Vanguard ETF with high dividend yield (VYM 0.95%) has a dividend yield of 2.7%. That may not sound like a high return, but it is more than twice the average of US stocks S&P500 (^GSPC 1.10%)which yields just under 1.2%. That comparison is actually interesting in another way, and highlights the value that the Vanguard High Dividend Yield ETF offers – even if you only have $200 to invest right now.
Vanguard High Dividend Yield ETF uses a simple approach
The first thing investors need to understand about any species exchange traded fund (ETF) they buy is the investment approach. These are pooled investment products, so you essentially hire someone else to handle the investment process for you. You have to make sure you know what they are doing.
Vanguard High Dividend Yield ETF is an index-based ETF, meaning it simply mimics an index. That index is the FTSE High Dividend Yield Index.
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The FTSE High Dividend Yield Index is quite simple. The first step in creating the index is to select all dividend-paying companies on the US stock exchanges. The second step is to list all these companies in terms of returns, from highest to lowest. The third step is to include the highest yielding 50% in the index.
The index is weighted by market capitalization, so the largest stocks have the biggest impact on performance. That’s pretty easy to understand and clearly focuses investors on the highest-yielding stocks. The costs for all this amount to just under 0.06% expense ratio.
Why isn’t the Vanguard High Dividend Yield ETF’s dividend yield higher?
Some dividend investors may hesitate at this point, wondering how an ETF designed to buy the highest-yielding stocks can deliver a return that actually seems quite modest on an absolute level. The answer comes down to the number of stocks included in the portfolio.
Like the S&P 500, the Vanguard High Dividend Yield ETF holds approximately 500 stocks. While they all pay dividends, the index it tracks actually falls quite low in the yield range of all dividend-paying stocks. There is no choice, given the vast number of dividend-paying stocks.
Data through Ygraphs.
But here’s the interesting thing: Until a few very large companies started dominating the returns of the S&P 500, the Vanguard High Dividend Yield ETF tracked the market’s performance quite closely, as shown in the chart. Considering the very diversified portfolio the possession, that is not shocking. This suggests that for a dividend investor, this ETF could be replaced by the S&P 500 as a core stock investment. In fact, now might be a good time to consider a switch, given the momentum driving the S&P 500 today.
There are some metrics to consider in this regard, beyond the additional revenue you would collect. For example, the average of the S&P 500 price-earnings ratio is 28.4 times, while Vanguard High Dividend Yield ETFs is 21.2 times lower. The same goes for the price-to-book value, with the S&P 500 five times higher and the Vanguard ETF 2.9 times higher. Essentially, you get a higher return and a portfolio that looks like it has a more reasonable valuation.
Vanguard High Dividend Yield ETF has a solid dividend base
If you don’t want to go through the trouble of picking individual dividend stocks, Vanguard High Dividend Yield ETF is a good way to create a foundation on which to build your portfolio. The diversification, above-market returns and simple portfolio construction are all attractive features. But the nice thing is that you can easily layer higher-yielding, more aggressive investments on top without turning your portfolio upside down, making it a solid fundamental investment whether you have $200 or $2 million to invest.
Ruben Gregg Brouwer has no position in any of the stocks mentioned. The Motley Fool holds and recommends Vanguard Whitehall Funds-Vanguard High Dividend Yield ETF. The Motley Fool has one disclosure policy.