2023-06-22 13:30:00 ET
Summary
- Combining Vanguard High Dividend Yield ETF and Invesco NASDAQ 100 ETF in an investment portfolio can offer a balance between dividend income and growth potential.
- VYM provides consistent dividend income from high-quality companies, while QQQM offers exposure to innovative technology and growth-oriented stocks.
- For long-term investors, dividend income generated from VYM can be reinvested into QQQM, allowing for potential capital appreciation and increased dividend payouts over time.
- Perhaps somewhat surprisingly, a backtest appears to show the potential of a combination of these 2 ETFs to outperform the S&P 500.
(This article was co-produced with Hoya Capital Real Estate.)
In the years I have been writing as ETF Monkey, I have read ever so many single-ETF reviews, including my own. Typically, such articles pick a single ETF, review it, and then issue a buy or sell recommendation. Don't get me wrong, such articles have their place. For example, if there is a certain ETF that charges a .50% expense ratio and it can clearly be shown that, over extended periods of time, multiple ETFs with expense ratios of .10% or less have done just as well or better, it makes sense not to waste your time looking any further at that particular ETF.
At the same time, the goal of any well-developed portfolio is to achieve a balance between risk and reward . In so doing, the ETF-focused investor looks to select multiple ETFs that work towards this goal.
In this article, my goal is to get you thinking along the lines of doing just that. We will take a look at two ETFs, both of which I have previously reviewed. These are Vanguard High Dividend Yield Index Fund ETF Shares ( VYM ) and Invesco Nasdaq 100 ETF ( QQQM ). Each of these ETFs bring unique, and very different, characteristics to the table. However, what if we were to combine them? Is it possible that this duo can provide investors with a robust investment strategy that combines dividend income and growth potential, possibly beating the S&P 500 along the way?
That's what I hinted at in the title, isn't it? Let's get into it and see if this is the case. First, though, we will start with a mini-review of each ETF.
Vanguard High Dividend Yield ETF - A Consistent Dividend Performer
With an inception date of November 10, 2006, Vanguard High Dividend Yield has an almost 17-year track record. As is the case with so many Vanguard offerings, VYM's expense ratio has gradually been reduced over the years and currently sits at .06%. This ETF tracks the subset of U.S. stocks within the FTSE All-World High Dividend Yield Index .
Here is how this index is constructed, per the fact sheet provided by FTSE.
The FTSE All-World High Dividend Yield Index comprises stocks that are characterized by higher-than-average dividend yields, and is based on the FTSE All-World Index, which is part of the FTSE Global Equity Index Series.
Real estate investment trusts (REITs) are removed from the index, as are stocks that are forecast to pay a zero dividend over the next 12 months ('dividends' excludes any non-regular or 'special' distributions). The remaining stocks are ranked by annual dividend yield and included in the target index until the cumulative market capitalization reaches 50% of the total market cap of this universe of stocks.
While a focus on high dividends open the door to at least some risk from value traps-stocks with deteriorating fundamentals and declining prices-the fund's significant number of holdings as well as its market-cap weighting goes a long way in diluting this to a manageable level.
The following comprehensive graphic from Seeking Alpha summarizes VYM's portfolio construction, as well as key data points.
VYM - Portfolio Characteristics & Data Points (Seeking Alpha)
In short, VYM's contribution to the portfolio lies in its ability to generate consistent dividend income . Dividends can act as a reliable income stream, particularly for income-focused investors who prioritize cash flow and passive income generation. By holding dividend-paying stocks across various sectors, including defensive sectors such as Consumer Defensive and Health Care, VYM offers the potential for sustainable returns even during market downturns.
Invesco NASDAQ 100 ETF - Growth With A Low Expense Ratio
For investors interested in an even deeper dive into this ETF, please see my recent in-depth review here on Seeking Alpha. However, I will briefly encapsulate key points here.
Invesco NASDAQ 100 ETF is a in a sense a relatively new offering in the world of ETFs. With an inception date of 10/13/20, it will be celebrating its 3rd birthday in approximately 3 months. QQQM's expense ratio is .15%.
In another sense, however, there is nothing new about it. You see, QQQM is a newer, and smaller, version of Invesco QQQ Trust, Series 1 ( QQQ ). The difference? Boiled down as simply as I can put it, QQQM is marketed towards buy and hold investors and QQQ may be preferred for trading purposes. Again, I go into this in depth in the linked article above.
Like its stablemate QQQ, QQQM is based on the NASDAQ-100 Index . The Index includes securities of 100 of the largest domestic and international nonfinancial companies listed on Nasdaq.
Similar to what I did above for VYM, here is the same comprehensive graphic from Seeking Alpha for QQQM.
QQQM - Portfolio Characteristics & Data Points (Seeking Alpha)
As can quickly be discerned, with 51.10% of the portfolio devoted to Technology, QQQM provides exposure to some of the world's most innovative and dynamic companies. These companies are at the forefront of technological advancements and have the potential for substantial growth over the long term. In addition, if you compare the sector weightings between VYM and QQQM, you will find tremendous diversification, as those most heavily weighted in VYM tend to be underweighted in QQQM, and vice versa.
In short, QQQM's contribution to the portfolio is enhanced growth potential , as companies within the Nasdaq-100 Index often exhibit above-average growth rates compared to the broader market.
Putting It All Together: Potential For Market-Beating Returns
Here's where things get exciting. You see, before sitting down to write this article, I had already done some research to be sure I had something worth presenting.
I've been around this game enough and learned from other savvy investors, including some of my readers (Thank you!) that when one presumes to talk about "market-beating" returns, this is not simply a matter of absolute returns.
For example, over the period I will cover in my analysis, in terms of absolute return an investor holding a portfolio comprised of 100% QQQ has handily beat the results from an investor holding Vanguard S&P 500 ETF ( VOO ), an excellent ETF proxy for the S&P 500.
But, this has come at the 'expense' of a significantly higher level of volatility . And volatility matters. Why? For at least a couple of reasons. The first has to do with emotion. Significant swings can lead to emotional turmoil, the point where the investor essentially says "get me out at any cost!" The second is that, due to a million uncertainties in life, an investor may face the need to raise funds at precisely the moment the value of their holdings drops precipitously.
So the challenge becomes, then, to try to achieve the greatest returns with the lowest amount of volatility.
With that in mind, look at the following backtest, from Portfolio Visualizer. In each case, the backtest runs some 12+ years, from January 2011 to the present. All dividends are included and reinvested, and the portfolio was rebalanced annually.
Portfolio Weights: 2011-2023 Backtest (PortfolioVisualizer.com)
As can be seen, Portfolio 1 is a simple 50/50 mix of VYM and QQQ. Bear in mind that, while I am specifically featuring QQQM in this article, we can only track performance for this ETF for the past 2 years or so. Since QQQ and QQQM are essentially mirrors of each other, we can take a much longer view by using QQQ for the backtest.
Portfolio 2 is what I will call an 'optimized' mix of QQQ and VYM. I will explain what I mean by this when I display the results. Finally, Portfolio 3 is 100% VOO, perhaps the best ETF proxy out there for the S&P 500.
Here are the results.
Results: 2011-2023 Backtest (PostfolioVisualizer.com)
As can be seen, a 50/50 mix of VYM and QQQ substantially outperformed the S&P 500, as represented by VOO, over this period. With a CAGR of 14.41%, this mix beats the S&P 500 by roughly 2% per year. Here's the interesting part, though. The volatility of the portfolio, as represented by the standard deviation, worst year, and max drawdown values, were roughly equivalent.
Next, let's talk about Portfolio 2. Let's say you are a slightly more risk-averse investor, willing to give up a little bit in absolute return for less volatility. I tweaked around with the VYM/QQQ ratio a little bit and settled on 78/22 as an interesting "sweet spot." You will notice that, at this ratio, the 2-ETF portfolio still beat the S&P 500 in terms of absolute return, but this time with significantly less volatility. What caught my eye, in particular, was that worst year value of -7.52%. For many investors, that alone may be extremely attractive.
But What About Going Forward?
Finally, let me get to one last question this examination brought to my mind. Go back and look at the last backtest again. While the comparison I featured looked stellar on the surface, it bugged me that a lot of the outperformance of Portfolio 1, the 50/50 mix of VYM & QQQ as represented by the blue line, came in the last couple of years. And we all know what has happened, don't we? A tiny handful of the FAANG-type companies has generated a significant share of the returns of the entire market!
But what if that doesn't continue going forward?
To at least take a look at that question, I ran one more backtest. In this second version, all the parameters are the same except that I ended the backtest at the end of 2018, before the recent dramatic surge in the FAANG-type stocks.
Here is how that version played out.
Results: 2011-2018 Backtest (PortfolioVisualizer.com)
Long story short, the overall results are surprisingly similar. Portfolio 1 beat Portfolio 3 by a fairly significant amount, with roughly the same volatility. And Portfolio 2, the more conservative mix of VYM and QQQ, still came out ahead in terms of total return and with less volatility.
Summary and Conclusion
In conclusion, combining VYM and QQQM in an investment portfolio appears to offer a compelling strategy that combines the power of dividend income and growth potential. VYM provides investors with a consistent stream of dividend income from high-quality companies, while QQQ offers exposure to innovative technology and growth-oriented stocks.
Finally, think about this. For a long-term investor, the dividend income generated from VYM can be reinvested into QQQM, allowing the potential for both capital appreciation and increased dividend payouts over time.
I hope this article has given you something to ponder, within the context of your personal circumstances. What do you think? I'd love to hear from you in the comments section below!
For further details see:
VYM And QQQM: A 2-ETF Combo That Offers Market-Beating Potential