The Best Global Dividend ETFs for UK Investors

The promise of regular income from your investments is an attractive one, and dividend ETFs are an easy way to achieve this. The need for a steady source of cash is heavily dependent on your personal situation – in retirement you might be living off the money generated by your investments, whereas earlier in life you will hopefully be more focussed on the growth of your portfolio.

However, there are no free lunches in investing. The balance between income potential, overall returns and the tax implications needs to be considered. Let’s get into it.

What is a Dividend?

When a company pays out dividends, it’s essentially taking a chunk of its cash reserves and handing it over to shareholders. This money isn’t conjured out of thin air; it comes from the company’s own pocket. So, when the dividends are paid, the company’s value (and thus its share price) typically drops by about the same amount as the dividend paid. It’s a bit like cutting a slice of cake – the cake (or the company’s value) is now smaller by exactly one slice.

It’s worth stressing the point that dividends are not free money. When a company distributes some of its cash to shareholders, the value of the company, and therefore its share price, falls by the corresponding amount.

So is that so different from selling some shares to create your own dividend? It is fundamentally the same thing, but with some important caveats. Whether it makes sense for you to chase dividends, or to create your own income by selling shares, is an important question we will investigate below.

How Dividend ETFs Work

Dividend ETFs specialise in holding shares of companies that pay dividends. These companies are often well-established with a history of distributing a portion of their profits back to shareholders. The ETF collects these dividends and then pays them out to its own shareholders.

There are ETFs that pay dividends, and there are ETFs that are designed to maximise the size of dividend investors are paid. It’s the latter we are interested in looking at here. Most, if not all ETFs that hold stocks will be invested in many companies that pay dividends, and these will be passed on to shareholders whether they are directly invested in the company or invested via an ETF.

Our focus in this article is on global ETFs – maximising both your geographical diversification as well as your income.

How ETF Dividends are Paid

There are two main ways a dividend ETF can handle the dividends it receives:

1. Distributing ETFs: The ETF passes these dividends directly to its investors, usually quarterly. This means if you own shares in the ETF, you get a cut of the dividends from its collection of stocks.
2. Accumulating ETFs: These ETFs automatically reinvest the dividends into more shares of the stocks within the ETF. This can help in compounding your investment over time.

The Role of the ETF Manager

Dividend ETFs are usually managed passively. This means they track a specific index of dividend-paying stocks. The ETF manager’s job is to ensure the ETF’s portfolio mirrors the components of the index. This passive management typically results in lower fees (and better performance) compared to actively managed funds.

Diversification

One of the main appeals of dividend ETFs is diversification. Instead of buying individual stocks and being exposed to the risk of any one company, you’re spreading your investment across multiple dividend-paying stocks. This can help reduce risk. This is especially true of the global dividend ETFs we explore below.

Individual stock dividends are not guaranteed, so relying on a small number of companies for your income could leave you short if one or two run into trouble. By spreading your risk around, the yield may be lower but the income will likely be more consistent.

Yield and Total Return

The attractiveness of a dividend ETF revolves around its yield, which is the ratio of annual dividends paid out relative to the ETF’s price. A yield of 2% means that you’ll receive 2% of the value of your investment annually.

But it’s not just about the current yield; you also need to pay attention to the total return, which combines the yield and any growth in the ETF’s share price. A common mistake is for investors to be beguiled by a high dividend, without noticing that the share price performance is lagging well behind the market.

Dividends vs Selling Shares

When looking at generating income from your ETF investments, there are two primary strategies: dividend investing and selling shares to create your own “dividend.” Each approach has its own set of advantages and drawbacks.

Dividend Investing

Pros:

• Steady Income Stream: Regular dividends provide a predictable income without selling your shares.
• Reinvestment Opportunities: Dividends can be reinvested to buy more shares, potentially increasing your future income.
• Long-Term Compounding: The power of compounding can significantly grow your investment over time.
• Less Taxing: If you are a lower rate tax payer, dividends are taxed at a lower rate than capital gains.

Cons:

• Tax Implications: Dividends can increase your tax burden, especially if you are a higher rate tax payer.
• Market Risk: Dividend-specific ETFs often don’t perform as well as their more general counterparts.
• Lower Growth Potential: Companies that pay high dividends may reinvest less in their own growth, potentially limiting stock price appreciation.

Selling Shares to Create Your Own Dividend

Pros:

• Control Over Cash Flow: You decide when to sell shares and how much income to generate.
• Capital Gains Tax Advantage: If held long enough, selling shares may benefit from lower long-term capital gains taxes.
• Flexibility: This method allows you to adjust your income based on personal needs.

Cons:

• Reduced Ownership: Each sale reduces your stake in the investment, potentially diminishing future growth and income.
• Market Timing Risk: Selling shares in a down market might be less than ideal.
• Complex Decision Making: Determining the best time and amount of shares to sell requires careful planning.

Which Strategy is Better?

The choice between dividend investing and selling shares for income depends on individual financial goals, tax considerations, and risk tolerance. Dividend investing is generally more suitable for those seeking a passive, steady income stream, while creating your own dividend through selling shares offers more control but requires active management and market understanding.

Both strategies can coexist in a well-rounded investment portfolio. It’s important to balance them in a way that aligns with your overall investment strategy and financial objectives.

Dividend ETFs and tax

As with regular shares, ETF dividends are taxed as income above the dividend allowance. For a more detailed look at tax, see our comprehensive guide to UK ETF tax.

UK investors tossing up between dividend investing and selling shares for income should consider the distinct tax implications of each strategy:

Dividend Investing

• Income Tax: Dividends are subject to UK Income Tax. There’s a dividend allowance, after which tax rates vary based on your income tax band.
• Tax Efficiency: For lower and basic rate taxpayers, dividend investing might be more tax-efficient due to the dividend allowance and lower tax rates on dividends compared to higher income tax bands.

Selling Shares

• Capital Gains Tax (CGT): When you sell shares, any profit above the annual exempt amount is subject to CGT.
• Tax Rate Advantage: CGT rates are generally lower than higher income tax rates. This can make selling shares a more tax-efficient option for higher-rate taxpayers.
• Allowance Utilisation: Utilizing the CGT allowance can be a strategic way to generate income, especially if your gains fall within the exempt amount.

Key Considerations

• Tax Planning: Your decision should be aligned with your overall tax planning strategy. A mix of strategy might be appropriate to take advantage of the tax-free thresholds.
• Long-term Strategy: Consider how each option fits into your long-term investment goals and whether you prefer steady income (dividends) or capital appreciation (selling shares).
• Portfolio Impact: Selling shares reduces your investment holdings, while dividends allow your portfolio to remain intact.

Vanguard FTSE All-World High Dividend Yield UCITS ETF vs. SPDR S&P Global Dividend Aristocrats UCITS ETF

When choosing between dividend ETFs, it’s important to delve into specifics, as each fund has its unique characteristics and performance history. Here’s a detailed comparison between the two biggest players for UK investors: Vanguard FTSE All-World High Dividend Yield UCITS ETF vs SPDR S&P Global Dividend Aristocrats UCITS ETF.

Vanguard FTSE All-World High Dividend Yield UCITS ETF (VHYL)

Objective and Strategy

• Index Tracked: FTSE All-World High Dividend Yield Index.
• Focus: “The Index is comprised of large and mid-sized company stocks, excluding real estate trusts, in developed and emerging markets that pay dividends that are generally higher than average.”
• Replication Method: Sampling technique, buying a selection of the most relevant index constituents​​.

Financials

• Fund Size: $3.6 billion.
• Expense Ratio: 0.29% per annum.
• Distribution Frequency: Quarterly.
• Currency Risk: Currency unhedged​​.

Performance and Yield

• 5-Year Return: +37.32%.
• Average Dividend Yield (2019-2021): Approximately 3.67%​​.

Further Reading

• Fund Website
• Key Investor Information Document

SPDR S&P Global Dividend Aristocrats UCITS ETF (GLDV)

Objective and Strategy

• Index Tracked: S&P Global Dividend Aristocrats Index.
• Focus: “The S&P Global Dividend Aristocrats Quality Income Index is designed to measure the performance of high-dividend-yielding companies within the S&P Global BMI that have followed a managed-dividends policy of increasing or maintaining dividends for at least 10 consecutive years and simultaneously have positive return on equity and cash flow from operations.“
• Replication Method: Full replication, buying all the index constituents​​.

Financials

• Fund Size: $995 million.
• Expense Ratio: 0.45% per annum.
• Distribution Frequency: Quarterly.
• Currency Risk: Currency unhedged​​.

Performance and Yield

• 5-Year Return: +13.22%.
• Average Dividend Yield (2019-2021): Approximately 4.14%​​​​.

Further Reading

• Fund Website
• Key Investor Information Document

Key Differences and Considerations

• Global Exposure: Both ETFs offer global exposure, but they track different indices.
• Expense Ratio: Vanguard’s ETF has a lower expense ratio (0.29%) compared to SPDR’s ETF (0.45%), which can impact net returns over time.
• Historical Performance: Vanguard’s ETF has shown a higher 5-year return (37.32%) compared to SPDR’s ETF (13.22%).
• Dividend Yield: While SPDR’s ETF has a higher average dividend yield, Vanguard’s ETF has exhibited stronger overall growth in the same period.

Verdict

With lower fees and a far superior overall performance, Vanguard’s dividend ETF is the clear winner here. Unless of course you are desperate for the extra 0.5% dividend yield.

How do they compare to a regular global equity ETF?

When we compare these ETFs to a bog-standard global equity ETF, you may question whether chasing dividends in this way is the best strategy. With a 5-year return of 57.06%, the Vanguard FTSE All-World UCITS ETF (VWRL) outstrips both by a considerable margin on a total return basis. It is also far cheaper, with a ongoing charge of just 0.22%.

VWRL dividends over the last few years have hovered around 1.8%, so from an income perspective you will be receiving a smaller pay packet. However, when you look at the whole picture, the total return is hard to ignore.

Again, there is no one-size-fits-all solution in investing and the decision about whether to chase dividends will be heavily dependent on your personal situation.

Conclusion

While the allure of dividends, especially from specialized ETFs, can be compelling, it is essential for UK investors to balance this against total returns. The Vanguard FTSE All-World High Dividend Yield UCITS ETF, with its lower fees and superior performance, appears to be a more advantageous choice over the SPDR S&P Global Dividend Aristocrats UCITS ETF, especially when prioritizing overall growth. However, comparing these specialized dividend ETFs with a standard global equity ETF like VWRL reveals a different perspective. VWRL’s lower dividend yield is offset by a significantly higher total return and lower fees, presenting a compelling case for investors to consider a more holistic approach to ETF investing.

Ultimately, the decision between focusing on dividend yields or broader market growth hinges on individual financial goals, tax considerations, and the stage of one’s investment journey. Balancing dividend income with capital appreciation, and understanding the tax implications of each, is crucial in crafting a strategy that aligns with one’s long-term financial objectives and personal circumstances.