Warren Buffett has famously said that the best investment most Americans can make is low-cost index funds. Two excellent ETF options available to dividend-seeking investors are the Vanguard High Dividend Yield ETF (NYSEMKT: VYM) and the iShares Select Dividend ETF (NYSEMKT: DVY). Here's a rundown of the similarities and differences between these two ETFs, so you can decide which is best for you.
A similar objective with two different approaches
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These funds are similar in that they both track indices of stocks that pay relatively high dividends and exclude REITs, but the details behind the two funds are quite different.
The Vanguard ETF tracks the FTSE High Dividend Yield Index and owns 406 stocks, while the iShares ETF tracks the Dow Jones U.S. Select Dividend Index and currently owns 99 stocks. So one difference is that the Vanguard ETF owns more than four times as many stocks and is more diverse, while the iShares product is more concentrated.
More importantly, the two indices have different methods of choosing which stocks to include. The FTSE High Dividend Yield Index includes stocks of U.S. companies that pay above-average dividends, excluding real estate investment trusts.
On the other hand, the Dow Jones U.S. Select Dividend Index includes stocks that have a positive five-year dividend growth rate as well as a five-year average dividend coverage rate of at least 167% (also excluding REITs). It is also weighted based on the companies' annual dividend -- not by market cap.
Because of the way the respective indices work, there really isn't much overlap among the portfolios' largest holdings. In fact, the two ETFs' top 10 stock positions as of the most recent available information have only one name in common.
One major difference
You'll notice from the introduction that there's a significant difference in expense ratio between the two ETFs. The Vanguard ETF has an expense ratio of just 0.08%, or $8 per year for every $10,000 you have invested. The iShares ETF has a 0.39% expense ratio, which is more than four times as much.
Now, you may be saying, "$39 for every $10,000 invested sounds pretty low -- how much of a difference can it really make?" The answer is that it can make a big difference over long periods of time.
As a simplified example, let's say the underlying indices of the two ETFs achieve total returns averaging 9% per year and that you invest $10,000 in each one. After 30 years, your investment in the Vanguard ETF would be worth roughly $129,800 while the iShares fund would grow to $119,150. That seemingly insignificant expense ratio difference would cost you more than $10,000 of your investment gains.
Which is the better buy?
To be clear, both ETFs in this comparison have excellent investment strategies that should do well over the long run.
However, the difference in cost is far more significant than it may look and could rob long-term investors of thousands of dollars in gains. For this reason, the Vanguard High Dividend Yield ETF is the clear winner.
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