Investors seeking to buy the best utilities ETFs are usually looking for income, growth, diversification, or some combination of those objectives. Utilities stocks tend to pay above-average dividends, they have good long-term returns, and they can outperform the market during times of volatility. This is why exchange-traded funds (ETFs) that invest in utilities can be useful investment tools.
What Are Utilities ETFs?
Utilities ETFs are exchange-traded funds that passively track a benchmark utilities index. Examples of businesses involved in utilities include electric companies, water utilities, gas companies, and energy traders. Large, publicly traded U.S. utilities include NextEra Energy (NEE), Duke Energy Corp. (DUK), Dominion Energy Inc., and Southern Co. (SO).
Utilities ETFs can be used as defensive holdings in a declining market, which investors now face as a result of challenging economic conditions. This is because, even in difficult times, people still need basic utilities services, such as water and electricity.
What Are the Benefits?
There are three primary benefits of investing in utilities ETFs:
- Low Expenses: Because they are passively managed, the expense ratios for ETFs in general tend to be significantly lower than actively managed mutual funds. This gives investors wanting to invest in stocks in the utilities sector a convenient, low-cost, diversified means of gaining exposure to those stocks.
- Income from Dividends: Utilities stocks customarily pay higher dividends than stocks in other sectors. This makes utilities ETFs attractive to retail, or consumer, investors, especially those in retirement, who want income from their investments.
- Diversification: Sector funds are often used as diversification tools to add exposure to a certain area of the market that an investor's portfolio may be lacking. Utilities stocks are considered to be defensive in nature because they do not typically suffer price declines as severe as aggressive stocks’ in a bear market.
What to Look for in the Best Funds
Investors seeking income will often look at the SEC Yield of utilities ETFs before buying. This yield is based on the 30-day period ending on the last day of the previous month. The yield figure reflects the dividends and interest earned during the period, after the deduction of the fund's expenses, a calculation that is required to be reported by funds to the Securities and Exchange Commission (SEC).
To find the best utilities ETFs, most investors are wise to look for a combination of yield and low expenses.
While performance is certainly a consideration, ETFs are passively managed, which means that the performance will closely mirror that of the benchmark index, making long-term returns a secondary consideration.
Best Utilities ETFs for 2020, Beyond
The best utilities ETFs will have a combination of high yield and low expenses. Also, when buying ETFs in general, it's wise to look for funds that have a long history and a large asset base. This provides a good record of the fund's ability to track its index, and the high relative assets under management (AUM) allow for greater liquidity.
With these qualities in mind, here are three of the best utilities ETFs to buy in 2020:
- Vanguard Utilities ETF (VPU): If you're looking for a solid combination of yield and low expenses, VPU is an outstanding choice. VPU tracks the MSCI US IMI Utilities Index, which consists of about 70 U.S. utilities stocks, such as NextEra Energy and Duke Energy. The current yield (as of March 31, 2020) is 3.6% and the expense ratio is 0.10%, or $10 for every $10,000 invested.
- Utilities Select Sector SPDR (XLU): With $10 billion under management, XLU is the largest ETF, as measured by assets. The target benchmark for XLU is the Utilities Select Sector Index, which includes many of the same holdings as VPU and other utilities ETFs, although a bit more concentrated at 28 holdings. The 30-day yield (as of April 2, 2020) for XLU is 3.63% and the expense ratio is 0.13%.
- Fidelity MSCI Utilities Index (FUTY): If low expenses are your priority, you'll like what you see in FUTY, which has an expense ratio of 0.08%, or $8 for every $10,000 invested. Like Vanguard's VPU, FUTY tracks the MSCI US IMI Utilities Index, which comprises 70 US utilities stocks. The 30-day yield for FUTY is 3.50% (as of March 27, 2020).
The Bottom Line
Utilities ETFs can be a smart way to add income-producing stocks to a portfolio. Although the utilities sector is considered to be defensive, and therefore desirable in a down market cycle, as well as a relatively stable growth investment, utilities ETFs may not be right for every investor. As with other concentrated funds that focus on a single sector, it's wise not to allocate all your portfolio assets to just one fund.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.