Purchasing stocks that consistently pay an above-average dividend can add an element of safety to a portfolio. When I say above average, I mean payouts exceeding the average dividend yield for companies in the S&P 500. That figure is currently 1.82%.
Companies that can regularly afford to top that figure often have a competitive advantage that supports consistent cash-flow generation. Of course, stocks that pay above-average dividends often have limited growth opportunities, so they may not beat the S&P 500 during bull markets, but they tend to be more resilient during bear markets.
Investors get exposure to hundreds of those stocks when they purchase shares of Vanguard High Dividend Yield ETF (NYSEMKT: VYM). What’s more, that exchange-traded fund (ETF) could turn $400 invested monthly into $627,200 over three decades, and that stake would generate about $18,900 in annual dividend payments based on its historical yield.
The Vanguard High Dividend Yield ETF tracks 557 large-cap value stocks forecast to have above-average dividend yields. The fund includes companies from 10 of the 11 market sectors — real estate being the lone exclusion — though its asset allocation leans most heavily toward the financial (20%), industrial (13%), and healthcare (12%) sectors.
The 10 largest holdings in the Vanguard High Dividend Yield ETF are listed below by weighted exposure.
JPMorgan Chase: 3.4%
Broadcom: 3.4%
ExxonMobil: 2.8%
Home Depot: 2.3%
Procter & Gamble: 2.3%
Johnson & Johnson: 2.3%
Merck: 2%
AbbVie: 1.9%
Chevron: 1.6%
Bank of America: 1.6%
There are three reasons the Vanguard High Dividend Yield ETF is an attractive investment. First, it carries a very low expense ratio of 0.06%, meaning the annual fee would total $6 on every $10,000 invested in the fund. The average expense ratio on similar funds is 0.9%, according to Vanguard.
Second, the fund outperformed the S&P 500 during the last bear market. Specifically, the S&P 500 suffered a maximum drawdown of 24% during that period, whereas the Vanguard High Dividend Yield ETF suffered a maximum drawdown of 16%. As a caveat, the S&P 500 has historically beat the Vanguard ETF during bull markets.
Third, patient investors that regularly buy shares of the fund can build a sizable portfolio that generates a substantial amount of dividend income each year. Better yet, the annual payout will continue to grow while the underlying sum remains untouched.
The Vanguard High Dividend Yield ETF has achieved a total return of 298% since its inception on Nov. 10, 2006, which is equivalent to an annual return of 8.25%. That number is arguably skewed to the downside because the Great Recession began less than a year later. For instance, the Vanguard ETF returned 9.8% annually over the last decade.
However, I will assume annual returns of 8.25% in the future to introduce a margin of safety. At that level of growth, $400 invested monthly would be worth about $627,200 in three decades (assuming all dividends are reinvested).
At that point, investors can stop reinvesting dividends and start collecting passive income. The Vanguard High Dividend Yield ETF paid an average dividend yield of 3.02% over the past decade. At that rate, the $627,200 portfolio would generate a little more than $18,900 in annual dividend income. As previously mentioned, that figure will actually increase over time if the underlying investment is left intact.
The Vanguard High Dividend Yield ETF has returned 5% annually since its inception if dividends are excluded. At that pace, the $627,200 portfolio — now paying $18,900 per year in dividends — would grow into $804,900 over the next five years. That would happen without investing another penny. Assuming a dividend yield of 3.02%, the new portfolio would pay $24,300 in annual dividends.
Here’s the bottom line: The Vanguard High Dividend Yield ETF is unlikely to beat the S&P 500 over long periods of time. However, its value-focused composition led to outperformance during the last bear market, and it pays an above-average yield. That makes the Vanguard High Dividend Yield ETF a good option for risk-averse investors looking for passive income.
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Bank of America is an advertising partner of The Ascent, a Motley Fool company. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Trevor Jennewine has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bank of America, Chevron, Home Depot, JPMorgan Chase, Merck, and Vanguard Whitehall Funds-Vanguard High Dividend Yield ETF. The Motley Fool recommends Broadcom and Johnson & Johnson. The Motley Fool has a disclosure policy.
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