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The Vanguard High Dividend Yield Index Fund (NASDAQMUTFUND: VHDYX) may be one of the best high-yield index funds on the market today. It's inexpensive to own, diversified, and offers a yield that is about 45% higher than the S&P 500 Index. 



Expense Ratio


Vanguard High Dividend Yield Index Fund


0.16% (0.09% for the ETF)


Data source: Vanguard.

Here's everything you need to know about the fund and why it is a great choice among high-yield mutual funds.

How the Vanguard High Dividend Yield Fund works

Index funds do not employ analysts or portfolio managers to pick stocks. Instead, they seek to match an index, and thus the performance of an index fund will only be as good as the index it tracks.

The Vanguard High Dividend Yield Fund is based on the FTSE High Dividend Yield Index. This index picks stocks with a simple, rules-based methodology. It first starts with every U.S. stock, and ranks them by yield. Stocks that do not pay a dividend as well as real estate investment trusts are thrown out of the list.

Starting with the highest-yielding companies, the index adds stocks one by one until the portfolio includes companies whose combined market value is equal to 50% of the market value of all the dividend stocks on its list.

Once selected for the portfolio, stocks are weighted by market cap so that the largest company in its portfolio makes up a much larger percentage of the portfolio. This results in a portfolio of about 420 stocks that is most heavily invested in high-yielding, large-cap companies in the United States.

What it invests in

Stocks that pay dividends are generally more mature companies with fewer growth opportunities. For this reason, dividend funds are typically overweight in some sectors of the market relative to traditional stock indexes.

Notice that this fund has a bias toward consumer defensive, utilities, and energy stocks. It invests less of its assets in healthcare, technology, and consumer cyclical companies. Because the Vanguard High Dividend Yield Index Fund seeks out the highest-yielding stocks, it necessarily invests more in slower-growing, higher-yielding sectors than a simple large-cap index fund.

Returns have roughly matched the returns of the S&P 500 over the fund's history. Over the last five years, the fund returned 14.58% vs. 14.67% for the S&P 500. Note, though, that more of the fund's performance came from dividends than capital appreciation, as the fund currently yields about 3.1%, or about 45% more than the S&P 500's 2.1% dividend yield.

Is this fund right for you?

The Vanguard High Dividend Yield Fund checks all the boxes of a "good" fund. It's diversified, doesn't take undue risks to maximize yields, and is predominately a large-cap stock fund that really isn't all that different from an S&P 500 index fund.

Investors who want to add more income stocks to their portfolio will certainly find its outsize yield to be very attractive, and it would be difficult to make the case that the fund is a bad fund for a diversified portfolio.

Investors who are particularly concerned about fees may prefer the Vanguard High Dividend Yield ETF (NYSEMKT:VYM), which is exactly the same as the index mutual fund, but carries an annual expense ratio of just 0.09% vs. 0.16% for the mutual fund. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.