The Key to Vanguard High Dividend Yield ETF's Success

By Dan Caplinger Markets Fool.com

Income investors like to have their portfolios pay them, and dividend stocks are a great way to get portfolio income. The rise in demand for income-paying investments has led to substantial growth for the Vanguard High Dividend Yield ETF (NYSEMKT: VYM), which is an exchange-traded fund that specializes in stocks that have above-average yields. The rise of the Vanguard dividend ETF itself shows just how hungry for income investors have gotten in recent years, and as long as interest rates on bonds and other fixed income investments remain low, dividend investments are likely to stay in vogue.

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The rise of Vanguard High Dividend Yield ETF

Vanguard High Dividend Yield has become one of the largest dividend ETFs in the industry. As of the end of its 2016 fiscal year, the Vanguard dividend ETF had $15.5 billion in assets under management, and when you add in share classes available to mutual fund investors, the total amount managed by those who oversee the ETF climbs to $21.4 billion.

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What's particularly amazing is how quickly Vanguard High Dividend Yield has achieved its status near the top of the industry. The ETF became available in 2006, and in its first year of operation, it managed to draw in only $115 million in assets. Even after five years of operation, the ETF's 2011 annual report showed that the Vanguard dividend offering had less than $2 billion in assets on its books.

What made Vanguard High Dividend Yield a destination ETF for dividend investors?

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The success of the Vanguard High Dividend Yield ETF comes from many factors. Rock-bottom interest rates on bonds have made it extremely difficult for fixed-income investors to get the income they need from bonds alone, and that has represented a major shift in thinking from market conditions that prevailed throughout the 1980s, 1990s, and 2000s. Investors have had to look to equity markets for greater income potential, even though it comes with greater risk as well. Dividend-focused ETFs are seen as having less market risk than growth-oriented funds, and so they've disproportionately attracted capital from the sort of investors who value income over capital appreciation in their investment portfolios.

At the same time, the fact that the ETF is part of the Vanguard Group has undoubtedly contributed to its ability to attract capital. Vanguard is well-known for its commitment to minimize costs, and its unusual ownership structure that vests control in its fund shareholders has helped it keep its expenses lower than more traditional asset management companies.

Indeed, over time, rising assets levels have allowed Vanguard High Dividend Yield to reduce its expense ratio. When the fund first became available, it charged 0.25% per year in fund expenses. In 2008, it reduced its annual fees to 0.20%, and within four years after that, costs had gotten cut in half to just 0.10%. Further reductions since then have brought the expense ratio all the way down to 0.08%. When you compare that against competing dividend ETFs charging 0.35% to 0.40%, the advantage of Vanguard High Dividend Yield's connection to its broader fund family becomes more concrete. Even though a quarter percentage point might not seem like all that much, the impact over time on even a modest portfolio can make a difference of thousands of dollars to the size of your eventual nest egg.

Will Vanguard High Dividend Yield ETF keep climbing higher?

Dividend investing shows few signs of losing popularity. So far, the stock market hasn't had to endure a major bear market, and some investors fear that dividend stock valuations are higher than they've typically been during past strong periods for the overall stock market. It's possible that those conditions could make dividend ETFs perform less well in a relative sense during the next market correction. However, for those who believe in the long-term power of dividend investing, the Vanguard High Dividend Yield ETF will remain a low-cost, highly diversified option to get exposure to high-quality dividend stocks from a single exchange-traded fund.

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Dan Caplinger has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.