Stock prices continue to grow to the sky, and the S&P 500 index has set 28 record highs this year through the end of September.
Moreover, valuations continue to stretch. At 39.7, the Shiller Cyclically Adjusted (CAPE) Ratio is at its second highest level of the past century (higher than the eve of the Great Crash of 1929, though still a bit lower than the eve of the Internet bubble burst in 1999).
What should a prudent investor do in such a frothy market?
Investing in defensive stocks that are less vulnerable to market pullbacks, drawdowns, and corrections is one great idea. And here's an even better idea: Buying reliable, stable defensive stocks that pay high dividends and reward investors with passive income.
Stability and income
So, what's the best exchange-traded fund (ETF) to buy right now if you want exposure to defensive stocks that provide stable earnings and dividends? I like the Vanguard High Dividend Yield ETF (VYM 0.44%) because it gives you a stake in a broad swath of high-yielding, stable, large-cap value stocks. Thus, you get safety and reliable passive income, and at a rock-bottom price.
The Vanguard High Dividend Yield ETF tracks the performance of the FTSE High Dividend Yield Index, which measures the return of a set of stocks characterized by high dividend yields. With total assets of $81.3 billion, the fund currently holds 579 stocks. Its top five holdings are:
- Broadcom, which accounts for 6.7% of the fund
- JPMorgan Chase, 4.1%
- ExxonMobil, 2.4%
- Johnson & Johnson, 2.1%
- Walmart, 2.1%
Such big, safe companies -- ones that we would expect to be around for the long haul -- are typical of the fund's holdings. And it avoids risky and distressed firms.
Other than chipmaker Broadcom, no one stock currently accounts for more than 5% of the ETF, which makes it highly diversified. It's also diversified among sectors. Its biggest holding by sector is financials, with about 22% of its assets in that industry. It also has large positions in consumer discretionary, healthcare, industrials, and technology, among a few other sectors.
The fund's current yield is a very respectable 2.49%, about 1.3 percentage points above that of the S&P 500. The annual fee is a minuscule 0.06%, which is far lower than the 0.87% average for similar funds. The ETF is up about 10.4% year to date, which is solid given the income it produces.
Not so boring
Investors who think dividends are boring should think again. From 1940 to 2024, dividend income contributed 34% of the total return of the S&P 500, according to Hartford Funds.
Source: Getty Images.
That contribution varies a lot by decade. Dividends contribute a larger share of the total market return when the stock market is rising slowly, and a smaller share when it's soaring. That makes sense. Companies with higher-yielding stocks tend to be large and slower-growing, just what you want to own in a challenging market environment.
Yes, there are stocks with much higher yields than those in the Vanguard High Dividend Yield ETF. But that's by design, too. The fund avoids stocks with deteriorating fundamentals and declining prices, limiting its exposure to risky companies.
Best of all -- considering the bubbly nature of the current stock market -- this dividend ETF outperforms in difficult markets. It beat similar funds during the COVID-19 sell-off of early 2020 and outperformed other funds in its category by 7 percentage points in 2022, when the S&P 500 fell more than 19%.
The Vanguard High Dividend Yield ETF provides a steady, safer approach to higher-yielding stocks, and reliable passive income. Such an approach is beginning to look very attractive to many investors.
