Pop quiz: What percentage of long-term stock market returns are thanks to the humble dividend? Five? 10? 20?
Try 90 percent, according to money managers BlackRock Inc .
That may explain a curious phenomenon happening with exchange-traded funds that focus on dividends. Conventional wisdom holds that in a rising interest rate environment, investors usually shed dividend stocks as they look towards fixed income instead.
But over the past year, money has continued to be sucked up by prominent funds like the Vanguard High Dividend Yield ETF (VYM), with assets of $2.7 billion, and Schwab U.S. Dividend Equity ETF (SCHD), at $1.35 billion, according to data provided by Chicago-based research shop Morningstar.
If you are a die-hard income lover, here is some free advice: Not all dividend ETFs are created equal.
"The biggest thing is to look for funds that balance quality with yield," said Adam McCullough, a passive strategies analyst at Morningstar. "You want to make sure that dividend payment is sustainable, and supported by earnings going forward."
That is because, in some cases, a juicy dividend can be a clever trap. Sometimes, the stocks with the highest yields are in real financial trouble. A tanking share price will push a yield higher, or companies will offer sky-high dividends in order to lure investors and patch over financials that are in mortal danger.
Another landmine: Rate-sensitive dividend stocks. Once interest rates rise and bonds start paying out more, investors' desire for some dividend payers (utilities, say) tends to wane, putting downward pressure on share prices. More than three-quarters of economists and analysts recently surveyed by CNBC predict that the Federal Reserve will hike rates again in December.
If you navigate correctly, you could be rewarded handsomely. That is because in a flat or down market investors tend to gravitate towards safer defensive plays like dividend stocks.
Why so? First, investors like to get paid while they wait. And second, when high-flying speculative stocks come crashing down to earth, investors take refuge in sturdier sectors with proven revenues and long dividend histories.