How to Buy an ETF for Dividend Stock Returns: What You Need to Know

If you want to invest, can you see results if you buy an ETF for dividend stocks as your goal? Can you purchase an ETF and expect dividend stock returns? 

Absolutely. Investing in ETFs is a great way to collect dividend returns on a regular basis and also garner other specific benefits.

Let's find out how you can buy an exchange-traded fund (ETF) with dividend returns in mind. In this article, we'll go over the definition of an ETF, how it works, how you can invest in ETFs to get returns and more. Let's get started learning more about dividend-paying ETFs.

Learn more: 8 Best Dividend Stock ETFs and How to Invest in Them

What is an ETF?

First of all, what is an exchange-traded fund (ETF)? 

An ETF is a basket of securities that intends to track an underlying index. An index tracks the performance of a group of assets. For example, it might track a list of publicly traded companies and their stock prices. Indexes help measure the performance of a group of holdings or an individual stock against overall market performance. ETFs can contain investments like stocks and bonds.

Why might you want to opt for an ETF vs. individual stocks? There are pros and cons to both.  Individual stocks are riskier but can end up offering you higher returns. ETFs are relatively low risk and provide more stable returns, though they might not be as profitable as individual stocks. Put simply, ETFs offer trading flexibility, portfolio diversification and tax benefits. 

However, it's important to note that ETF investors never outperform an index because they are designed to track the index. Individual stocks can help you earn larger returns on your investments.

How Does an ETF Work?

As soon as a fund manager puts together some funds to track, investors can buy shares of that fund to sell to investors. Investors can buy any number of shares of the "basket" being sold. It's very similar to purchasing individual stocks, only it's a more diversified type of investment.

An ETF can be traded throughout the day, very similarly to a stock and periodically, you may be able to take advantage of dividend payments for the investments that make up the index. 

What Are Dividends?

A dividend is a cash or stock payment that companies distribute to shareholders at various intervals. Companies pay out dividends based on their company's profits in order to attract investors and keep current investors interested in continuing to invest in the company. Companies can do more than pay out dividends — they can reinvest money back into their company, pay off debt or buy back stock. 

Dividend payments are usually paid monthly, quarterly or annually. You can choose to take the dividend as a cash payment or reinvest it in more shares.

How Do You Invest in ETFs for Dividend Returns?

If you think you want to invest in dividend ETFs, take a look at this quick investment guide.

Step 1: Know your financial goals.

First, know your financial goals. It's a good idea to understand your goals so you know how you want to invest. If you're not sure, consider getting help from a fiduciary financial advisor. A professional can help you learn more about your future goals — risk tolerance, investment timeline and more. Furthermore, it's a good idea to make sure you consider when you need the money. Dividend ETF investment could be a great approach if you want to tackle a long-term investing approach.

Learn more: 6 Benefits of Dividend Stocks (and 4 Downsides)

Step 2: Open an account with a broker. 

Next, you must open an account with a broker. If you already have an account, you're sitting in a good position. However, doing some quick research on some potential brokerages can help you find the right one if you don't already have one. 

How do you choose the right broker? Look at the commissions for a certain brokerage you're investigating, check for a track record of reliability, account minimums and fees for various brokerages. Don't forget to take a look at the fine print, which will outline more pricing and execution information. Finally, take a look at all the bells and whistles you'll get along with your brokerage — tools, education and features remain a very important part of your decision. You want to make sure you're getting an account that is user-friendly and that fits your specific needs.

Step 3: Do your research.

It's important to do your research before you choose the ETF(s) you want to invest in. You'll want to look at: 

• ETF past performance (though it doesn't guarantee future performance)
• Dividend history
• Expense ratios
• Commissions (most brokerages are commission-free, but it doesn't hurt to check before you buy)
• Total holdings
• Trading prices
• Diversification over many sectors (concentrating on one sector can be a mistake because if one company in a sector goes down)

When researching dividend ETFs, check out dividend yield, which is the annual dividend payment divided by the share price. This shows how much the ETF pays in relation to its stock price. 

Check out the return on equity as well, which you can do by dividing net income by shareholder’s equity — you can find this on the company’s balance sheet. You'll also want to know about a company’s debt-to-equity (D/E) ratio, which is the company's total liabilities divided by shareholders’ equity.

In addition to the research above, it's a good idea to take a look at company profit. Look for a steady or increasing profit margin, which can help dividend payments increase. A decreasing profit margin can affect future dividend payments, but not necessarily!

Understanding the company's full financials can help you assess whether you've found the right type of ETF. You may consider some of the top stocks in the ETF portfolio before you choose the right ETF for you by analyzing each one: 

• Price-to-book (P/B) ratio: The P/B ratio refers to the value of a company’s assets divided by the stock price. It's a good way to find undervalued stocks, particularly if it's lower than the current value of the assets.
• Price-to-earnings (P/E) ratio: The P/E ratio compares the market value of individual shares to the earnings per share. Higher numbers can indicate that it's an overvalued stock. Compare them to others in the same industry.
• Cash flow: Check out cash flow by looking at quarterly or annual reports and income statements to get an idea of the main companies' cash flow in an ETF. 

You may feel as if you have to drag yourself through this part, because trying to analyze the ETFs may seem incredibly nitpicky. However, it's beneficial to do all this research because it can help you feel more confident in your investment decisions and hopefully allow you to see the returns you're planning on.

Step 4: Decide on the number of shares you want and invest. 

Finally, it's ready to purchase. Navigate the trading section of your brokerage’s website. Enter the ticker symbol and enter the number of shares you want to purchase. 

Check the price of the ETF before you plan to buy a dividend stock. Check out the latest market price and understand real-time information displayed in your trading platform.

You can choose between a few different order types:

• Market order: In the case of a market order, you buy the ETF immediately at the best available price.
• Limit order: A limit order indicates that you'll buy an ETF at a specified price (or lower).
• Stop order: A stop order means you'll purchase an ETF after a specified price (the stop price) has been reached.
• Stop-limit order: Once the stop price has been reached in a stop-limit order, the trade turns into a limit order and it gets filled to the point where specified price limits can be met.

Does Investing in Dividend ETFs Make Sense for You?

Dividend ETFs can offer incredible benefits for investors, but it's not the right investment method for everyone. That said, do you think ETF investing fits your financial needs? Dividend-paying ETFs can help you grow wealth over time. Not only can you receive dividends on a quarterly, yearly or monthly basis, you may also choose to sell your ETFs later on, which might even offer a nest egg to live off during your retirement years. 

Consider meeting with a financial advisor to help consider your entire portfolio and future to make sure that dividend ETFs make sense for your portfolio, but don't get scared away from doing the research on your own. You can do a lot of research on your own and make some concrete decisions on your own. If you're a brand new investor, a robo-advisor may be able to help you make intelligent decisions based on your goals. A robo-advisor uses artificial intelligence (AI) to help you invest in the right types of ETFs for you.