The S&P 500 (^GSPC +0.84%) has historically been a fantastic way to compound wealth -- generating annualized total returns of 9% to 10%. The proliferation of low-cost index funds and exchange-traded funds (ETFs) has made it easier than ever to invest in the S&P 500 without racking up high fees.
The Vanguard S&P 500 ETF (VOO +0.82%) -- one of the largest S&P 500 index funds by net assets -- has an expense ratio of just 0.03% -- or 3 cents for every $100 invested. When I first began investing, it was normal to see flat fees per stock trade of around $5 to $10. So fees and expense ratios are no longer a major drag on returns for investors who regularly pour their savings into equities.
One issue with buying the S&P 500 is that it doesn't have a high yield. Today's top S&P 500 companies are growth stocks that have yields well below 1% or don't pay dividends at all -- a stark contrast to the days when the most valuable companies were oil and gas giants, industrials, or consumer staples behemoths with high yields.
As a result, the yield of the S&P 500 has fallen to just 1.2%. What's more, the valuation of the S&P 500 has gotten more expensive as stock prices have outpaced earnings growth.
Here's why investors looking to use passive income as a key way to achieve their financial goals may want to consider buying the Vanguard Value ETF (VTV +0.55%) over the Vanguard S&P 500 ETF.
Image source: Getty Images.
A lower yield at a better valuation
The Vanguard Value ETF sports an expense ratio of 0.04%, so it has just one cent more in annual fees per $100 invested than the Vanguard S&P 500 ETF. It also offers a full percentage point higher in 30-day SEC yield at 2.2% compared to 1.2% for the S&P 500 ETF.
In addition to having a higher yield, the Value ETF sports a 19.6 price-to-earnings (P/E) ratio (as of June 30) and holds 335 stocks compared to a 27.2 P/E ratio (also as of June 30) and 505 holdings for the S&P 500 ETF.
The Value ETF's higher yield and significantly lower valuation may appeal to investors looking to avoid paying a premium for the top stocks that are leading the S&P 500.
A different cast of characters
The Value ETF's higher yield and lower valuation result from its composition.
|
Vanguard Value ETF |
Vanguard S&P 500 ETF | |||
|---|---|---|---|---|
|
Holding Rank |
Company |
Weighting |
Company |
Weighting |
|
1 |
4% |
Nvidia (NVDA +1.73%) |
7.3% | |
|
2 |
JPMorgan Chase (JPM 1.34%) |
3.6% |
Microsoft (MSFT 1.33%) |
7% |
|
3 |
ExxonMobil (XOM 1.37%) |
2.1% |
Apple (AAPL +2.08%) |
5.8% |
|
4 |
Walmart (WMT +0.34%) |
2% |
Amazon (AMZN +0.55%) |
3.9% |
|
5 |
Procter & Gamble (PG +0.31%) |
1.7% |
3.5% | |
|
6 |
Oracle (ORCL +0.75%) |
1.7% |
Meta Platforms (META 1.18%) |
3.1% |
|
7 |
Johnson & Johnson (JNJ 0.54%) |
1.7% |
Broadcom (AVGO +4.27%) |
2.5% |
|
8 |
Home Depot (HD 1.61%) |
1.7% |
Berkshire Hathaway |
1.7% |
|
9 |
AbbVie (ABBV 0.57%) |
1.5% |
Tesla (TSLA +3.93%) |
1.7% |
|
10 |
Bank of America (BAC 2.79%) |
1.4% |
JPMorgan Chase |
1.5% |
|
Total |
23.1% |
Total |
38% |
Data source: Vanguard.
Aside from Berkshire Hathaway and JPMorgan Chase, there are no other companies that overlap the top 10 holdings in the Value ETF and S&P 500 ETF.
You'll also notice that the S&P 500 is much more top-heavy -- meaning that just a handful of names can move the index. Whereas the Value ETF is more balanced and not as dominated by just 10 companies.
Far more than a passive income vehicle
Over the last decade, the Value ETF has gone up 111.5% and has a total return of 173.5%. Meaning that capital gains have made up a much higher percentage of the total return than dividend income. The investment thesis centers around the companies it holds rather than being all about yield, a stark contrast to ETFs that prioritize passive income over upside potential.
The JP Morgan Nasdaq Equity Premium ETF (JEPQ +0.34%) sells covered call options on the Nasdaq-100 as a way to generate income -- which provides a sizable stream of monthly payouts while capping the upside potential of the Nasdaq-100 moving higher. The fund sports an 11.2% 30-day SEC yield (as of June 30), so it could be a great way for investors who are primarily focused on passive income. However, the Value ETF offers a way to get a higher yield than the S&P 500 without having any cap on upside potential.
The Schwab U.S. Dividend Equity ETF (SCHD +0.25%) doesn't use call options to achieve its high 3.9% yield. But many of its holdings are arguably lesser quality companies than what you'll find in the Value ETF.
The Vanguard Value ETF remains a top fund to buy now
The Value ETF is a good buy if you already own many of the top growth stocks in the S&P 500 and are looking to diversify your portfolio into different companies and boost your passive income.
It's also a good option for investors who want to participate in the broader market and collect more passive income than the S&P 500.
While there are plenty of ETFs that offer higher yields than the Value ETF, I would argue that the quality of companies in the ETF makes it one of the best ways to consistently collect more passive income than the index.
