Why Dividend Investors Should Buy the Vanguard Dividend Appreciation ETF Instead of AGNC Investment

Dividend investors are often drawn to high yields like moths to a flame. When it comes to yields today, there are few that are loftier than AGNC Investment's (NASDAQ: AGNC) 15%-plus dividend yield. Yet if history is any guide, most investors would be better off buying the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) instead, even though it only has a relatively modest 1.8% yield. Here's why.

What do AGNC Investment and Vanguard Dividend Appreciation ETF do?

AGNC Investment is a mortgage real estate investment trust (mREIT). That's a fairly complex niche within the broader REIT sector. AGNC Investment buys mortgages that have been rolled up into bond-like investments, often making use of leverage to do so. Mortgage securities prices can be impacted by interest rates, housing market dynamics, and mortgage repayment trends, among other things. And they trade all day, so stocks like AGNC Investment can be fairly volatile.

Image source: Getty Images.

The Vanguard Dividend Appreciation ETF is a diversified exchange-traded fund (ETF). It tracks the S&P U.S. Dividend Growers index. That index starts by taking all of the U.S. companies that have increased their dividends for at least 10 consecutive years and then removes the highest yielding 25% of the list. The rest get into the index (and the ETF) based on a market cap weighting. Note that it is specifically avoiding the highest-yielding stocks.

Income versus total return and back to income again

Here's the interesting thing: AGNC Investment is very clear that income is not its primary goal. Management says its goal is "Favorable long-term stockholder returns with a substantial yield component." That means that delivering a strong total return, which assumes dividend reinvestment, is the main goal, and AGNC Investment has done reasonably well at hitting that target.

AGNC Total Return Level data by YCharts.

Looking at the entire span that both AGNC Investment and Vanguard Dividend Appreciation ETF have existed, AGNC Investment has provided a slightly better total return. But take a look at the dividend and price history of each of these investments. After early spikes in the dividend and price of AGNC, it has been all downhill. By contrast, the Vanguard Dividend Appreciation ETF's dividend payouts and share price have both generally risen over time.

AGNC data by YCharts.

A strong total return is great, but that metric is based on the assumption that you're reinvesting your dividends. Income investors are usually looking to live off of the dividends their investments generate, which means spending them. As the chart above makes very clear, AGNC Investment's dividend payouts haven't been sustainable, while the smaller payouts from Vanguard Dividend Appreciation ETF were sustainable and generally grew over time.

In fact, AGNC Investment has over time reduced its payouts by more than 60% while the total payouts from the components of the Vanguard Dividend Appreciation ETF have increased by more than 200%. For someone whose plans over that period involved using the dividends their portfolio generated to help cover their living expenses, it's pretty clear which investment would have been the better choice.

AGNC isn't a bad investment

AGNC Investment isn't a bad investment -- it's just one that requires a more nuanced view. Yes, its dividend yield is huge, but that doesn't necessarily make it a good income stock. The real gains from owning it come from reinvesting the dividends and focusing on total return, which is not what most dividend investors are likely to be doing. If you are trying to live off of the income your portfolio generates, the Vanguard Dividend Appreciation ETF, despite its much lower yield, will probably be a better choice for your portfolio.

Should you invest $1,000 in AGNC Investment Corp. right now?

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Dividend Appreciation ETF. The Motley Fool has a disclosure policy.