Could Buying the Vanguard Dividend Appreciation ETF Today Set You Up for Life?

The Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) is a popular dividend-focused exchange-traded fund (ETF) that has over $100 billion in assets. Clearly investors think it is a good investment, but is it the right investment for your portfolio? Can it set you up for life? Perhaps, but you should read this before you buy it.

What does the Vanguard Dividend Appreciation ETF do?

The Vanguard Dividend Appreciation ETF is an index-tracking exchange-traded fund. So the real question when trying to understand the ETF is, what does the index it tracks do? That index is the S&P U.S. Dividend Growers Index.

Image source: Getty Images.

The S&P U.S. Dividend Growers Index has a pretty simple stock selection approach. First, it takes all of the U.S. companies that have increased their dividends for a decade or longer. Second, it removes the highest-yielding 25% of the list. All of the remaining stocks are included in the index and weighted by market cap. That basically means that the largest companies have the biggest impact on the index's performance.

There are two notable takeaways here. The Vanguard Dividend Appreciation ETF, which tracks the S&P U.S. Dividend Growers Index, is focused on stocks that increase their dividends. And the Vanguard Dividend Appreciation ETF is not focused on generating the largest dividend it can, since the index it tracks specifically removed the stocks with the highest dividend yields from consideration.

VIG Total Return Price data by YCharts

How has the Vanguard Dividend Appreciation ETF performed?

As the chart above highlights, the Vanguard Dividend Appreciation ETF's total return has been fairly strong over time. While it lags the S&P 500 index (SNPINDEX: ^GSPC), much of that index's outperformance has occurred in just the last few years. And, notably, the income stream produced by the Vanguard Dividend Appreciation ETF has grown at a far more rapid clip than the one produced by an investment in the S&P 500 index.

From this perspective, dividend growth investors might find the Vanguard Dividend Appreciation ETF an appealing investment. There's just one small wrinkle. The dividend yield is only around 1.8% today. That's higher than the S&P 500 index's skinny little 1.2% yield, but not by a huge amount. As the ETF's investment approach suggests, the Vanguard Dividend Appreciation ETF is a total return investment, not an income investment.

If you are looking to live off of the income your portfolio generates, you would need a huge amount of capital for the Vanguard Dividend Appreciation ETF to set you up for life in retirement. It might be able to set you up for life if you buy it in your 20s, dividend reinvest, and benefit from the long-term dividend growth it is built to produce. That might result in a lofty yield-on purchase price when you retire. But if you buy it when you are 65 and ready to retire, the low starting yield could be a non-starter.

VIG Total Return Price data by YCharts

If you need a higher yield, you might be better off with the Schwab US Dividend Equity ETF (NYSEMKT: SCHD), which yields around 4% and has a similarly strong total return history. The Schwab US Dividend Equity ETF uses a screening process that focuses the portfolio on 100 stocks that combine high quality, high yield, and dividend growth. The Schwab US Dividend Equity ETF is far more likely to set you up with a lifetime of income if you need that income right away.

The Vanguard Dividend Appreciation ETF is good for some but not all investors

At the end of the day, the Vanguard Dividend Appreciation ETF is an attractive exchange-traded fund. It has offered strong total returns and a growing dividend. But what it lacks is a large dividend yield. If you are looking at the ETF because you need income, you'll probably be better with a different ETF, like the Schwab US Dividend Equity ETF.

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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.