Many dividend investors have turned to exchange-traded funds to find the diversified exposure they want, and the Vanguard High Dividend Yield ETF (VYM -0.02%) is one of the most popular choices in the market. With holdings that combine high-quality business fundamentals with above-average dividend yields, Vanguard High Dividend Yield is exactly what many dividend investors want. Yet with a wide variety of dividend ETFs in the market, it's important to understand what Vanguard High Dividend Yield does and doesn't do for its shareholders. In particular, knowing the particular traits and idiosyncrasies of the Vanguard ETF is critical for you to make the best dividend investing choice for your financial situation.
1. Not every stock in the portfolio has a super-high dividend yield
Vanguard High Dividend Yield counts more than 400 different stocks among its holdings, and the selection criteria that the ETF uses in tracking its target index requires that all of them be "dedicated to consistently paying larger-than-average dividends." Yet with the stock market currently carrying an overall dividend yield of around 2%, you'll find that some of the stocks that Vanguard High Dividend Yield owns wouldn't meet most investors' definitions of a high-yield investment.
For instance, no one can question the long and prosperous history that industrial conglomerate 3M (MMM -1.33%) has had during its tenure. With a commitment to innovation in multiple fields, 3M has been able to boost its dividend payments to investors for 59 straight years. However, even with its recent 6% dividend increase, 3M still yields less than 2.5% at current prices. Again, that meets the definition of "above average" yield, but it makes it clear that the Vanguard ETF values diversification and inclusiveness to a greater extent than it requires extremely high dividend yields.
2. Investors won't get equal dividend payments every quarter
One thing that income investors like about dividend stocks is that they tend to be predictable. Every three months, most dividend investments send their shareholders a check, and in most cases, the size of that check stays constant from quarter to quarter. The predictability of the cash flow from dividend stocks can help those who rely on portfolio income to budget more effectively.
Because Vanguard High Dividend Yield aggregates dividend payments from hundreds of stocks, it doesn't make equal payments. Instead, it distributes whatever dividend income it has available on a quarterly basis. Some of the stocks that the Vanguard ETF owns make payments on a semi-annual or annual basis, and that leads to larger payments in June and December than shareholders typically see in March and September. The differences aren't huge, but they're large enough to be noteworthy for those who would prefer exactly equal distributions every three months.
3. Dividend ETFs aren't necessarily crash-proof
Finally, conservative investors often turn to dividend investments in order to act as a cushion against stock market volatility. In particular, dividend stocks have a reputation for falling less dramatically during bear markets, and their defensive nature makes dividend investments extremely popular for those who can't afford to see major losses in their portfolios.
Vanguard High Dividend Yield ETF isn't unique in having posted significant declines during tough market conditions in the past. For instance, few stocks were able to weather the market meltdown in 2008 without suffering some damage, and the Vanguard ETF lost roughly a third of its value during that tumultuous year. Long-term investors were able to recover from those losses, and the ETF has subsequently climbed to new all-time record highs. Yet if you're counting on avoiding market volatility entirely, dividend ETFs won't be able to promise a smooth ride if things get bad enough in the market.
Vanguard High Dividend Yield is a solid way to invest in dividend stocks, and the ETF has plenty of advantages over some of its peers. However, it's important to know the limitations inherent in the Vanguard ETF so that they won't come as a big surprise later in your investing career.