3 Top Vanguard Dividend ETFs

Want high dividend yields and diversification? An ETF might be right for you. Vanguard dividend ETFs offer low fees and sound strategies that won't leave you taking unnecessary risks for higher yields.

Here are three of Vanguard's best dividend ETFs.

Data source: Vanguard.

Vanguard Dividend Appreciation ETF

The Vanguard Dividend Appreciation ETF (VIG 0.25%) invests in so-called "dividend achievers," or companies that have paid a dividend that has grown in 10 or more consecutive years. The fund tracks the NASDAQ U.S. Dividend Achievers Select Index, which uses proprietary filters to select what it believes are the best of the dividend achievers, and generally seeks to exclude stocks that have low potential for increasing dividends in the future.

This ETF uses traditional market cap weighting, with the only requirement being that no one stock make up more than 4% of its portfolio. As a result of its market cap weighting, this fund invests more of its assets into larger companies and relatively less into smaller companies.

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The fund is widely diversified across 185 different companies and across industries. Its sector weightings do differ from other large cap funds, however. It invests substantially more of its assets in consumer staples and industrial firms, and holds less of its assets in riskier and lower-yielding financial and technology companies than the S&P 500.

Historical performance can be summed up as "market matching," as its multiyear performance closely approximates the S&P 500. Note, though, that this fund seems to do better in downturns. It lost just 26.5% of its value in 2008 vs. a 37% decline for the S&P 500. And although its yield of 2.1% isn't any better than the 2.1% yield of the S&P 500, its focus on companies that can grow their dividends may give it an edge in yield as time goes on.

Vanguard High Dividend Yield ETF

The Vanguard High Dividend Yield ETF (VYM 0.21%) is built for income, boasting a 3.1% dividend yield that is about 45% higher than the S&P 500's 2.1% yield. The ETF tracks the FTSE High Dividend Yield Index, which ranks dividend-paying stocks by yield, and invests in the largest half of stocks by market cap. Like the Dividend Appreciation ETF, this fund also excludes real estate investment trusts.

It isn't particularly choosy about stock selection, and thus holds more than 400 stocks. Unlike the Dividend Appreciation ETF, it doesn't have requirements for the longevity a stock's dividend, whether or not the dividend has been increased in the past, or whether it can or will be increased in the future.

The ETF's median stock has a market cap of about $135 billion, which is about two and a half times larger than the median of the Dividend Appreciation ETF. This is very much a large-cap fund.

Performance has been good, exceeding the S&P 500 marginally over the most recent three-year period, while lagging it marginally over the most recent five-year period. Notably, it also shines in periods of market weakness, shedding only about 32% of its value in 2008 compared to a 37% decline in the S&P 500.

The primary advantages to this fund are its outperformance in down markets, and the fact that more of its return comes in the form of dividends. If you're in the hunt for bigger dividends, this fund's 3.1% yield from large-cap stocks certainly sticks out as being especially attractive.

Vanguard REIT ETF

Where Vanguard's dividend-focused ETFs exclude REITs, the Vanguard REIT ETF (VNQ +0.16%) only invests in REITs. It isn't exactly a dividend fund by definition, but real estate investment trusts are all about dividends. REITs are required to distribute 90% of their taxable income to shareholders in order to avoid corporate-level taxation.

This fund tracks the performance of the MSCI US REIT Index, which tracks equity REITs that invest in tangible real estate. The index does not include mortgage REITs (mREITs), which are perhaps more like banks than real estate firms, as they use bank-like leverage to invest in mortgage securities rather than real property. The ETF and index also exclude companies with market caps of less than $100 million, as well as companies that do not have enough trading volume to be practical holdings.

The Vanguard REIT ETF holds 150 different REITs, weighting each investment by market cap. REITs in the index vary tremendously by property type, from office and industrial lessors, to mall, hotel, and apartment operators.

If there is just one caveat to investing in a REIT ETF, it's that your investment results will be driven largely by interest rate expectations. REITs are typically valued based on their dividend yields relative to U.S. Treasury yields. As such, rising rates can drive down REIT valuations, while falling rates send REIT shares rocketing higher.

Vanguard's REIT ETF returned about 2.4% in 2013 while its S&P 500 ETF ran away with a 32.3% return, dividends included. The very next year, Vanguard's REIT ETF posted a 30.3% return vs. the S&P 500's 13.6% return, as worries about rising rates subsided. Remember that this is a sector-specific ETF, and for that reason it probably shouldn't be a big part of your investment portfolio. 

Why dividend stocks?

Dividend-paying companies have historically outperformed their non-dividend paying rivals. The American Association of Individual Investors found that from 1927 to 2014, the companies which paid out the highest dividends outperformed, and returns were correlated to dividend yields. The top 30% of dividend payers had an average return of 11.3%, compared to an average return of 8.6% for companies that did not pay a dividend.

Furthermore, companies that pay dividends are generally less volatile (excluding companies like BDCs and mREITs), declining less in bear markets. Whether this will persist in the future is something that remains to be seen, but there are logical reasons for dividend-paying companies to outperform their counterparts. Most obviously, dividend-paying companies must be profitable, and perhaps more consistently so, in order to pay a dividend to their investors.

If history is any guide, the long-term performance of dividend-paying companies should exceed that of companies that pay low or no dividends to investors. That bodes well for Vanguard's lineup of high-yield ETFs.

It's useful to know what an ETF is -- your portfolio might thank you.