Comparing Two Vanguard ETFs for Dividend Growth and Better Returns Instead of Just Focusing on Yields

One of a Wall Street’s firm’s chief economist thinks that the Fed will raise rates by a full percentage point, or 100 basis points, from the current range of 0%-0.25%, This is in response to high inflation, which should, in turn, induce further volatility to the stock market. Thus, stocks can underperform for a long time and it is here that the dividend rationale starts to make sense, not only for income-oriented investors but also for those looking to diversify away from growth.

The contribution of dividends to total return, which includes capital gains (share price appreciation) and distributions, is also higher, in contrast to capital gains alone.

Thus, total returns over a period = share price appreciation + dividends paid.

For the purpose of this thesis, I use two Vanguard ETFs. First, there is the Vanguard High Dividend Yield ETF (VYM) and second, the Vanguard Dividend Appreciation ETF (VIG).

Starting with the VYM dividend ETF

For illustration purposes, I provide the difference between the share price appreciation (price return as shown in the orange chart below) and total return of (VYM) which is trusted by many investors because of its low expense ratio of 0.06% and dividend yields of 2.7%. The ETF pays quarterly distributions and holds stocks from the Financials sector at 22.20% of overall holdings followed by Consumer Staples (12.60%) and Healthcare (12.50%).

Moreover, with 410 holdings and net assets of the ten largest holdings only constituting 24% of the total, the fund exhibits low concentration risks and as shown by the blue chart below, VYM’s with total returns of $184, exceeds its price return by nearly 70% and signifies that VYM has constantly paid dividends and not deceived investors for the last five years despite inflation whipsawing during that time period.

Source: Ycharts.com

Going one step further, it is equally important that investors just choose ETFs based on those paying the highest dividends, but rather make sure they are investing in those funds which also look for the quality metric when selecting holdings. It takes a lot of research to spot stocks paying high-quality dividends, whereby distributions made to shareholders increases with time.

The search can be very time-consuming, hence the interests of looking for an ETF like the VIG where the fund managers are experienced and spend time screening the market. Now, the ETF pays a dividend yield of just 1.59%, or 70% less than VYM’s 2.70% ((2.70-1.59)/1.59)*100), leaving the possibility of the ETF being easily overlooked.

Income potential of VIG

To verify whether lower yields translated into lower dividend numbers, I calculated the quarterly distributions made by these two dividend ETFs over a period of about seven years, from March 2014 to December 2021. Then, I plotted the figures in the chart below. Now, as expected, VYM’s chart (in red) is higher along the Y-axis (dividend paid) than for VIG due to the fact that it pays better yields.

Source: Computed by author through data from Nasdaq.com

However, things look different when calculating the total amount of dividends paid during this period. It is $20.16 for VYM while $16.28 for VIG, which is again normal, but upon computing the total amount by which VYM exceeds VIG, I found that the former paid 24% (((20.16-16.28)/16.28)*100)) more dividends than VIG. This is substantially less than the 70% figure by which VYM’s yield exceeds its peer.

VIG offers better total returns

Consequently, when computed over a period of time, VYM’s higher yields do not translate into the same percentage of income gains as provided by VIG. This signifies that VIG has been growing its dividend faster than its peer. Additionally, the Vanguard Dividend Appreciation ETF has produced a better five-year share price performance, or capital gains. As a result, it is VIG which has delivered better total returns by (116.4-78.15) or 38.25% as per the chart below.

Source: Ycharts.com

Furthermore, VIG offers exposure to Industrials (20.70%), Financials (15.00%), technology (14.6%) and Healthcare (13.20%), which means more sector-based diversification compared to VYM to better navigate inflation-induced volatility. Finally, increased contributions also matter more at times when the market is volatile as it helps provide income and security when it is needed the most, and especially in the current market environment where total return across any of the major indices is likely to be lower than in 2021.

Disclosure: This is an investment thesis and is intended for informational purposes. Investors are kindly requested to do additional research before investing.