answer that, let’s first get to know more about these funds.

What Are Dividend ETFs?

Dividend ETFs are funds that invest in a variety of dividend-paying stocks. These are companies that make regular payments to investors based on their profits. These are typically issued monthly or quarterly.

Dividend ETFs provide investors with instant diversification. They also offer retirees a regular stream of income, depending on the performance of the underlying stocks.

With that said, remember dividend ETFs are still stock funds. So they could also provide capital appreciation, provided that the underlying stock prices go up.

What Are Bond Funds?

Bond funds invest in a variety of bonds from different issuers and with different maturities. As with dividend ETFs, they offer instant diversification. And bond funds make regular payments, often monthly, based on the underlying bonds and the payment schedules of each. So payment amounts can vary over time.

But the net asset value (NAV) of bonds increases and decreases based on market conditions. So you may also enjoy capital appreciation from bond funds.

Risks

Mitigating risk is a goal for all investors, but it’s paramount for many retirees who have spent decades working hard and diligently saving.

So let’s take a look at what to watch out for when evaluating these funds.

Remember, dividend ETFs are stock funds. Therefore, they can be as volatile as other stock funds. For example, when the index that a dividend ETF is tracking falls dramatically, the share price of that fund is likely to follow suit.

And dividends aren’t guaranteed. The underlying companies in a dividend ETF can reduce their dividends or end them altogether. This is why it’s important to carefully analyze the historic distribution schedule of a dividend ETF you may be interested in.

Another factor investors need to look out for is yield. The yield of an ETF basically tells you the strength of its dividends. But an unusually high yield should raise a red flag. In some instances, struggling companies pay out high yields to attract investors.

The typical dividend ETF pays a yield of around 2 percent to 4 percent.

But while generally less volatile than stock funds, bond funds have their risks as well.

It’s important to know that interest rates and bond prices are inversely related. This opens the door to interest rate risk.

So a bond fund’s net asset value (NAV) would be likely to decline if interest rates rise.

By how much? A bond fund’s duration can help you measure how sensitive the fund would be to interest rate movements.

For instance, if interest rates increase by 1 percent, a bond or bond fund with a 5-year average duration is expected to lose about 5 percent of its value.

And the impact that interest rates have on the price of the fund’s underlying bonds will also affect the income that the fund distributes each month.

Moreover, investors should also look at credit risk. Bonds are rated to analyze the issuer’s ability to meet its obligations. This represents their creditworthiness. Agencies that designate these ratings include Moody’s and Standard & Poor’s.

Based on the underlying bonds, bond funds are typically classified as either investment-grade quality or below investment-grade quality.

Funds that invest in high-yield bonds often carry major credit risk.

Fees

Dividend ETFs and bond funds all have expense ratios, which represent their fees. The higher the expense ratio, the more that fees would cut into your returns.

So which is right for you?

The Bottom Line

Dividend ETFs and bond funds can both share a place in your retirement portfolio. Some investors blend both in a bucket strategy. This divides your retirement savings into time-based buckets based on risk ranging from low to high. Dividend ETFs and bond funds may fit well in the intermediate bucket, which aims for moderate growth and limited risk to support years three to seven in retirement.

But despite instant diversification, you need to do your due diligence when picking the right funds for your portfolio.

To help, here are some dividend ETFs and bond funds that have historically stood out for factors like performance, low fees, and diversification.

• Schwab U.S. Dividend Equity ETF (SCHD)

• Vanguard High Dividend Yield ETF (VYM)

• JPMorgan Equity Premium Income ETF (JEPI)

• iShares Core Dividend Growth ETF (DGRO)

• Vanguard Total Bond Market ETF (BND)

• iShares Core U.S. Aggregate Bond ETF (AGG)

• Fidelity Total Bond ETF (FBND)

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