These 3 ETFs will help you build a fat passive income

Passive income is something every investor who has ever looked at dividend stocks would like to achieve. ETFs, however, are often seen as a safer or easier option for many investors. But is it possible to build passive income with ETFs? The answer is: Yes. In today's article, we'll take a look at 3 stable ETFs that are delivering promising performance and paying a fat dividend to boot.

Do you prefer ETFs or stocks?

ETFs are often purchased by investors who like safety and more certainty, as picking individual stocks can be more challenging, but also riskier. After all, I understand the idea of someone putting their money into an ETF that targets hundreds to thousands of stocks, which will also create decent diversification and, in the case of the ones I've chosen, help generate passive income.

Fidelity High Dividend ETF $FDVV+0.9%

FDVV has a dividend yield of 3.83% and has paid out $1.31 per share in the past year. The dividend is paid every three months.

TheFidelity High Dividend ETF avoids the common risks of high-yield investing, making it an attractive low-cost fund that should accumulate well over the long term.

This fund takes a holistic approach to stock selection, meaning that returns tend to be measured relative to sector peers. This can create risk as fundamentally weak companies with low valuations often have attractive returns. The fund combats this by screening the 5% of firms with the highest payout ratios and incorporating payout ratio and dividend growth - signals of financial health - into stock selection. Quality plays second fiddle to yield here, but these measures protect the fund from many of the riskiest bets in the market.

Measuring return on a sector-relative basis makes sense. It facilitates cleaner comparisons between stocks and highlights sectors that are often underrepresented in dividend funds, such as technology. Normally this would dampen returns, but this fund rebalances the portfolio weighting from lower yielding sectors (such as technology) to higher yielding sectors (such as real estate) at each rebalance.

Schwab US Dividend Equity ETF $SCHD+0.1%

Dividend 3.53%

The Schwab U.S. Dividend Equity ETF creates a modified portfolio of disciplined dividend stocks weighted by market capitalization with sound fundamentals. It applies restrictions and reserves to diversify risk and limit potential turnover.

The Dow Jones U.S. Dividend 100 Index, which this fund fully replicates, contains 100 stocks that have paid dividends for at least 10 consecutive years and boast the financial health to continue their streak. Most of the top holdings are industry fixtures like PepsiCo and Pfizer. The index favors value stocks because it incorporates yield into stock selection. Selecting stocks based on yield alone can increase risk, but the fund's fundamental requirements protect it from problems.

The fund's focus on fundamentals supports a sustained yield because stocks on a solid financial footing are well positioned to continue a dividend policy. It also allows the fund to leverage a quality factor that has historically been tied to market performance. The fund's profitability metrics, such as return on invested capital, comfortably outperform the Russell 1000 Value Index

This portfolio weights stocks by market capitalization, an efficient approach that directs the market's collective view of the relative value of each stock. However, the Fund takes a modified approach, limiting the weight of each stock to 4% of the portfolio and the weight of each sector to 25%. These measures help the fund to be diversified.

SPDR S&P Dividend ETF $SDY+0.6%

SDY has a dividend yield of 2.90% and has paid out $3.28 per share in the past year. The dividend is paid every three months.

The SPDR S&P Dividend ETF invests in only the most disciplined dividend stocks in the market, creating a high-quality portfolio that safely tracks yield. This fund favors the most reliable dividend payers over those with the highest yields, but its yield-weighting approach maximizes income.

The index strategy's demanding requirement that each stock increase its annual dividend in each of the last 20 years delivers benefits. Since only consistently profitable companies check this box, this fund returns to the quality factor that has historically been tied to market-beating returns. With a portfolio of mature, well-established companies such as Johnson & Johnson $JNJ-0.3% and IBM $IBM+0.5%, the fund should hold up well during turbulent markets, but during rallies it can look sluggish when looking at growth.

The challenge to this thesis is a different perspective - that the broader market downturn is not over. While buying during bear markets can be rewarding in the long term, it can also be painful in the short term if your losses continue. No one knows when a bear market will "end," so every stock investor must be prepared for further losses. In addition, we must consider that corporations face challenges with rising labor and input costs.

Fundamentally, the diversity of the SDY is far greater compared to the S&P 500. While the S&P500 is dominated by technology and also very consumer focused, the SDY has more exposure to industrials, consumer staples, financials and utilities (high diversification). It's also worth pointing out that one of the larger components is the financials sector, which is good in a period of rising rates.

While equities rose in August on hopes that the Fed would shift to a dovish stance, the last few weeks have sidelined that outlook. In contrast, recent comments from Fed officials suggest that the rate hike cycle is far from over and hopes for a rate cut in 2023 are remote at best.

Conclusion

If I had to pick just one ETF out of these 3, I would choose $SDY+0.6%. They really take care in selecting individual stocks that have to meet their perhaps almost exacting criteria at all costs, but that is all the more good as we can be sure they are forming a quality and healthy portfolio. It may not be an ideal candidate for the next bull run, but I probably wouldn't have a problem in this challenging period. Additionally, I'm glad for the currently larger column in the financials sector, which I would welcome as I'm counting on another tough and uncompromising Fed stance and rate hikes.

Please note that this is not a financial advisory. Every investment must go through a thorough analysis.

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