Vanguard High Dividend Yield ETF (NYSEMKT: VYM) has a 2.7% dividend yield. That may not sound like a high yield, but it is more than twice the average of stocks in the S&P 500 (SNPINDEX: ^GSPC), which is yielding a little under 1.2%. That comparison is actually interesting in another way, and it highlights the value that Vanguard High Dividend Yield ETF provides — even if you only have $200 to invest right now.
The first thing that investors need to understand about any exchange-traded fund (ETF) they buy is the investment approach. These are pooled investment products, so you are really hiring someone else to handle the investing process for you. You have to make sure you know what they are doing.
Vanguard High Dividend Yield ETF is an index-based ETF, which means it simply mimics an index. That index is the FTSE High Dividend Yield Index.
The FTSE High Dividend Yield Index is pretty simple. The first step in creating the index is to select all dividend-paying companies on the U.S. exchanges. The second step is to line up all of those companies by yield, from highest to lowest. The third step is to include the highest-yielding 50% in the index.
The index is market-cap weighted, so the largest stocks have the greatest impact on performance. That’s pretty easy to understand and clearly focuses investors on the highest-yielding stocks. The cost for all of this is a tiny 0.06% expense ratio.
Some dividend investors might balk at this point, wondering how an ETF that is designed to buy the highest-yielding stocks can have a yield that actually seems fairly modest on an absolute level. The answer boils down to the number of stocks being included in the portfolio.
Just like the S&P 500, Vanguard High Dividend Yield ETF holds around 500 stocks. While all of them pay dividends, the index it tracks actually pushes fairly low down into the yield range of 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 to dominate the S&P 500’s returns, Vanguard High Dividend Yield ETF tracked fairly closely with the market’s performance, as highlighted in the chart. Given the highly diversified portfolio it owns, that isn’t shocking. This suggests that, for a dividend investor, this ETF could be switched out for the S&P 500 as a core stock holding. Right now might even be a good time to consider a switch, given the dynamics driving the S&P 500 today.