The Motley Fool: ETFs can also offer dividends

Exchange- traded funds (ETFs) that focus on dividends have the same advantages over traditional mutual funds as regular ETFs, including low fees and the ability to buy and sell during the day. There’s a wide menu of dividend-friendly ETFs, but these funds aren’t all alike, and investors need to understand how they differ to determine which funds best meet their risk and return objectives.

Dividend ETFs perform differently because they track indexes from various providers. Some ETFs may be very concentrated, with little industry diversification, making them riskier investments. Financial stocks are a common holding in dividend funds, and these stocks can be extremely sensitive to shifts in inflation and interest rates. Here are three dividend-focused ETFs to consider.

The iShares Dow Jones Select Dividend (NYSE: DVY), the first dividend ETF, invests in 100 of the highest dividend-yielding securities (excluding real estate investment trusts) in the Dow Jones U.S. Total Market index. It sports a three-year annualized return of nearly 14 percent, beating the S&P 500 index, and a recent yield of 3.1 percent. Its expense ratio is a reasonable 0.40 percent.

The relatively new First Trust Morningstar Dividend Leaders (AMEX: FDL) invests in the top 100 stocks of the Morningstar Dividend Leaders index. These are the index’s highest-yielding stocks, ranked by the consistency with which they pay dividends and the ability to sustain those dividends going forward.

Also new, the State Street SPDR Dividend (AMEX: SDY) invests in the 50 highest dividend-yielding S&P Composite 1500 constituents. This index tracks stocks that have consistently increased dividends every year for at least 25 years. Investing in such long-term dividend-paying stocks reduces the risk that the fund’s holdings will cut their dividends.

Ask the Fool

Q: What are “Spiders”? — J.K., Riverside, Calif.

A: “Spiders” is a nickname for Standard & Poor’s Depositary Receipts, or SPDRs. Investors who own Spiders own proportionate amounts of all the companies in the S&P 500, such as General Electric, Microsoft, Wal-Mart and Apple. Unlike index funds, which work like traditional mutual funds, Spiders are exchange-traded funds (ETFs), structured like shares of stock. They trade on the American Stock Exchange under the symbol “SPY.”

Whereas mutual funds sometimes require minimum investments of several thousand dollars, you can buy and sell as little as one Spider share at a time — but aim to buy enough to spread the commission cost over at least several shares. Learn more at www.fool.com/etf/etf.htm and www.morningstar.com/Cover/ETF.html. We recommend Spiders and regular broad-market index funds for most, if not all, investors. They’re a simple way to own most of the stock market.

Q: If one company buys another, will the acquired company’s stock price go up or down? — P.D., Henderson, Ky.

A: It depends on the purchase price. If the firm’s current market value is around $1 billion, and it’s bought for $1.5 billion, you can expect the stock price to jump on the news. When a company is very desirable, perhaps due to its products or growth prospects, a buyer may have to outbid other interested companies. But if a firm is struggling, it might get scooped up for a song.

Meanwhile, if investors think that the acquiring company has struck a good deal, its price might also rise. But if they think that the company overpaid or won’t see a good return on its investment, the price can fall.