XOM - Financial Freedom With VIG Vs. DGRW: Only One Is A Worthy Compounder

2024-01-17 07:45:00 ET

Summary

• Compound interest is a powerful tool for long-term wealth creation and financial independence.
• Dollar cost averaging into a low-cost ETF can minimize the impact of market fluctuations and provide diversification benefits.
• We compared VIG and DGRW side-by-side to see which one is a worthy long-term compounding vehicle.

Albert Einstein once said :

Compound interest is the eighth wonder of the world. He who understands it earns it ... he who doesn't ... pays it.

Compound interest is a powerful phenomenon where both the initial sum and accumulated interest generate returns, leading to exponential growth over time. Its ability to turn small investments into significant sums makes it a powerful force for wealth creation, giving even low- and middle-income earners hope of being able to one day achieve financial independence and a comfortable retirement.

One of the simplest paths to long-term financial freedom is to regularly invest in a low-cost exchange-traded fund ('ETF') through a process called dollar cost averaging. This investment strategy involves consistently investing a fixed amount of money at regular intervals into a pre-selected fund, regardless of market conditions. While it requires considerable discipline to implement over the long term, this approach minimizes the impact of short-term market fluctuations, as investors buy more shares when prices are low and fewer when prices are high.

Moreover, dollar cost averaging into a low-cost ETF offers several merits:

1. Low-cost ETFs typically have minimal expense ratios, reducing the drag on returns and allowing investors to retain more of their investment gains.
2. This strategy also provides diversification benefits inherent in ETFs, spreading risk across a broad portfolio.
3. By systematically investing over time, investors benefit from the compounding effect, potentially accumulating a larger portfolio at a lower average cost per share, while avoiding the temptation to try to time the market or allowing emotions to impact their commitment to saving and investing.

In this article, we will compare two popular ETFs - the Vanguard Dividend Appreciation Index Fund ETF ( VIG ) and the WisdomTree U.S. Quality Dividend Growth Fund ETF ( DGRW ) - based on their fitness as long-term compounders for a dollar cost averaging strategy.

VIG ETF Vs. DGRW ETF: Long-Term Track Records

As the chart below illustrates, DGRW has meaningfully outperformed VIG since DGRW's inception over ten years ago:

This outperformance appears to be particularly pronounced in the years since the COVID-19 outbreak, potentially implying something about their underlying portfolios and strategies. We will look at this further later in the article.

VIG ETF Vs. DGRW ETF: Expense Ratios

First, let's look at their expense ratios. DGRW sports a decent but not great 0.28% expense ratio whereas VIG has a very low 0.06% expense ratio. While 22 basis points may not seem like much when comparing two expense ratios, the difference is actually quite stark. First of all, DGRW's expense ratio is 4.7x greater than VIG's, meaning that investors will pay greater fees in the same proportion for holding DGRW relative to VIG over the long term.

For example, if you invest $500,000 into each of these funds and earn an average pre-fee annual return of 10% from each investment, after 20 years, you would end up paying a whopping $167,169 in fees for holding DGRW compared to just $36,515 for holding VIG. That equates to about one-third of your original principal going to pay investing fees to DGRW compared to a more reasonable 7.3% of your original principal going to pay investing fees to VIG.

What this ultimately means is that DGRW will need to continue to meaningfully outperform VIG over time to justify its higher expense ratio. While its past track record provides hope that it can do this moving forward, we first need to look into their differing portfolios and strategies to determine if this is likely sustainable moving forward.

VIG ETF Vs. DGRW ETF: Portfolio Breakdowns

DGRW's strategy is centered on trying to track the performance of U.S. large-cap companies that have a consistent track record of paying dividends. Moreover, its investment strategy focuses on dividend growth, aiming to include companies with a history of increasing their dividend payments over time, thereby providing investors with exposure to stocks that have the potential for both capital appreciation and a growing stream of income through dividends.

In terms of sector allocation, DGRW's focus on large cap stocks that pay out consistent dividends means that its portfolio has significant exposure to the tech sector with Technology constituting 28.29% of its portfolio, Health Care is second with 18.24%, Industrials is third at 12.86%, Financials is fourth at 11.75%, Consumer Defensive is fifth at 11.40%, and Consumer Cyclical rounds out its primary sector exposures at 10.20%. Energy, Basic Materials, Communications, Real Estate, and Utilities combine to make up the remaining 7.27% of its portfolio.

DGRW's top 10 holdings make up a whopping 36.84% of its portfolio, which is significant given that it has 300 total holdings in its portfolio. They consist of the following:

• Microsoft Corp ( MSFT ): 7.63%
• Apple Inc ( AAPL ): 4.76%
• AbbVie Inc ( ABBV ): 3.87%
• Johnson & Johnson ( JNJ ): 3.82%
• Broadcom Inc ( AVGO ): 3.48%
• The Home Depot Inc ( HD ): 3.07%
• Procter & Gamble Co ( PG ): 3.00%
• Coca-Cola Co ( KO ): 2.70%
• PepsiCo Inc ( PEP ): 2.29%
• Cisco Systems Inc ( CSCO ): 2.22%

Given that its top portfolio allocations are technology, health care, and consumer stocks, it makes a lot of sense that its top 10 holdings consist entirely of stocks from these sectors. That being said, its overweight exposure to large-cap technology in particular is quite telling and explains its outperformance since the COVID-19 outbreak given that technology stocks have boomed over that period due to two main catalysts:

1. The COVID-19 lockdowns accelerated virtual/internet-based businesses, thereby boosting technology stocks.
2. The AI boom of 2023 also sent many large cap tech stocks soaring.

However, we now believe that large cap tech stocks are mostly overvalued , and by a considerable amount in some cases. As a result, DGRW could have meaningful underperformance in store for it and it appears that its strategy is nothing particularly special. Rather, its emphasis on large cap dividend stocks just happened to direct it towards big tech at a time when big tech was in an epic bull market.

In comparison, VIG takes a bit of a more balanced and diversified approach to sector allocation as its focus is on selecting companies with track records of increasing their dividends for at least 10 consecutive years and does not exclude companies that are not large cap stocks. That being said, its holdings are somewhat market cap weighted, so it still is somewhat overweight large cap technology stocks.

As a result, Technology is its largest sector (23.77%), Financials is second (18.77%), Health Care is third (14.69%), Industrials is fourth (13.18%), Consumer Defensive is fifth (11.53%), and Consumer Cyclical is sixth (7.25%). Once again, similar to DGRW, Basic Materials, Energy, Utilities, and Communication stocks round out its portfolio, albeit with a bit higher combined percentage at 10.8%. The main difference between DGRW and VIG in their sector allocations is that VIG is more diversified in general and also has a much greater exposure to Financials stocks than DGRW does.

Meanwhile, this greater diversification is also evidenced by the fact that it has more total holdings (318) and also has less of its total portfolio concentrated in its top 10 positions (31.76%). These consist of:

• Microsoft Corp ( MSFT ): 5.31%
• Apple Inc ( AAPL ): 4.44%
• JPMorgan Chase & Co ( JPM ): 3.25%
• UnitedHealth Group Inc ( UNH ): 3.22%
• Broadcom Inc ( AVGO ): 3.14%
• Exxon Mobil Corp ( XOM ): 2.65%
• Visa Inc Class A ( V ): 2.63%
• Johnson & Johnson ( JNJ ): 2.49%
• Mastercard Inc Class A ( MA ): 2.35%
• The Home Depot Inc ( HD ): 2.30%

As you can see from these lists, there is considerable overlap between them, including the top two holdings for each fund. As a result, we can conclude that overall these two funds are quite similar in their portfolio breakdowns, with DGRW being a bit more concentrated in nature and placing greater weight on mega cap Technology and large cap Healthcare/Pharma stocks, whereas VIG is more diversified, including putting greater weight on Financials stocks.

VIG ETF Vs. DGRW ETF: Investor Takeaway

DGRW has a better track record than VIG has over the past decade. However, upon closer examination, we see that this is pretty much exclusively due to the fact that DGRW is a more concentrated bet on mega cap Technology stocks that pay dividends, whereas VIG is a bit better diversified. Over the long-term, we think that this will result in a negligible advantage - if any - for DGRW and in fact, from current valuations may very well be considered a disadvantage.

When you add in the fact that VIG's expense ratio is far lower than DGRW's, it becomes clear to us that VIG is the no-brainer choice between these two when looking for a worthwhile long-term compounder .

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