Buying stocks that consistently pay an above-average dividend can add an element of safety to a portfolio. When I say above average, I mean distributions exceeding the average dividend yield of companies in the sector. S&P500. This figure is currently 1.82%.
Companies that can regularly afford to exceed this figure often have a competitive advantage that allows them to generate consistent cash flow. Of course, stocks that pay above-average dividends often have limited growth opportunities. So they can’t beat the S&P 500 in a bull market, but they tend to be more resilient in a bear market.
Investors are exposed to hundreds of these stocks when they purchase shares of Vanguard High Dividend Yield ETF (NYSEMKT:VYM). Additionally, this exchange-traded fund (ETF) could turn $400 invested monthly into $627,200 over three decades, and this stake would generate approximately $18,900 in annual dividends based on its historical return.
The Vanguard High Dividend Yield ETF
The Vanguard High Dividend Yield ETF tracks 557 large-cap value stocks that are expected to perform above average. dividend yields. The fund includes companies from 10 of the 11 market sectors – real estate is the only exclusion – although its asset allocation leans more heavily towards the financial (20%), industrial (13%) and healthcare (12%) sectors.
The 10 largest holdings in the Vanguard High Dividend Yield ETF are listed below by weighted exposure.
JPMorgan Chase: 3.4%
Broadcom: 3.4%
ExxonMobil: 2.8%
Home deposit: 2.3%
Procter & Gamble: 2.3%
Johnson & Johnson: 2.3%
Merck: 2%
AbbVie: 1.9%
Chevron: 1.6%
Bank of America: 1.6%
There are three reasons why the Vanguard High Dividend Yield ETF is an attractive investment. First, it has a very low expense ratio of 0.06%, meaning that annual fees would total $6 on every $10,000 invested in the fund. The average expense ratio on similar funds is 0.9%, according to Vanguard.
Second, the fund outperformed the S&P 500 during the last bear market. Specifically, the S&P 500 suffered a maximum decline of 24% during this period, while the Vanguard High Dividend Yield ETF suffered a maximum decline of 16%. As a caveat, the S&P 500 has historically beaten the Vanguard ETF during bull markets.
Third, patient investors who regularly purchase fund shares can build a large portfolio that generates a substantial amount of dividend income each year. Better yet, the annual payment will continue to grow without the underlying amount remaining unchanged.
History says $400 invested monthly could create $18,900 in annual dividend income
The Vanguard High Dividend Yield ETF has achieved a total return of 298% since its inception on November 10, 2006, which equates to an annual return of 8.25%. This figure is likely skewed downward, as the Great Recession began less than a year later. For example, the Vanguard ETF has returned 9.8% annually over the past decade.
However, I will assume annual returns of 8.25% going forward to introduce a margin of safety. At this level of growth, $400 invested monthly would be worth approximately $627,200 in three decades (assuming all dividends are reinvested).
At this point, investors can stop reinvesting their dividends and start earning passive income. The Vanguard High Dividend Yield ETF has paid an average dividend yield of 3.02% over the past decade. At that rate, the $627,200 portfolio would generate just over $18,900 in annual dividend income. As mentioned earlier, this figure will increase over time if the underlying investment remains intact.
The Vanguard High Dividend Yield ETF has returned 5% per year since inception if dividends are excluded. At that rate, the $627,200 portfolio – now paying $18,900 a year in dividends – would grow to $804,900 over the next five years. This would happen without investing an extra cent. Assuming a dividend yield of 3.02%, the new portfolio would pay $24,300 in annual dividends.
Here’s the bottom line: The Vanguard High Dividend Yield ETF is unlikely to beat the S&P 500 over long periods of time. However, its value composition led to outperformance during the last bear market and it offers an above-average yield. This makes the Vanguard High Dividend Yield ETF a good option for risk-averse investors looking for passive income.
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Bank of America is an advertising partner of The Ascent, a Motley Fool company. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Trevor Jennevine has no position in any of the stocks mentioned. The Motley Fool has positions and recommends Bank of America, Chevron, Home Depot, JPMorgan Chase, Merck, and Vanguard Whitehall Funds-Vanguard High Dividend Yield ETF. The Motley Fool recommends Broadcom and Johnson & Johnson. The Mad Motley has a disclosure policy.
This High-Yielding Vanguard ETF Could Turn $400 a Month into $18,900 in Annual Dividend Income was originally published by The Motley Fool
