Dividend stocks have been a saving grace for investors seeking income in recent years, because other sources of investment income largely dried up due to low interest rates. The Vanguard Group recognized early on the value of dividend-paying stocks, and it runs two of the largest dividend-focused exchange-traded funds in the business.
Vanguard's two dividend ETFs have different ways of tackling the question of which dividend stocks are best for investors. For the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG), the key ingredient for a successful dividend stock is consistency in delivering rising payouts to investors year in and year out. Meanwhile, for those who just want the highest yield possible, the Vanguard High Dividend Yield ETF (NYSEMKT: VYM) uses a more straightforward approach. As it turns out, only one of these funds has managed to post better returns than the broader S&P 500 so far in 2018, and it's interesting to draw conclusions from the two ETFs' relative performance.
Image source: Vanguard Group.
Which dividend ETF is winning the race?
The winner of the race between these two Vanguard dividend ETFs so far in 2018 is Vanguard Dividend Appreciation. It's also managing to outpace the broad-market index tracker Vanguard S&P 500 ETF, albeit by only the slimmest of margins.
Vanguard High Dividend Yield, on the other hand, hasn't done nearly as well. It's trailing the market by almost exactly 5 percentage points so far in 2018, and it's underperforming its counterpart by an even larger amount.
However, when looking at a longer time frame, the situation is different. Over the past 10 years, Vanguard High Dividend Yield has posted average annual returns of 10.4%, just edging out the 10.2% figure for Vanguard Dividend Appreciation.
Why high-yield dividend stocks are under pressure
A closer look at the two funds shows some potential reasons for the difference in performance. High Dividend Yield has a lot of consumer stocks that have performed relatively poorly so far this year, many of them facing challenging conditions in their respective retail and consumer goods markets. Energy stocks also play a key role for High Dividend Yield, and the up-and-down movements in crude oil prices haven't been able to produce lasting gains for the major integrated oil companies that you'll find among the ETF's top holdings.
By contrast, Dividend Appreciation has been able to focus in on much better performers in the dividend space. Microsoft, for instance, doesn't have a particularly high dividend yield right now, weighing in at just 1.5%. But it's dedicated itself toward joining the growing number of technology stocks that are returning more of their capital to shareholders through dividends, and that new mission has earned it a top allocation of 4.5% of Dividend Appreciation's assets. In addition, even in the consumer space, Dividend Appreciation has been able to profit from success in names like Nike and Costco Wholesale -- strong industry leaders, but stocks whose dividend yields have historically lagged even the market average.
Which Vanguard dividend ETF is right for you?
When you look at short-term performance, it might seem like a no-brainer to go beyond simply looking at high-yield dividend stocks to focus on companies that have been able to grow their dividends over time. But when you look beyond 2018, it's not nearly as clear-cut. Sometimes high-yield stocks dominate. Performance depends on many factors, ranging from the direction of interest rates and the overall stock market to the strength of various sectors of the economy.
Either Vanguard High Dividend Yield or Vanguard Dividend Appreciation can be good investments for dividend investors. Even with Dividend Appreciation leading so far in 2018, history has shown that you can't go wrong with either of these top dividend ETFs over time.
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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Dan Caplinger owns shares of Vanguard Dividend Appreciation ETF. The Motley Fool recommends Costco Wholesale and Nike. The Motley Fool has a disclosure policy.