Key Points
Vanguard Dividend Appreciation is a large ETF with $115 billion in total net assets.
Despite its dividend-investing mantra, the fund avoids some of the highest yielders in its universe of available stocks.
Most of the total return under ideal conditions will come from capital gains, not dividend income.
It's easy to see why investors are drawn to the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG). It's a low-cost and high-profile exchange-traded fund (ETF) with an aspirational goal. It invests only in stocks with at least a decade of annual dividend hikes. It aims to mirror the S&P U.S. Dividend Growers Index.
The Vanguard Dividend Appreciation is certainly popular. Investors have a collective $115 billion in the fund, making it one of the country's 20 largest ETFs by total net assets. It's a smart and sound choice for an investor looking to pick up a basket of stocks with a proven track record of consistently pushing their payouts higher, but it may not be for you.
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Let's start by going over the reasons why Vanguard Dividend Appreciation could be the perfect place for your next investment. Then, let's get into some of the nuances and knocks of the ETF that might make you look elsewhere.
This could be a buy for you right now
Vanguard has a strong reputation in the realms of mutual funds and ETFs. This may be reason alone to consider investing in Vanguard Dividend Appreciation, but let's dig deeper. A big reason for Vanguard's appeal with savvy ETF seekers is how it keeps ownership costs low. The fund has an annual expense ratio of a mere 0.05%. A $10,000 position will have only $50 doled out over the course of a year to cover operating expenses.
The market appreciates the low price of admission for Vanguard offerings. Among the rest of the mutual funds and ETFs specializing in companies with ascending distributions, Vanguard Dividend Appreciation is 6 times larger than its closest competitor.
Even retail investors who prefer to snap up individual names will find it hard to resist the ability to grab a basket of stocks with an impressive annual streak of juicing up their payouts with a single low-cost investment. Vanguard Dividend Appreciation also helps skim some of the risk off that list by not including all the investments that check the hike box.
It removes a quarter of the stocks that make the first cut, leaving out the highest-yielding names from the S&P U.S. Dividend Growers Index. The thinking there is that the higher-yielding names are often out of favor, packing chunky but potentially unsustainable distributions.
The remaining 75% of the stocks in the index then get allocated using a market-cap-weighted methodology, where no position is initially more than 5% of the total portfolio. The ETF is rebalanced annually, typically around March. There is only one position -- Broadcom (NASDAQ: AVGO) -- that currently makes up more than 5% of the fund. The tech infrastructure specialist has doubled over the past six months and commands the third-largest market cap of the companies in the index. It's currently 6.4% of the scorecard and likely to get pared back at the next rebalancing.
Despite the annual rebalancing and stocks entering and exiting the S&P U.S. Dividend Growers Index, the portfolio turnover rate is a modest 11% over the past year. Low management fees and low trading costs make Vanguard Dividend Appreciation a smart choice for cost-conscious investors looking for a play on successful companies with long runs of rising disbursements.
Image source: Getty Images.
This may not be a buy for you right now
The biggest potential deal breaker when it comes to Vanguard Dividend Appreciation is the surprisingly small quarterly distributions. If income is your top priority, you may feel disappointed by the current annual yield of 1.6%. Investing only in the 75% lowest-yielding members of the S&P U.S. Dividend Growers Index is part of the explanation, but a bigger ingredient is at play.
Companies with the ability to consistently boost their payouts are also likely investments with improving growth prospects. These stocks are more likely to attract growth over value investors. The largest contributor to the overall return of Vanguard Dividend Appreciation has historically been capital gains. The fund's total return has risen by nearly 11% over the past year, growing at a 13.5% annualized clip over the past 10 years. Capital gains account for more than 80% of those returns.
There's nothing wrong with healthy returns from appreciating assets, but it may be turnoff if you're looking for a high-yielding play from a fund with the word Dividend as a middle name. Dividend income is a secondary objective.
Vanguard Dividend Appreciation may also get panned by investors looking for a diverse collection of small-, mid-, and large-cap stocks. With its market-cap-weighting methodology, large cap stocks make up nearly 77% of the total portfolio. Small caps make up just 3% of the scorecard mix.
This also isn't a portfolio of cheap stocks. Vanguard Dividend Appreciation's weighted portfolio is trading for 26 times trailing earnings and 5 times book value. To its credit, this same basket of stocks has a healthy earnings growth rate of 12.5%. If you're looking for a large-cap growth fund with rising dividends as a theme, great. If you're looking for high-yielding value stocks, you may want to turn your attention elsewhere.
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Rick Munarriz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Dividend Appreciation ETF. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.