Key Points
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When choosing dividend stocks or ETFs, it’s important to look beyond just the yield figure.
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Ultimately, total returns are what matter. The Vanguard Dividend Appreciation ETF (VIG) shows that dividend growth has outperformed over the past decade.
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Investing in dividend growth stocks means you can count on financially healthy companies and steady pay increases that often beat inflation.
- 10 stocks we like better than Vanguard Dividend Appreciation ETF ›
When it comes to investing in dividend stocks, there are two broad strategies you can choose from: dividend growth stocks or high-yield stocks.
Each strategy has its advantages and disadvantages.
Dividend growth stocks often come with lower yields. The Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) currently pays just 1.5%, but it invests in the more financially durable companies that are able to sustain and grow their dividends over time.
High-yield stocks pay higher current income right now. The Vanguard High Dividend Yield ETF (NYSEMKT: VYM) yields around 2.3%, but there’s typically no consideration given to the company’s financial health. They may or may not be able to continue paying that yield.
In my opinion, income investors seek out dividend stocks because they’re reliable, predictable, and often of higher quality. That’s why if I had one thing I could tell every dividend investor right now, it’s this:
Dividend growth offers a better long-term setup than high yield.
Why dividend quality beats yield
Many income seekers focus on an investment’s yield first before considering other factors. It makes sense since the dividend is what shows up in your account now.
Regardless, total return is what matters. Over the past decade, which considers returns beyond just the current artificial intelligence (AI) boom, the Vanguard Dividend Appreciation ETF has beaten the Vanguard High Dividend Yield ETF by an average of 1.4% per year. Shareholders of the latter might have received bigger quarterly payments, but they also gave up more in capital appreciation in the process.
One of the big advantages of dividend growth stocks is that you can count on your income to consistently grow. High-yielders can’t make that claim. They may have a higher yield to begin with. But whether it rises or falls from there is a big unknown.
The yield of dividend growers may be lower, but if that annual dividend is increasing by 5% per year, you’re getting regular raises and likely staying ahead of the purchasing power damage being done by inflation.
And that’s a major consideration right now. The current inflation rate is more than 4%, and it could be months before it comes back down. The Iran war shows no signs of ending. Since the biggest source of inflation risk right now is the energy sector, this could be a problem that sticks around for a while.
The overall idea I’m suggesting here is to look beyond just the yield a dividend stock or ETF is offering. Dividend growers usually offer a combination of inflation-beating income increases and balance sheet quality that some high-yield stocks can’t.
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David Dierking has positions in Vanguard Dividend Appreciation ETF. The Motley Fool has positions in and recommends Vanguard Dividend Appreciation ETF and Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.
