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In a world where dividend yields are frequently higher than bond yields, investors are increasingly using exchange-traded fund investments to generate income. Top ETFs like the High Dividend Yield ETF(NYSEMKT: VYM)offer payouts 50% larger than the stock market average by investing in the market's best dividend stocks.
Here's everything you need to know about this dividend-yield focused ETF.
How this high-yield ETF works
Like most of Vanguard's funds and ETFs, the High Dividend Yield ETF is an index fund. It picks stocks mechanically, following a multi-step formula, rather than picking stocks recommended by in-house analysts.
The ETF picks stocks by compiling a list of all U.S.-listed dividend-paying companies, excluding real estate investment trusts. It then sifts out the highest-yielding half of the list, and then weights each company by market cap. The result is a highly diversified fund that holds more than 420 stocks, with a bias toward large-cap stocks.
The fund is thus most heavily invested in companies that should be recognizable to almost anyone. Recently, it reported that its five-largest stock holdings were Microsoft, ExxonMobil, Johnson & Johnson, General Electric, and AT&T, all large-cap companies that are frequently found in high-yielding portfolios.
What it holds
Some industries are simply more capable of paying dividends to investors, and it's only natural that the Vanguard High Dividend Yield ETF would skew its holdings toward sectors where dividends are the largest and most common.
As a result of its focus on dividend yield, this Vanguard ETF holds significantly more utilities, consumer staples, and energy stocks than Vanguard's S&P 500 ETF. However, it is also meaningfully underweight consumer cyclical, technology, and healthcare stocks. This isdue to the sectors' low dividend yields and fewer dividend-paying companies. Real estate exposure is also lower because real estate investment trusts are specifically excluded from Vanguard's ETF.
You'll notice that this ETF, like most dividend-focused ETFs, is heavily invested in "value" sectors compared to traditional "growth" sectors. This is because the fund's methodology favors lower-valued companies -- high P/E ratios and high-dividend yields are mathematically mutually exclusive -- and because mature companies with few growth opportunities are much-more likely to pay dividends than their faster-growing counterparts.
Fees and performance
Like most Vanguard ETFs, the High Dividend Yield ETF is certifiably cheap, carrying an expense ratio of just 0.09% of assets, a tiny premium relative to an annual expense ratio of 0.05% for Vanguard's S&P 500 ETF.
Riding the tailwinds of dividend-paying stocks, the High Dividend Yield ETF has put up five-year returns of 15.44% annually vs. 15.22% for Vanguard's S&P 500 index fund, with more of its return coming in the form of frequent dividends to its investors.
If you're looking for a low-fee way to own a diversified portfolio of more than 400 stocks that yield about 50% more than the stock-market average, the Vanguard High Dividend Yield ETF may be your best bet.
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Jordan Wathen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Johnson and Johnson. The Motley Fool owns shares of ExxonMobil, General Electric, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.