VYM ETF: There Are Better Dividend Funds (NYSEARCA:VYM)

I totally get the appeal of holding a reputable ETF such as the Vanguard High Dividend Yield Index Fund (NYSEARCA:VYM). Dividend ETFs offer instant diversification, a decent starting yield, and an easy-going investing experience. I can’t help but come to the conclusion that you are doing yourself a disservice, though. Underperformance compared to the (SPY) and its brother, Schwab U.S. Dividend Equity ETF (SCHD).

However, I do believe that VYM provides a low-risk set of holdings that can provide any investor with a “buy and forget” type of investment style. I understand that many people have different levels of risk tolerance, but I think VYM is not capable of delivering exceptional total returns. Therefore, VYM is a pass for me as funds are better allocated elsewhere.

Funds Overview

VYM is an exchange-traded fund (‘ETF’) that tracks a proprietary Index originating from the FTSE Global Equity Index. This index covers almost the entire U.S. equity market. Vanguard’s selection process for the index holdings is based on projected dividend yield and yield stability.

Funds like VYM are extremely popular within the dividend investing community for the low expense ratios and the diverse set of holdings in blue-chip names. These are both great foundations of any portfolio, but I have trouble determining why anyone would choose to hold VYM at the moment. This is especially true if you are looking to capture Total Return over a long time span.

We can see in the illustration below that VYM sort of follows the price movements of the SPY, but it severely underperforms, even against SCHD.

Diversity

VYM Holdings

Looking at the sector breakdown, we can conclude that VYM is set to be defensive in its strategy. This is what makes it such a great foundation for dividend portfolios. It enables investors to invest stress-free and capture some great names: Johnson & Johnson (JNJ), Exxon (XOM), JPMorgan (JPM), and Home Depot (HD) are all great dividend stocks with a proven history of delivering results, stable income, and appreciation.

The health care, utility, and consumer defensive sectors collectively make up 38% of the ETF’s holdings. The fund’s exposure to cyclical sectors, including industrials, financials, consumer cyclicals, and technology, is substantial, constituting nearly 50% of its assets. Moreover, the ETF demonstrates notable involvement in the energy sector’s cyclical companies. At the forefront of this fund’s allocation is the financial sector.

Given the increasing indications of an economic slowdown and the Fed’s commitment to raising rates, market volatility is expected to persist. While VYM has delivered commendable performance over the last decade, it’s likely to significantly lag behind most dividend funds during a recession. Additionally, the Vanguard ETF’s minimal income payout and low yield are unlikely to change going forward. As markets grapple with formidable challenges, dividend investors can uncover more appealing income opportunities that also promise superior total returns in the prevailing economic environment of investing.

Low Expense Ratio

Something that does stand out for VYM is an extremely low expense ratio. VYM currently has an expense ratio of 0.6%.

An expense ratio of 0.6% places this fund among the most competitively priced in the market, offering substantial cost savings compared to higher-priced alternatives. This cost-effectiveness is particularly crucial for investors seeking to optimize their returns over extended investment horizons. By keeping expenses to a minimum, VYM empowers investors to compound their wealth more efficiently, translating into greater potential for wealth accumulation over time.

Moreover, a low expense ratio aligns with the philosophy of dividend growth investing, which emphasizes the long-term benefits of steady, consistent growth. By minimizing costs, this can enable investors to retain a larger share of the dividend income generated by their holdings. This steady stream of dividends, when reinvested, can further enhance the power of compounding, ultimately contributing to the growth of investors’ portfolios.

This sounds great in practice, but the reality is that even though VYM has a low expense ratio, the dividend growth rate has been underwhelming compared to similar funds.

Underwhelming Cash Flow

VYM’s extensive, 400-plus holdings, contribute significantly to its lackluster performance in terms of Total Return against the S&P 500 over the past decade. In my opinion, VYM is a clear case of overdiversification.

While VYM’s broader diversification may provide some level of stability and confidence, the lower exposure to industries experiencing substantial growth will ultimately keep this ETF underwhelming.

Furthermore, with inflationary pressures as an ongoing concern, VYM’s dividend of 3% is very underwhelming for an ETF that aims to provide investors with cash flow. Examining the portfolio breakdown reveals that REITs are nonexistent to VYM, thereby constraining a portion of the dividend income that may be possible. Seeing consistent growth in dividend payments helps safeguard against the eroding effects of inflation, but this has not been the case with VYM. The dividend growth has also been very underwhelming.

During a time when inflation is high, the cost of living is rising, housing is off the charts, and credit card debt has surpassed $1 trillion, more and more investors are looking for additional sources of income to make their money work for them. VYM’s dividend growth rate is approximately 4.32%, but this lacks in comparison to the median dividend growth rate of 16.12% for equivalent ETFs.

I would sell VYM if the dividend yield were to sink below 3%, which we are very close to. Secondly, I would move funds from VYM into SCHD if the average 5-year dividend growth rate average were to fall below the 5% mark.

I Would Reconsider My Position If

I would reconsider my stance on VYM if the portfolio composition contained more technology-based holdings that are more likely to capture the upside swings in the market. As it stands, VYM will always underperform in my opinion because of the lack of tech in my opinion. I would possibly feel different about the lack of technology holdings if the dividend growth rate was better. Underperformance in price would be a bit more acceptable if the income generation was higher. As it stands, a current 3% dividend yield with a lackluster dividend growth rate compared to its competitors isn’t attractive. If the starting yield was in the 5% territory, then the conversation may be a little different.

Conclusion

Ultimately, I have no interest in starting a position in VYM as there are plenty of funds that provide more dividend income, have a better dividend growth rate, and are capable of capturing the upside from growth-ier based holdings.

While the appeal of holding a reputable ETF like the Vanguard High Dividend Yield Index Fund is understandable, it’s crucial to consider its performance in relation to other options. Dividend ETFs offer diversification and a convenient investing experience, but a deeper analysis reveals that VYM might not be the optimal choice for maximizing returns or income.

While VYM provides a low-risk portfolio suitable for a “buy and forget” investment style, it’s essential to recognize that its historical underperformance compared to benchmarks like the SPDR S&P 500 ETF Trust (SPY) and its counterpart, the Schwab U.S. Dividend Equity ETF, raises questions about its potential for delivering exceptional total returns over the long term.

Furthermore, the minimal dividend growth rate of VYM, at approximately 4.32%, falls far short of the median dividend growth rate of 16.12% for equivalent ETFs. In a context where inflation and rising costs are significant concerns, investors are seeking reliable income sources to counteract these effects. VYM’s lackluster dividend growth makes it less appealing, particularly considering the current economic climate.