Set Realistic Expectations With Vanguard’s High Dividend Yield ETF: It’s More About Strategy than Yield #NewsETFs

When an exchange-traded fund (ETF) puts the words dividend and yield into its name, it is looking to attract a certain type of investor. However, just because an ETF name includes those words does not mean that it is a good yield investment. This is the skepticism that investors need to have when they research Vanguard High Dividend Yield ETF (VYM -0.10%). Here’s why some dividend investors might not like what they get with this ETF.

Vanguard High Dividend Yield ETF’s yield stats

Vanguard High Dividend Yield ETF’s dividend yield is roughly 2.8%. That’s actually a fairly large yield compared to the S&P 500 index, which is only offering a yield of around 1.2%. So, at least in one way, Vanguard High Dividend Yield ETF does live up to its name.

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The problem for investors is that there are other dividend-focused exchange-traded funds with even higher yields. For example, Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) is offering a yield of 3.4%. And SPDR Portfolio S&P 500 High Dividend ETF (NYSEMKT: SPYD) has a yield of 4.1%. By comparison, these two ETFs make Vanguard High Dividend Yield ETF look like an income laggard.

The difference is in the way these index-based ETFs create their portfolios. Which, in the end, is the single most important thing an investor should understand when examining an index-driven ETF. You are basically buying the methodology. The ETF’s performance is just a byproduct of the approach it takes. So what is Vanguard High Dividend Yield ETF doing that leads to a yield that is above the market but below that of other dividend-focused ETFs?

Vanguard High Dividend Yield ETF owns a lot of stocks

The first thing that Vanguard High Dividend Yield ETF does is create an investable universe, which is composed of all dividend-paying U.S. stocks. It then removed real estate investment trusts (REITs). The remaining stocks are lined up from highest yielding to lowest yielding. The highest-yielding 50% of the list gets into the ETF’s portfolio.

At first glance, this clearly suggests that Vanguard High Dividend Yield ETF is focused squarely on owning high-yield stocks, which it is. The problem comes in when you consider the pool from which Vanguard High Dividend Yield ETF is selecting — all U.S. stocks. That’s a huge list that isn’t parsed in any way. So long as a company pays a dividend and has a yield, of any size, it can make it into Vanguard High Dividend Yield ETF. There are over 500 stocks in the portfolio!

Effectively, Vanguard High Dividend Yield ETF is more about diversification than it is about dividend yield. By including so many stocks, the impact of high-yielding stocks is diluted by all of the lower-yielding stocks that, by design, are in the portfolio. The end result is a lower overall yield. That’s not bad, per se, if you are focused on diversification. But if you are focused on yield, well, there are likely to be better ETF options for your portfolio.

Make sure you understand what you own

There’s nothing wrong with Vanguard High Dividend Yield ETF. It does exactly what it is intended to do, which is own a very large and diverse portfolio of dividend-paying stocks. And those stocks are the highest yielding within the ETF’s pool of potential investments.

But for investors looking to concentrate on a more select group of the highest-yielding dividend stocks across the market, Vanguard High Dividend Yield ETF may not be the best choice. Other dividend ETFs with a smaller number of top-yielding holdings might be a better fit.