Exchange-traded funds, or ETFs, can be a great way to achieve strong long-term performance in your portfolio without much ongoing effort from you. Whether or not you invest in individual stocks, high-quality index funds can form a solid backbone to your nest egg and help give you peace of mind during turbulent markets.
Two excellent low-cost index fund ETFs are the Vanguard S&P 500 ETF (VOO 1.16%) and the Vanguard High Dividend Yield ETF (VYM 0.69%). While it's tough to make a good argument that either ETF is a bad choice, there are some key differences between them.
Two low-cost ETFs with excellent portfolios
The Vanguard S&P 500 ETF is a bet on large American businesses. As the name implies, this fund invests in the 500 companies that make up the S&P 500 benchmark index, and it aims to match the performance of the index over time. And with a bare minimum annual expense of 0.03% of fund assets, the long-term performance should be extremely close to that of the actual index.
Since 1965, the annualized total return of the S&P 500 has been 10.2%. While there's no guarantee that the S&P 500 will match this rate of return going forward, the point is that over long periods of time, investing in the S&P 500 has been a winning strategy, and will likely continue to be one for the foreseeable future.
The Vanguard High Dividend Yield ETF, on the other hand, tracks an index of companies that pay above-average dividend yields. As of the latest information, the ETF had 557 stocks, and like the S&P 500, it is a weighted index, meaning that larger companies make up more of the fund's assets.
Just to give you an idea of what the fund invests in, top holdings include JPMorgan Chase, Broadcom, ExxonMobil, and Home Depot, just to name a few.
Important differences to know
Of course, the obvious difference between these two ETFs is that one is focused on income, while the other is not. Both pay dividends, but with yields of about 1.4% and 3%, respectively from the S&P 500 and High Dividend Yield ETFs, the latter is likely the natural fit for investors who rely on their portfolios for current income.
There are a few other key differences to keep in mind. For one thing, the Vanguard S&P 500 ETF is heavily weighted to megacap tech companies, so your performance will be more dependent on just a few large (and in some cases -- like with Nvidia and Tesla -- rather volatile) stocks.
In general, the stocks held by the Vanguard High Dividend Yield ETF tend to be more mature businesses, so the ETF is likely to be less volatile over time. To be sure, it can still experience rather large price swings over short periods, but overall, it's likely to be the less volatile of the two.
Another factor that is important to point out, especially in the current climate, is that dividend stocks tend to be more sensitive to interest rate fluctuations than their nondividend counterparts. The short explanation is that when yields from risk-free instruments (like Treasuries) rise, yields from "riskier" income investments like dividend stocks tend to trend higher as well. Since price and yield have an inverse relationship, rising rates put pressure on dividend stock prices.
To illustrate this, consider that since the Federal Reserve began its current rate hike cycle in March 2022, the Vanguard S&P 500 ETF has outperformed the High Dividend Yield ETF by nearly 11 percentage points.
Which is best for you?
There's no clear winner between the two. Both of these are fantastic ETFs with low fees and a high likelihood of strong returns over long periods of time. The best fit for you depends on your personal investment goals and risk tolerance, so be sure to keep the major differences in mind as you decide which is the best choice for your portfolio.
