Years ago, people would categorize themselves as either “growth” or “income” investors. The latter group typically consisted of people who were either retired or independently wealthy.
Today the lines are a little fuzzier …
Many younger investors like to see cash flowing into their portfolios regularly as they wait on long-term profits, while retired folks want inflation-beating growth potential on top of steady dividends.
Can you have it both ways? You can certainly try — with a good chance of succeeding, too! And the new world of exchange-traded funds (ETFs) makes your job a whole lot easier.
Today I’m going to talk about a sector with a long history of generating both capital gains and current income: Utilities.
My Money and Markets colleague Nilus Mattive recently listed the utilities sector as one of his top picks for dividends. And I think he is right on.
So why is the utilities sector so attractive right now?
I’m sure you’ll agree that we are in uncharted economic waters. Investors are nervous about the future. Many care more about the return of their investment than the return on their investment.
When people are forced to prioritize their spending, they cut out the luxuries first. Hence non-luxury sectors like health care, utilities, and consumer staples have long been considered “defensive” investments. On a relative basis, they tend to do better than other sectors during economic downturns.
Utility companies provide electricity, natural gas, water, and other services that are essential to modern life. Moreover, the complex infrastructure necessary to deliver these services means they usually have little competition. The result: Healthy profit margins, in good times or bad.
On the other hand, utility stocks are still stocks. They get caught up in market turbulence along with other sectors. That’s why I prefer …
Growth & Income in One Package
ETFs give you diversification as well as convenience — usually for a very reasonable cost. And here is a quick rundown of some utilities sector ETFs you may want to consider:
- SPDR Utilities (XLU) is the granddaddy of all ETFs in this sector. Not only is it the oldest with inception in 1998, it’s also the largest by far. XLU had assets of more than $3 billion as of the most recent quarter end. XLU is a large-cap fund; essentially, it is the utilities portion of the S&P 500. That means it is well-known and very liquid.
- Vanguard Utilities (VPU) and iShares Dow Jones U.S. Utilities (IDU) are two more name-brand ETFs covering this sector. Both are much smaller than XLU, in terms of both size and trading volume. They are still decent funds, though, if you are looking for diversified, domestic utilities exposure.
- PowerShares S&P SmallCap Utilities (XLUS) is a new ETF, only a few months old. As the name suggests, it specializes in the small-cap corner of the utilities sectors. This is a good niche — many of these companies could become takeover targets as the industry consolidates.
- iShares S&P Global Utilities (JXI) is one-stop shopping for utilities stocks from around the world. Almost 60 percent of the portfolio is based outside the U.S., including Japan, the United Kingdom, Germany, Hong Kong, Brazil, and more. This global exposure only adds to the sector’s appeal, in my opinion.
- WisdomTree International Utilities (DBU) and SPDR S&P International Utilities (IPU) both exclude the U.S. and dedicate substantially all their assets to foreign stocks. Does this make them riskier? Yes, but the return potential is higher, too, especially if the U.S. dollar loses value against other currencies.
The estimated yield on utilities ETFs currently runs in the 3 percent to 5 percent range — not bad considering long-term Treasury bonds are yielding 3 percent or less.
When you look at total return (capital gains plus dividends), most utilities ETFs have nicely outperformed the broad market benchmarks over the last few years. And if the economy remains weak, which I think it will, look for the ETFs I’ve just named to keep outperforming nicely.
P.S. You can find a handy listing of all sector ETFs, including utilities, in my new ETF Shopper’s Handbook. Inside, you’ll discover a wealth of useful data including trading volume, liquidity, yield and more for 1,000+ ETFs and ETNs. You can get the ETF Shopper’s Handbook — FREE — when you order my ETF Field Guide. Click here for more information.