Whenever markets get turbulent, many investors turn to dividend stocks. The income that dividend stocks provide often acts as a counterbalance to falling share prices, and long-term investors like to consider the growth opportunities that such stocks have. Vanguard Dividend Appreciation ETF (VIG +0.41%) aims to concentrate on the dividend stocks that have the best history of not only weathering past storms but also finding ways to boost their quarterly payouts year after year.
Substantial market declines in February and October this year showed that dividend ETFs can still lose ground when the overall stock market is falling. However, the rebound in Vanguard Dividend Appreciation has many investors thinking again about the potential defensive nature of dividend growth stocks, and it's worth a closer look to see if the dividend ETF belongs in your portfolio.
How Vanguard Dividend Appreciation has done lately
2018 has been a solid year for Vanguard Dividend Appreciation, but it hasn't been without its hiccups. The fund jumped out to a gain of around 6% in the first month of the year before giving up all of those gains and then some, eventually falling to a 4% loss. Dividend stocks tend to be susceptible to rising interest rates, and the prospects for the Federal Reserve to move forward with consecutive quarterly hikes on a continuing basis didn't sit well with income investors. The magnitude of the February drop made some investors think twice about the value of dividend stocks as a hedge against poor stock market performance, since the dividend ETF didn't really provide much protection in comparison to broader market benchmarks.
The summer rally brought relief for Vanguard Dividend Appreciation investors, with shares of the ETF climbing further to post at one point a nearly 10% year-to-date rise for 2018. Once again, though, market volatility returned, and by late October, the ETF had returned to a net loss for the year. The fund's subsequent bounce has left it up about 5% for the year -- outpacing the S&P 500 by a modest margin but failing to produce the outperformance that so many of its shareholders expect during tough market environments.
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A longer-term trend
Vanguard Dividend Appreciation is having to deal with what could become a massive shift in the bond market, and that has consequences for the income investors who've piled into the dividend ETF's shares over the past decade. Since the financial crisis, the Federal Reserve was extremely slow to raise short-term interest rates, and that left most income investors without viable alternatives to dividend stocks. Even though many of those investors weren't particularly aggressive in terms of risk tolerance and would have preferred to stay in investments like bonds or bank certificates of deposit, the lack of yield made those alternatives impractical.
Now, interest rates are starting to climb back higher. Yields on 1-year CDs are pushing closer to 3%, and a few longer-term CDs offer rates approaching 4%. That's not huge, but it's still quite a bit better than the average yield on the S&P 500 index, and that's prompting some risk-averse income investors to move back toward fixed-income securities and cut their holdings of dividend-paying stocks.
None of that changes the fact that Vanguard Dividend Appreciation has many attributes that are far superior to a typical bond. With fixed-income investments, the only return you can possibly get is the interest that the investment pays, and there's no opportunity for those payments to rise in the future. By contrast, the dividend-paying stocks that Vanguard Dividend Appreciation focuses on do boost their payments to shareholders over the years, and the prospect for capital appreciation of the shares themselves adds to the potential total return of the investment.
Worth a closer look
The biggest concern that investors in Vanguard Dividend Appreciation ETF should have is that the underlying stocks that the fund owns are fairly richly valued. Investors like dividend income and protection from bear markets, and most dividend growth stocks are seen as offering both. Those beliefs could prove unwarranted if rates keep rising and consumers start to feel the pinch.
However, the risk of a worst-case scenario has been largely overblown. With the combination of a solid yield of more than 2% and possible dividend hikes and capital gains down the road, Vanguard Dividend Appreciation is worth buying -- regardless of whether you need income from your portfolio right now.
