Surging Bond Yields: A Double-Edged Sword for Investors

Investors seeking income have reason to rejoice as bond yields surge. However, for those who already hold bonds in their portfolios, this development can be a drag, as bond prices tend to fall when yields rise. Fortunately, there is an alternative for income hunters—dividend funds.

Rise in Bond Yields Signals Change

After a prolonged period of near-zero levels, bond yields have been climbing steadily. In fact, the yield on the 10-year Treasury note is now approaching 5% for the first time since July 2007.

Morningstar’s Upgrade: A Boost for Income Seekers

Recognizing the changing landscape, Morningstar has upgraded the process ratings on four dividend exchange-traded funds (ETFs). This upgrade offers investors seeking regular income from dividend stocks an advantage when it comes to choosing their investments.

Diversifying Sources of Income

Bryan Armour, the director of passive strategies research for North America at Morningstar Research Services, advises investors to consider multiple sources of income. With the potential for higher interest rates and increased inflation, staying solely invested in bonds could prove challenging. Historically, having exposure to stocks alongside bonds has resulted in better long-term returns.

Introducing the Top ETFs for Dividend Investors

Let’s take a closer look at the four dividend ETFs that Morningstar has identified as “best in class”:

1. Schwab U.S. Dividend Equity ETF (SCHD)

   • 12-month dividend yield: 3.7%
   • Strategy: Focuses on companies with a long history of paying dividends and solid yield expectations
   • Holds a well-balanced portfolio of 100 stocks, with top holdings including Amgen (AMGN), Broadcom (AVGO), AbbVie (ABBV), Chevron (CVX), and Merck & Co (MRK)

2. Vanguard High Dividend Yield ETF (VYM)

3. Vanguard Dividend Appreciation ETF (VIG)

4. Vanguard International Dividend Appreciation ETF (VIGI)

Each of these ETFs not only excels in identifying different types of dividend companies but also boasts a robust equity portfolio.

With the rise in bond yields, now is the time for income hunters to explore alternative options. Dividend funds offer a compelling solution, providing regular income while potentially delivering better long-term returns than bonds historically have.

Vanguard High Dividend Yield ETF: A Consistent Performer

The Vanguard High Dividend Yield ETF has established itself as a top performer in its category, consistently outperforming its peers with impressive annualized returns of 10.79% over a period of 10 years. In fact, it is in the top one percentile among funds in the same category, setting it apart from the other 99%. Furthermore, it has managed to achieve this level of success while maintaining below-average volatility, as confirmed by Morningstar.

A Winning Strategy for Success

The ETF’s strategy revolves around selecting and weighting U.S. large- and mid-cap stocks, excluding real estate investment trusts, based on their expected dividend yield in the coming year. By focusing on the higher-yielding half of eligible dividend-paying stocks and using market capitalization to determine their weights, the fund adopts a straightforward approach that has proven to be highly effective in leveraging the market’s pricing of different stocks.

The inclusion of a market-cap weighting system also ensures that the portfolio is tilted towards larger, more stable stocks. With over 450 stocks in its holdings, the fund can effectively mitigate the impact of any potential value traps that may arise. Additionally, as the price of certain stocks falls, their percentage within the portfolio decreases proportionally. This has greatly minimized the risks associated with dividend and value investing.

Vanguard Dividend Appreciation ETF: Quality and Stability Across Geographies

In a similar vein, both the Vanguard Dividend Appreciation ETF and Vanguard International Dividend Appreciation ETF follow a strategy that focuses on companies with a proven track record of increasing dividend payments over a period of 10 years. This stringent criterion ensures that only high-quality, stable businesses make it into the funds’ holdings.

The Vanguard Dividend Appreciation ETF boasts a 12-month dividend yield of 2.04%, while its international counterpart offers a slightly higher yield of 2.24%. These figures reflect the steady income potential that investors can expect from these funds.

Conclusion

With a well-defined investment approach and a history of strong performance, the Vanguard High Dividend Yield ETF has consistently delivered impressive returns. Its market-cap weighted portfolio and focus on high-quality, dividend-paying stocks have proven to be a winning combination. Similarly, the Vanguard Dividend Appreciation ETF and Vanguard International Dividend Appreciation ETF adopt a similar strategy, offering investors the opportunity to tap into quality and stability across different geographies.