This Brilliant Dividend ETF Can Build Passive Income While You Sleep. Here's How.

Most income investors focus on the yield they can see today. This ETF follows an even smarter approach: it holds companies that pay rising dividends. As a result, the income grows on its own year after year, even while you sleep.

This brilliant ETF is the First Trust Rising Dividend Achievers ETF (NASDAQ: RDVY). Here's how it can help you build passive income and wealth while you sleep.

Image source: Getty Images.

Getting to know RDVY

The First Trust Rising Dividend Achievers ETF follows the Nasdaq U.S. Rising Dividend Achievers Index, which screens companies specifically for consistent dividend growth. The index starts with a universe of the 750 largest companies and whittles the list down based on several screens, including:

• Its dividend payments over the last 12 months must be greater than those paid in the trailing 12-month periods for the last three and five-year periods.
• It must have positive earnings per share in the most recent fiscal year that exceed its earnings per share three fiscal years ago.
• It needs to have a cash-to-debt ratio greater than 50%.
• It must have a trailing 12-month dividend payout ratio below 65%.

It then ranks these holdings and selects up to 50 for inclusion in each of the four sub-portfolios, which it reconstitutes and rebalances on a staggered schedule. The net result is a rotating portfolio of the best dividend growth stocks, currently totaling 71 holdings.

This ETF might not initially pass the screen of many income-focused investors because it currently has a low dividend yield (0.8% over the last 12 months). However, thanks to its focus on dividend growth, today's low yield should grow into a much bigger payday tomorrow.

Building your income (and wealth) while you sleep

Most income investors focus on a fund's current yield because it's the number they can see today. However, the smarter strategy is to concentrate on growth. A fund that's growing its distribution should provide more income over the long term. As a bonus, the total return should be much higher thanks to price appreciation, enabling you to grow your income and your wealth while you sleep.

For example, at RDVY's January 2014 inception, an investor would have paid $19.93 per share. They would have collected around $0.42 per share in income distributions that first year, or a roughly 2.1% yield on cost. Fast forward to this year, and they would have collected about $0.68 per share in distributions, or a 3.4% yield on their initial cost basis.

That rising income stream is only part of the story. RDVY's price is currently over $82 per share, a more than 300% increase. If an investor also reinvested their dividend income, their total annualized return would be 13.8% since the fund's inception.

While past performance doesn't guarantee similar results in the future, dividend growth stocks have a multi-decade record of delivering above-average total returns. Given its laser focus on dividend growers, RDVY should continue to deliver long-term income growth and strong total returns.

Built for growth

RDVY might not be the best ETF for those who need an income stream today. However, if you're still a long way from retirement, it's a smart fund to buy. It should pay a rising dividend while delivering strong price appreciation, growing your passive income and wealth while you sleep.

Matt DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.