Cons: Besides the potential for capital loss, these stocks generally lack diversity. Dividend-paying stocks, or funds that invest in them, tend to concentrate on a few industries that aren't known for rapid growth.
Risk: Equities can lose money, so buying dividend-rich stocks requires homework.
Exchange-Traded Funds (ETFs)How they work: ETFs have qualities of both stocks and funds. Though they comprise a basket of securities, they're traded like a stock, so prices vary throughout the day. But like mutual funds, ETFs can be include equities, bonds, commodities, currencies, derivatives, etc. ETFs are generally designed to mirror indexes, but that's not always so. Demand for ETFs is fueling rapid growth in their offerings. It's possible for inflation-leery individuals to find ETFs invested in high-growth stocks or dividend-rich equities.
Who they're good for: Relatively low management costs and tax efficiency make ETFs better for budget-minded retirees who are looking to invest a sum of money for years instead of weeks or months, and who may be seeking to diversify assets. They also offer a convenient, no-fuss alternative to individual securities because it's relatively easy to pick one off the shelf and plug it into a portfolio.
Price: Varies throughout the day. Commissions are charged with purchases and sales.
Liquidity: Very liquid. You can trade ETFs as frequently as you want, just as with stocks. You can place limit orders on them, short them, buy them on margin.
Pros: Low management costs and rich yields. Because most ETFs are not actively run by a manager, ETFs are generally cheaper than a mutual fund.
Cons: Transaction fees. Investors must pay commissions every time they trade an ETF, so they can wind up being pricy for active traders. And dividends that are reinvested in an ETF can be subject to brokerage commissions, too.
Tax efficiency: Generally, underlying assets in an ETF are pegged to an index, so they're not traded as frequently as an actively managed mutual fund. And ETFs usually don't make large capital gain distributions to investors either, keeping taxes in check.
Risk: An ETF's market price may skew widely from its net asset value. Though it's uncommon, investors need to be aware this adds a certain level of uncertainty. ETFs are often made up of a pool of assets in a narrowly defined index or in a particular sector. That concentration can increase the risk for price declines more than actively managed funds, which tend to have more diversification.