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Is Vanguard High Dividend Yield ETF a Buy?

Dan Caplinger, The Motley Fool

Dividend stocks offer a great combination of current income and potential growth opportunities, and many investors have turned to the Vanguard High Dividend Yield ETF (NYSEMKT: VYM) to get a diversified selection of high-yielding dividend stocks in a single package. With many high-yield stocks also having defensive characteristics, some conservative investors like funds such as the Vanguard ETF as a way of protecting against market downturns.

Yet as we saw in early February, even dividend exchange-traded funds (ETFs) aren't entirely invulnerable from falling markets. That's made some investors think twice about whether Vanguard High Dividend Yield is really a good buy right now. Below, we'll take a closer look at the dividend ETF to see whether it has the legs to last through whatever turbulence the market throws its way.

Letters ETF spelled out in white mosaic tiles on a background of gold mosaic tiles.

Image source: Getty Images.

The ups and downs of Vanguard High Dividend Yield

Last year, investors in Vanguard High Dividend Yield didn't have much to complain about. The ETF's total return of around 16% to 17% wasn't quite as strong as the overall market, but that's a price that most investors in the fund are willing to pay in exchange for the perceived lower volatility that dividend stocks have traditionally delivered.

The Vanguard ETF also got out to an even better start to 2018. January's big gains sent the ETF higher by more than 6% at its best point, and many investors predicted even better times ahead for the fund thanks to positive impacts from U.S. tax reform and strong corporate fundamentals.

However, the good times quickly came to an end in late January and early February. Fears about higher interest rates took their toll on the overall market, and Vanguard High Dividend Yield took an especially large hit. The ETF's shares lost more than 10% of their value between Jan. 26 and Feb. 8, offering no real protection compared to the similar 10% correction that major market benchmarks like the S&P 500 and the Dow suffered.

Why Vanguard High Dividend Yield didn't cushion the blow

A big part of the reason Vanguard High Dividend Yield didn't give investors relatively smaller losses during the recent sell-off has to do with the nature of what caused the correction. Yields on 10-year Treasuries moved sharply higher, with some predicting that they'd eventually hit the 3% level as a result of the upward push. Even though the Vanguard ETF holds plenty of dividend stocks in areas that aren't rate-sensitive or can even benefit from rising rates, many of the dividend-paying giants in its portfolio were among those stocks that led the market to the downside.

More importantly, it's unfair to draw too firm a conclusion from a single downturn in the market. In the past, there have been several occasions during which the Vanguard ETF produced considerably smaller losses than the overall market during periods of poor performance for major market benchmarks. As bond rates start to rise, it's indeed possible that some income investors will shift away from dividend stocks back toward fixed-income investments like bonds and bank CDs. Yet on the whole, given their positive experience both with receiving more income than they could get from the fixed-income sector in recent years and the potential for capital appreciation over the long haul, dividend stocks and the ETFs that own them have demonstrated their long-term value to the investors who've gravitated toward them during the low-rate environment of the past decade.

A solid choice for investors

In the short run, anything's possible for the market, and so making a purchase of Vanguard High Dividend Yield ETF right now isn't sure to make you big money in the next month or even the next year. Yet nothing about the ETF's response to the most recent downturn raises long-term questions about its viability as a suitable dividend-paying investment for most investors. If you need income from your portfolio and want some of the favorable attributes that dividend stocks have, then the Vanguard High Dividend Yield ETF is a smart choice for you.

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Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.