Since their inception in 1993, exchange-traded funds, or ETFs, have become some of the hottest assets on the stock market. Today, passive investing represents around half of all the investing that takes place in the United States.
One of the most popular managers of these funds is Vanguard, and they’ve climbed to popularity for several good reasons. Not only do their funds have a strong history of compelling performance, they’re also known for charging some of the lowest fees seen on the market today.
However, even funds created by the same manager will perform differently.
If you’re looking to generate meaningful growth and income from your investments, chances are that you’ve come across the Vanguard Dividend Appreciation ETF (VIG) and the Vanguard High Dividend Yield ETF (VYM). But which is best?
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When looking into the best ETFs for dividend investors, there are a few key features you’ll want to keep in mind. Most importantly:
- Investing Style. While dividend investing is a common style, there are different ways to go about it, which is why Vanguard offers multiple options for dividend investors. Before diving in, you’ll want to think about the methodology behind the fund’s investing style and whether it fits in with your goals.
- Cost. All investments come with a cost. For ETFs, that cost is outlined in its expense ratio, which represents annual management costs as a percentage of the investment. The higher your expenses are, the less of your earnings you’ll be able to keep, so it’s important to keep costs to a minimum.
- Historic Performance. Dividend investors are interested in income, but price appreciation is important as well. After all, what good is income if the value of your shares consistently falls? So, it’s important to consider the historic performance of the fund before making your investment.
- Dividend Income. Of course, if you’re investing in a dividend-centric fund, you’re ultimately hoping to generate income through your investments. While multiple funds may be focused on generating dividends for investors, the amount of those dividends will differ from one fund to the next. To ensure you’re getting the best deal, it’s important to look into the dividend history of the fund and compare it to others you may be interested in.
- Portfolio Composition. Finally, a solid investment portfolio is built with diversification in mind, investing in a wide range of thoughtfully chosen assets that fit in with the investment style of the fund. It’s always wise to know what those assets are and what they’ll do for your investment portfolio before you decide to buy shares in the fund.
Here’s how the VIG and VYM compare with the above factors in mind.
Both of these funds were designed to provide meaningful income while avoiding significant volatility, but how they go about doing so is completely different. Here’s the methodology behind each fund and how it will affect your returns should you decide to invest:
VIG Investing Style
The Vanguard Dividend Appreciation ETF is a dividend growth ETF that was designed to offer investors diversified exposure to domestic companies that have a long track record of increasing dividends annually, also known as dividend growth stocks.
In order to be considered for an investment by the fund, the stock must be listed on the Nasdaq US Dividend Achievers Select Index, formerly known as simply the Dividend Achievers Select Index. Companies listed on this index have a longstanding history of increasing dividend payments consistently on an annual basis over at least the past 10 consecutive years.
The basic idea behind the fund is that companies must be financially strong and consistently growing in order to consistently increase their dividends annually for a decade or more. Investing in these companies exposes your portfolio to companies with a long history of growth and a track record of sharing the fruits of their growth with their investors.
VYM Investing Style
Instead of focusing on companies that have a long history of increasing dividends, the Vanguard High Dividend Yield ETF is focused on investing in companies that have higher dividend yields than the averages for their industry.
The fund tracks the FTSE High Dividend Yield Index, which tracks the returns of stocks characterized by higher-than-average dividend yields, excluding real estate investment trusts (REITs).
There are two key differences between the way stocks are chosen for this fund and the VIG fund:
- Dividend Yield. Stocks in the VYM fund are chosen for higher-than-average dividend yield. While the VIG fund invests in dividend stocks as well, the stocks chosen for that fund are chosen for their record of consistently increasing dividends, even if the yields on those stocks are below average.
- Dividend Growth. The VYM fund pays no attention to growth in dividends. Stocks in the fund may even reduce dividends from time to time, but as long as they offer yields that are higher than average, they’ll remain prime picks for this fund. On the other hand, the VIG fund focuses specifically on stocks with a pattern of growing dividends, regardless of the size of the yield.
It’s crucial to consider costs when investing, regardless of whether you’re investing in individual stocks, ETFs, mutual funds, or any other asset.
The costs associated with ETFs are outlined with an easy-to-understand expense ratio, and when it comes to these two funds, their costs are the same. They both come with an industry-low expense ratio of 0.06%. To put that into perspective, the average expense ratio on an ETF sits at about 0.44%, meaning the fees for both of these funds are well below the industry averages.
To get an idea of just how inexpensive investing in these funds is, consider an investment of $1,000. With a 0.06% annual cost, you’ll pay just $0.60 per year to hold either of these funds, which is less than a pack of bubble gum these days.
One of the most important metrics to consider when choosing an ETF is its historic performance in terms of price appreciation.
Sure, investors interested in either of these two funds will be primarily focused on generating income through their investments. However, there’s nothing wrong with wanting a little price appreciation to go along with your income.
Although dividend funds won’t perform as well as those designed for growth or value, it is important to consider historic price appreciation before making your investment. Here’s how the two funds stack up:
VIG Historic Performance
Since inception, this fund has been a stellar performer, especially among dividend-focused funds, earning it a three-star (out of five) Morningstar rating.
Over the past year, investors in the fund have earned more than a 34% return. Throughout the past three-, five-, and 10-year periods, returns have clocked in at 17.21%, 15.42%, and 13.01%, respectively.
To put that into perspective, the average returns over the past year, three years, five years, and 10 years among dividend-centric ETFs have been 13.45%, 10.14%, 15.76%, and 7.33%, respectively, outlining an incredible performance by the fund.
VYM Historic Performance
The Morningstar rating on this fund is four out of five stars, but as you’ll see below, the fund’s historic performance has been slightly below that of VIG.
Over the past year, VYM investors have enjoyed returns of 37.24%, outpacing its counterpart. However, over the past three-, five-, and 10-year periods, its returns have been 11.66%, 11.43%, and 12.28%, slightly below those of the VIG fund.
Of course, if you’re interested in investing in either of these funds you’re looking for dividend income. So, how do they compare to each other in terms of the income they generate?
VIG Dividend Payments
When thinking about dividends, there are a couple factors you’ll want to consider:
- Dividend Yield. Over the past five years, dividend yields on the fund have ranged from 1.49% to 2.39%, which works out to about half of the yield offered by VYM.
- Dividend Growth. Growth in dividends is also an important consideration. After all, a great dividend yield today on a stock that’s not known for increasing dividends can become a poor yield in the future. VIG has been a stellar performer, with annual dividends increasing consistently, which makes sense considering the fund was designed to track stocks that are known for consistently increasing their dividends.
VYM Dividend Payments
The dividend related stats for this fund are as follows:
- Dividend Yield. Over the past five years, the dividend yield on the VYM fund has ranged from 2.64% to 4.5%, outpacing its counterpart by a wide margin.
- Dividend Growth. Although growth in dividends isn’t the core focus of the fund, it has also been a stellar performer, with payments to investors increasing relatively consistently over the past several years.
See the chart below for an outline of the asset allocation of each fund:
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VIG Top Holdings
The top five holdings in this fund include Microsoft (MSFT), JPMorgan Chase (JPM), Johnson & Johnson (JNJ), Walmart (WMT), and UnitedHealth Group (UNH).
VYM Top Holdings
The top five holdings in this fund include JPMorgan Chase (JPM), Johnson & Johnson (JNJ), The Home Depot (HD), Procter & Gamble (PG), and Bank of America (BAC).
The Verdict: Should You Choose the VIG or the VYM?
As is always the case in the world of investing, neither of these will be the better option for all investors. After all, every investor has their own goals, financial capabilities, investing styles, and time horizon.
There’s no such thing as a one-size-fits-all option, but here are some factors to consider when choosing between these two excellent dividend funds.
You Should Invest in the VIG Fund If…
The VIG fund is a better fit if:
- You Want Income but Price Appreciation Is More Important. The VIG fund provides reasonable income, but is nowhere near the level of income provided by VYM. The difference is made up in the returns over the long run. While price appreciation has been somewhat similar, the price growth of the VIG fund has outperformed the VYM fund over the long haul.
- You’re Interested in Growth Investing. Growth investing is a popular investment style, and mixing growth and income comes with perks. Because the fund focuses on companies with consistently increasing dividends, the majority of stocks it invests in are known for not only growth in dividends, but other metrics like revenue and earnings.
- You Want Reduced Drawdown Risk. While the performance of these funds has been similar over the years, when you look at the charts for each, you’ll find that the VIG fund seems to be the more stable option when corrections or bear markets set in. If you want a fund that comes with less drawdown risk, this is the way to go.
You Should Invest in the VYM Fund If…
The VYM fund is a better fit if:
- Income is Your Core Focus. There’s no arguing the fact that the VYM fund generates higher levels of income between the two. Throughout the past five years, dividend yields on the fund have just about doubled what you would expect to see from VIG.
- You Don’t Mind Increased Drawdown Risk. As mentioned above, during times of market corrections or bear markets, the VYM fund has experienced larger drawdowns than the VIG fund. That may be a turn-off to some investors with shorter time horizons who don’t have the ability to recover from significant declines.
Both Are Great If…
For most investors, a mix of both options will be the better choice. Both of these funds are great options if:
- You Want Heavy Diversification. Spreading your investments across a wide range of stocks, sectors, and market caps is one of the best ways to protect your portfolio from significant losses. That way, if one stock or sector takes a dive, stability from other holdings in your portfolio will help to limit your losses.
- You’d Like Exposure to Growth and Compelling Income. The VYM fund is the clear choice for those focused on income, while the VIG fund is the clear choice for those focused on growth investing strategies. However, if you’d like exposure to both, mixing the two funds together is a great way to go.
Both the Vanguard Dividend Appreciation ETF and the Vanguard High Dividend Yield ETF are great options, as you would expect from such a well-respected fund management firm. Not only do they both provide income and compelling historic performances, they also come with industry-low costs, allowing you to hold onto more of your gains.
While some investors will prefer one to the other, for the vast majority of investors, the best way to go about choosing between the two is to choose them both. In doing so, you’ll increase your diversification while taking advantage of the best of both worlds — growth and strong dividends.