Vanguard Dividend Appreciation ETF: There Are Better Alternatives (NYSEARCA:VIG)

Investors looking for passively increasing investment income might consider Vanguard Dividend Appreciation Index Fund (NYSEARCA:VIG) in their overall strategy. As a Vanguard product, this ETF is well-established with $80 billion in assets under management and comes with ultra-low expenses (0.06%). Vanguard is a top firm in the passive investing realm. Read on to the end of this article to see how this ETF really measures up.

The Vanguard Dividend Appreciation Index Fund holds a portfolio of publicly traded equities that have a history of increasing dividends over time. The fund seeks to track the performance of the S&P U.S. Dividend Growers Index. The fund’s holdings are diversified across multiple sectors and industries and include companies such as Microsoft (MSFT), Johnson & Johnson (JNJ), and Procter & Gamble (PG).

Using a dividend appreciation strategy is an important and sometimes overlooked way to generate passive investment income. It is a type of strategy that focuses on choosing equities with dividend payments made by companies that are growing earnings and increasing payouts. These companies often have a strong history of increasing their dividend payments over time. This can be done through stock investments, mutual funds, and perhaps most-importantly exchange-traded funds (ETFs).

The concept of dividend appreciation investing is rooted in buying strong companies that consistently increase their dividends. Partly, the strategy is centered on the idea that companies that pay consistent and growing dividends are likely to be financially sound and well-managed. The increase in annual dividends is a sign of the company’s continuing success, and investors can benefit from this by owning shares of the solid company and collecting the increasing and consistent dividend payments.

As the dividend payments increase, the value of the investment often also increases, resulting in a higher passive cash income but also capital gains. Dividend appreciation investing is a long-term strategy, and investors should be aware that the overall market can go down and bring these stocks with them. This investing strategy is best suited for investors who are looking for a steady stream of passive dividend income over the long-term.

As you can see here, Vanguard Dividend Appreciation Index Fund and SPDR S&P 500 ETF Trust (SPY) both have negative total returns year-to-date. However, VIG has outperformed SPY during this period, only dropping -9.69% when accounting for dividends, while the broader index has a total return of -18.07%. The payment of dividends has helped this index to perform with less overall volatility.

Over the long-term, the difference swings the other way. As you can see here, the broader SPDR S&P 500 ETF Trust returned 222.9% over the past ten years, when including dividends. However, Vanguard Dividend Appreciation Index Fund returned a respectable 210.1%, much of which was cash dividends paid to the investor. Many investors may accept cash dividends instead of capital gains, especially when the results are so similar.

How does VIG really measure up against SPY or VOO?

In theory, a dividend appreciation strategy sounds like a way to create strong cash flows with capital appreciation. At this time, however, investors might just consider buying an index fund like SPDR S&P 500 Trust ETF (SPY) or Vanguard S&P 500 ETF (VOO). There simply isn’t enough outperformance in Vanguard Dividend Appreciation ETF (VIG) to justify this purchase over the broader index.

When comparing the dividend yield, VIG has a paltry 1.95% yield at this time. Compare this to SPY at 1.66% and VOO at 1.7% and you see that the difference is very small. Yes, VIG does pay more, but you would see to have a significant amount of money invested in this fund to receive a dividend that adds more than a few hundred dollars.

Weigh the dividend yield against the dividend growth rate and you see that these are also nearly the same. Over the past ten years, these three funds, VIG, SPY, and VOO, have all grown dividends by 7.74%, 7.37% and 7.69%. There’s no significant difference in dividend growth between these options.

Vanguard actually makes a handy comparison tool to look at their different fund options. Related to valuation, you may think that the Vanguard Dividend Appreciation ETF might present a better valuation, but actually the opposite is true at this time. On a trailing basis, Vanguard S&P 500 ETF actually looks cheaper with higher earnings growth. This could be due to a flight to quality during the past year, as equity markets have sold off.

Consider Vanguard High Dividend Yield ETF Instead

If you are relying on dividend income, and want long-term capital appreciation, there is a better option out there. Vanguard High Dividend Yield ETF (VYM) offers a 2.99% yield, which is almost double the S&P 500 dividend yield. Further, the ETF has a 10 year dividend growth rate of 7.4%, which is comparable to the S&P 500 over that period.

Another positive here, for the risk averse investor, is that the ETF has actually had a positive overall return for the past year, while the broader market has been dropping.

Regarding valuations, these stocks fall into the value territory. The overall P/E ratios on these equities are 31% lower than VIG and P/B ratios are 39% lower.

All of this isn’t to dissuade the average investor from purchasing the Vanguard Dividend Appreciation Index Fund. They should simply be aware that the Vanguard High Dividend Yield ETF offers a higher dividend yield with similar dividend growth rates and Vanguard S&P 500 ETF offers lower valuations and similar dividend yields and growth rates.

Dividend appreciation investing can be a great way to generate increasing passive income and increase returns over the long-term. By investing in equities that pay increasing dividends, investors can benefit from the steady growth in passive cash income and have the added benefit of the potential appreciation of the stock price. Vanguard Dividend Appreciation Index Fund is a great option to accomplish these goals with minimal expense, but investors should also consider Vanguard High Dividend Yield ETF or Vanguard S&P 500 ETF.