Vanguard High Dividend Yield Fund (NYSEMKT:VYM) It has a dividend yield of 2.7%. That may not sound like a high return, but it’s more than double the average for U.S. stocks Standard & Poor’s 500 (SNPINDEX: ^GSPC)which is just under 1.2%. This comparison is actually interesting in another way, and it highlights the value that the Vanguard High Dividend Yield ETF provides — even if you only have $200 to invest in it right now.
The first thing investors need to understand about anything Exchange-traded fund (ETF) they buy is the investment approach. These are bundled investment products, so you are effectively hiring someone else to handle the investment process for you. You have to make sure you know what they are doing.
The Vanguard High Dividend Yield ETF is an index-based ETF, meaning it simply mimics the index. This indicator is FTSE High Yield Index.
The FTSE High Dividend Yield is pretty simple. The first step in creating the index is to select all dividend-paying companies on US stock exchanges. The second step is to rank all those companies by return, from highest to lowest. The third step is to include the highest 50% return in the index.
The index is weighted by market capitalization, so the largest stocks have the greatest impact on performance. This is very easy to understand and investors are clearly focused on stocks with higher returns. The cost of all this is a small 0.06% Expense ratio.
Some dividend investors may balk at this point, wondering how an exchange-traded fund (ETF) designed to buy the highest-yielding stocks can have a return that actually looks rather modest at an absolute level. The answer boils down to the number of stocks included in the portfolio.
Just like the S&P 500, the Vanguard High Dividend Yield ETF holds about 500 stocks. While they all pay dividends, the index it tracks actually pays fairly low into the yield range for all dividend-paying stocks. It has no choice, given the sheer number of dividend-paying stocks.
But here’s the interesting thing: Until a few very large companies started dominating the S&P 500’s returns, the Vanguard High Dividend Yield ETF tracked market performance fairly closely, as shown in the chart. Given the highly diversified portfolio it holds, this is not shocking. This suggests that for a dividend investor, this ETF can be substituted for the S&P 500 as an underlying stock. Now may be a good time to consider a switch, given the dynamics driving the S&P 500 today.
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