2023-09-25 18:23:38 ET
Summary
- Building a passive income snowball is an effective approach to saving for retirement, providing peace of mind during market fluctuations.
- We discuss three reasons why Vanguard High Dividend Yield Index Fund ETF Shares could be all you need to make this happen.
- We also explore ways to supplement the VYM ETF to make up for its shortcomings.
Building a passive income snowball is arguably the most effective approach to saving for retirement. By relying on their passive income cash flow stream, retirees can enjoy peace of mind during bear markets and recessions, knowing they never need to liquidate their investments to pay for living expenses. As a result, they can effectively ignore short-term changes in the market value of their assets and instead focus solely on the income that they provide them with.
Moreover, passive income snowballs tend to throw off increasing amounts of passive income over time, as the larger a snowball gets, the more snow it gathers as it rolls due to its growing surface area. As a result, the passive-income snowball approach to investing can serve as a safeguard against inflation over the long term - as long as your snowball can grow its cash flow at a pace comfortably over the long-term rate of inflation.
While there are many paths to building a passive income snowball, one of the easiest is to simply buy a low-cost diversified exchange-traded fund, or ETF, that pays out a reasonable dividend yield and generates dividend growth at a rate above inflation over the long-term, and then let the power of compounding and time do the rest for you.
In this article, we will look at three reasons why the Vanguard High Dividend Yield Index Fund ETF Shares ( VYM ) may be a solution for this approach.
VYM ETF: Dividend Yield & Growth
VYM's trailing twelve-month dividend yield of 3.2% is not particularly exciting given that the Federal Funds rate is at 5.5% and long-term interest rates are still about 60 basis points higher:
That said, compared to the major equity indexes, the yield is actually quite high. For example, it is over twice the current yield being offered by the S&P 500 ( SPY ), over five times the current yield being offered by the Nasdaq ( QQQ ), and ~62% greater than the yield being offered by the Dow Jones Industrial Average ( DIA ):
Moreover, the dividend growth rate offered by VYM is quite strong, with a 6.97% CAGR over the past decade, a 5.6% CAGR over the past half decade, and a 5.25% CAGR over the past three years. In addition to being considerably above the long-term rate of inflation, these figures also outpace the dividend growth generated by DIA over those time frames despite also offering a significantly higher dividend yield.
VYM ETF: Expense Ratio & Total Returns
Another big benefit of VYM is that it charges a meager 0.06% expense ratio, meaning that it is very inexpensive for investors relative to the convenience it provides. As a result, its long-term total returns are much more likely to fall in line with the broader market's rather than be reduced by the considerable drag that a hefty expense ratio would cause. When we look at VYM's performance, we see that this is generally the case, as it has significantly outperformed other higher yield sectors such as REITs ( VNQ ), Utilities ( XLU ), and Midstream Infrastructure ( AMLP ). It is only due to the massive bull run that mega cap tech has been on over the past decade that VYM has lagged the performance of SPY over that period.
VYM ETF: Diversification & Recession Resistance
VYM's diversification and recession resistance also make it a potentially suitable solution for a retiree's passive income snowball needs. This is because:
- It puts a higher weighting on more defensive sectors rather than higher growth, more speculative sectors.
- It is very well diversified across many different stocks, guarding investor principal against any single company in its portfolio encountering major financial difficulties.
As we can see in the graphic below, VYM invests the majority of its funds into more defensive industries such as financials, consumer defensive, health care, and industrials companies. Moreover, it has an 11.04% stake in energy companies. While energy ( XLU ) is not necessarily a defensive sector, it is somewhat uncorrelated with the broader stock market and also benefits significantly from inflation, helping drive VYM's dividend growth rate above the rate of inflation over time, even if inflation rates are elevated over an extended period of time.
Moreover, as we see in the graphic below, VYM's portfolio is diversified across a whopping 465 individual holdings, with only 25.2% allocated to its top 10 holdings, with its top holding only representing 3.34% of its total portfolio. Moreover, its top holdings are very strong blue-chip companies that should be able to weather hard economic times quite well, including Exxon Mobil ( XOM ) (AA- credit rating from S&P), JPMorgan Chase ( JPM ) (A- credit rating from S&P), and Johnson & Johnson ( JNJ ) (AAA credit rating from S&P):
Investor Takeaway
Retiring on a passive income snowball brings with it numerous benefits. However, building and maintaining an effective passive income snowball that properly mitigates risks can take a lot of time, effort, and knowledge. With VYM, however, investors can get instant diversification across 465 holdings with a single click of a mouse and a mere 0.06% expense ratio.
Moreover, investors can earn a dividend income yield that is vastly superior to what is offered by the major indexes and also grows at a mid to high single-digit CAGR. As a result, VYM could be a viable solution for investors looking to build a simple, but effective, passive income snowball.
The only major critique of VYM as a retirement passive income instrument is that its current yield is still quite a bit lower than current interest rates. Investors who wish to amend this issue and juice the yield it offers a bit may want to subsidize it with higher-yield blue chip stocks, particularly from industries where VYM has low exposure. For example, given that VYM only has less than 1% exposure to the real estate sector, retirees may want to consider buying shares of Realty Income ( O ), which currently offers an attractive 6% dividend yield, has grown its dividend every year for over quarter of a century, enjoys an A- credit rating from S&P, and is quite recession-resistant given its vastly diversified portfolio of high-quality real estate.
There are several other stocks like this that investors can buy in addition to VYM to juice their portfolio's weighted average yield to the 4-5% range, thereby helping to accelerate their path to retirement without giving up the dividend growth potential while keeping a fairly low risk profile.
For further details see:
Retirement Passive Income Snowball: VYM May Be All You Need