If you’ve ever considered adding a dividend ETF to your portfolio, you’ve probably at least looked at the Vanguard Dividend Appreciation ETF (VIG) and the Vanguard High Dividend Yield ETF (VYM). They’re currently two of the three largest dividend ETFs in the marketplace. They’re ultra-cheap. They come from one of the largest and best-known investment managers in the world. They check all the main boxes for an investment fund.

If you look at almost any list recommending the “top” or “best” dividend ETFs for your portfolio, one or both of these almost always show up. I’ve written about them plenty in the past myself. It’s natural to sort of gravitate towards VIG and VYM if you’re looking to invest in dividend stocks and I think that’s natural.

In my dividend ETF rankings, VYM lands at #2 and VIG comes in at #3, behind only the SPDR Portfolio S&P 500 High Dividend ETF (SPYD). Those rankings, however, are based solely on quantitative factors, such as expense ratios, trading costs and diversification. Those are certainly good starting points when it comes separating the good from the less good, but it doesn’t tell the whole story. They can’t quantify investment objectives, index construction or targeting criteria. These are as or more important than just a low expense ratio, which is why investors always need to look under the hood before investing.

On that front, I’ve been a little less impressed with VIG and VYM, particularly the latter one.

Vanguard Dividend Appreciation ETF (VIG)

VIG tracks the S&P U.S. Dividend Growers Index. It targets companies that have increased their dividends for at least 10 consecutive years, while eliminating the top 25% highest yielding eligible companies in order to eliminate the risk of potentially artificial high yields being included. The final portfolio is market cap weighted.

Not that VIG’s targeting strategy is necessarily bad, but I prefer those that take a multi-pronged approach. Evaluating stocks based solely on their dividend growth history doesn’t give any consideration to the present or the future. In 2023, we saw Big Lots, Newell Brands, Taiwan Semiconductor and Intel all cut their dividends. Walgreens, which had a nearly 50-year streak of dividend growth, reduced its dividend in the first week of 2024. Clearly, some big name companies are demonstrating some vulnerability when it comes to dividend sustainability. VIG doesn’t do anything to identify or screen those out.

A strategy that pairs dividend growth with a quality screen makes more sense. The iShares Core Dividend Growth ETF (DGRO) does this.

Vanguard High Dividend Yield ETF (VYM)

VYM tracks the FTSE High Dividend Yield Index. The strategy starts with a broad universe of U.S. stocks and ranks them according to forecasted dividends over the next 12 months with the top half making the cut. Qualifying stocks are then weighted by market cap.

I have issue with this fund for a couple of reasons. First, the screening process is way too loose. Any stock (REITs are excluded) that pays an above average yield makes the cut? If you’re looking for a high dividend yield ETF, you ideally want something that’s a little more targeted and concentrated. VYM’s generalized approach increases diversification, but the 3% yield doesn’t compare very favorably with other high yield funds in this space that are offering 4-5%, a direct result of its overly broad scope.

Second, the market cap weighting just emphasizes the biggest companies, not the companies with the biggest dividend payouts, like WisdomTree does, or even the highest yields. Both of these factors combined give VYM a far too vanilla approach to constructing a high yield portfolio and ultimately becomes less effective than other options, in my opinion.

That being said, they’re used by a lot of income seekers, so it makes sense to view them both individually and collectively. With that in mind, I want to try to answer two questions today…

• How do VYM & VIG fit together in a portfolio?

• As a pair, do they do enough to effectively offer “complete” dividend stock coverage?

How Do VYM & VIG Fit Together?

To start, we need to look at the factors of both ETFs to see where there are similarities and differences. VIG’s focus on dividend growth and VYM’s on high yield bodes well for its diversification potential based on the difference in strategy alone. But I like to look at the factor differences between two ETFs when assessing whether they’re a good fit for each other.

Let’s start by looking at VIG and VYM individually first.

VIG’s category benchmark according to Morningstar is “Large Blend”. In other words, think the S&P 500. Comparing a dividend growth portfolio to a tech & growth driven benchmark should produce some fairly obvious results and it clearly does.

VIG rates as below average on the growth front and above average on yield. Shouldn’t be surprising at all.

I don’t tend to focus on the momentum factor much. It’s just driven by what’s hot at the moment and doesn’t really tell us much as to how it relates to a fund. The fact that VIG’s momentum range is all over the spectrum confirms that notion.

The fact that VIG scores as below average on the quality front surprises me a little. Dividend payers tend to be more durable and have stronger balance sheets. We’ll come back to this in a bit when we examine the Fama-French factor analysis as a cross check to this one.

Volatility rates as low. Again, not surprising.

VYM is almost entirely on the extremes of the factor ranges. It’s very much value-tilted and, while the extent to which it leans towards value raises some eyebrows, high yield portfolios are almost always value-oriented. They tend to lean heavily into cyclicals, such as financials, industrials and energy, which gives them a different sector exposure profile than other styles of funds.

Yield is well into the high end. Not surprising.

The quality factor, however, is way on the low end, something that’s relatively common with these kinds of ETFs. Funds that select purely on yield usually give no consideration to fundamentals or balance sheet health. Just because a fund has a high yield doesn’t mean its components are cash flow heavy. The stock price could be down. It could potentially be considering a dividend cut. The fact that VYM is so diversified eliminates a lot of idiosyncratic risk, but there’s a broader risk to getting involved in high yielders.

Next, I want to look at how these funds rate on the Fama-French factors. As a refresher, here are the five factors we’ll examine.

• Market exposure factor (Rm-Rf)

• Small company factor (SMB)

• Value factor (HML)

• Profitability factor (RMW)

• Conservative investment factor (CMA)

I’m going to measure VIG and VYM against both the S&P 500 (SPY) and the WisdomTree U.S. Total Dividend ETF (DTD), my usual proxy for the broad dividend stock universe.

The high market exposure factor scores just mean that most of the returns of these funds are driven by the returns of the market. All four rate as having below average small cap exposure. Not surprises so far.

VIG rates better on the profitability factor, but all funds have statistically significant exposures to higher quality companies. This runs counter to what we learned when looking at the Morningstar ratings, but Fama-French has a longer lookback period. I’d give stronger consideration to what Fama-French is telling us.

As expected, all three dividend ETFs have above average factor loadings to the conservative investment factor.

VYM and DTD both have heavy value exposure, but VIG rates as neutral, something which is a bit surprising. One possible explanation is its more lax requirement of a 10-year dividend growth history. We’ve seen a number of tech companies start to fall in this “emerging” dividend grower category, which is likely upping the growth factor slowly over time. Since VIG gets market cap weighted, the biggest tech names end up getting the biggest portfolio allocations, even if they barely qualify to be in the fund at all. As a result, you get Microsoft, Apple and Broadcom as three of the fund’s four largest holdings, comprising 13% of the portfolio’s assets combined.

We see that confirmed in looking at VIG’s sector exposures relative to VYM.

VIG has a much larger allocation to tech, while VYM is overweight in several of the cyclical and defensive sectors. The 52% overlap in assets is a little surprising. I would have thought there was a little more separation given how dividend growth vs. high yield are disparate strategies with little inherent similarity.

Do VYM & VIG Constitute A Complete Dividend Portfolio?

They don’t necessarily do a bad job, but I think there’s room for improvement.

First, the positives…

• VIG tends to be a low yielder, while VYM, obviously, focuses on high yield. The combination of the two together gives you a good balance.

• Even though there’s no specific call out or strategy to consider quality, Fama-French suggests they both are overexposed to profitable and conservatively invested companies as a byproduct anyway.

• VIG’s inclusion provides some unexpected growth pop, something that’s usually missing in dividend equity strategies.

Now, the negatives…

• The 52% overlap in the two portfolios limits some of the benefits of diversification.

• I’m a fan of using all three pillars - dividend growth, dividend quality and high yield - in a complete dividend strategy. The VIG/VYM combo only targets two of those pillars. Tagging on a fund, such as DGRO, or even a lesser-known dividend ETF, such as the ALPS O’Shares U.S. Quality Dividend ETF (OUSA) or the Global X S&P 500 Quality Dividend ETF (QDIV), might be a good addition.

Conclusion

Therefore, I’d rate the VIG/VYM combination as good, but not great, for complete dividend coverage. Adding a quality-focused ETF to the pair would be a good option as would just going with DTD instead and grabbing the entire dividend stock universe.

I don’t see any reason to rush out and make radical portfolio changes if you own VIG, VYM or the pair, but a tweak here or there could also be helpful.