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If you’re looking for some more sophisticated investment discussion than you typically find on Reddit, I would suggest checking out the Bogleheads forum. It is largely populated by followers John C. Bogle And his philosophy around low-cost index investing. Although different portfolio implementations vary, the basic principles remain the same: keep fees low, diversify widely and stay the course.
Naturally, this makes Bogleheads quite skeptical of many modern alternative investment products. Most are not fans of covered call ETFs because systematically selling to the upside can impact long-term total returns. They dislike many buffer ETFs because of their higher fees and more complex payment structures. And generally speaking, most Bogleheads aren’t particularly enthusiastic about dividend investing.
However, there are some exceptions. One of the rare dividend ETFs that gets a relatively positive reception from that crowd Vanguard Dividend Appreciation ETF (NYSEARCA: VIG). That’s why VIG stands out even for these hardcore passive investors.
What is VIG?
VIG is a passive ETF that tracks the S&P US Dividend Growers Index. The primary screen requires companies to have at least a 10-year history of consistent dividend growth, which immediately creates a quality bias within the portfolio. Additionally, the methodology applies another important filter: it excludes the top 25% highest-yielding companies.
It may seem counterintuitive at first to have a dividend ETF, but it actually serves a very useful purpose. By removing the highest-yield quartile, VIG removes many potential yield traps, which are companies whose dividend yields appear to have increased largely because their share prices have fallen due to deteriorating business fundamentals.
From there, the remaining companies are weighted by market capitalization, but unlike the S&P 500, no individual stake can exceed 4% upon rebalancing. Today, VIG holds 332 companies and leans toward large-cap stocks.
The valuation at 25.9x earnings isn’t exactly cheap, but the quality of the portfolio is extremely strong. The ETF currently returns an average of 29.4% on equity with an 11.5% earnings growth rate. The 1.56% 30-day SEC yield won’t excite income-focused retirees looking for a massive payout, but that’s not really the point of this ETF.
VIG is primarily a total return vehicle. And historically, it has worked very respectably. Over the past 10 years, the ETF has grown at a compound annual rate of 13.06%. However, the biggest reason why bogleheads love it is because of the cost reduction. VIG only charges a 0.04% expense ratio.
Use cases for VIG
Personally, I think VIG has the potential to outperform the S&P 500 over certain market cycles. Now, it hasn’t done this in the past decade, but it makes sense when you consider that the strategy naturally excludes or undervalues many of the highest-flying technology names that have recently made a comeback in the market.
companies like Tesla, NVIDIAAnd Palantir Technologies Either pay no dividends or keep the yields too low to make a material contribution to the portfolio. But given where we currently stand in this market cycle, I think there’s a valid argument for focusing more on quality and reducing the concentration risk associated with mega-cap technology stocks.
VIG accomplishes this very cleanly. And unlike many factor ETFs that explicitly target quality or dividend growth, this one does so without charging excessive fees. At a rate of 0.04% annually, you’re paying just $4 per $10,000 invested. This is extremely appropriate.
I also think VIG is an important step forward for investors who are curious about dividend investing but hesitant to abandon broad market investing entirely. You can pair it with a traditional S&P 500 ETF as a hedge, or if you like its quality bias and slightly lower volatility profile, you can even use it as the core of a long-term portfolio.
Just don’t pay too much attention to headline yields. The real appeal here is the total return, and on that front, VIG quietly outperforms many of the higher yielding covered call ETFs sought by investors chasing income.