A Proven Wealth-Creator for Your IRA
Apr 13th 2012 10:52AM
Updated Apr 13th 2012 10:54AM
This article is part of our Right for Your IRA series, in which Foolish writers each pick a stock or ETF that could be a great fit in a tax-advantaged retirement account.
People love to discuss and read about stocks. There are stories behind companies -- stories that engage the imagination. Funds, on the other hand, seem boring, even sterile.
If you're only interested in individual stocks, that's fine; I'll understand if you'd rather take a look at the other articles in this series. But if you came here to learn about a first-rate vehicle you can sock away in your IRA to accumulate real wealth -- one that will require little upkeep and beat the majority of stocks the pundits push at you -- read on.
The elevator pitch
The Vanguard High Dividend Yield ETF (NYS: VYM) is perfectly consistent with the "high quality" theme I've been pushing for the past few years (with degrees of enthusiasm that vary in line with changing valuations). The Vanguard ETF's top holdings list is a roster of familiar U.S. blue-chip names, including Johnson & Johnson, Exxon Mobil, and Procter & Gamble. These are companies that have compounded investor wealth at above-normal rates for decades and are likely to continue doing so for some years to come.
In a world of negative real interest rates, the prospect of owning world-class franchises that will send you a dividend check every quarter remains attractive -- especially when you can expect the dividend to grow at or above the rate of inflation. You can't say the same for an ordinary Treasury bond! The fund's current yield is 3.2%. According to Morningstar, it has historically yielded one percentage point more than the S&P 500 Index (INDEX: ^GSPC) .
What else is there to like about the Vanguard ETF, and how does it compare to similar ETFs? Let's take a look.
What's inside the box?
Vanguard High Dividend tracks the FTSE High Dividend Yield Index, a custom index that the FTSE Group developed with Vanguard. The index is constructed from U.S. stocks with higher-than-average dividend yields, and it contains no REITs or stocks that aren't expected to make a dividend payout over the next 12 months.
This is no mere detail: Fees makes an enormous difference to long-term investment returns! The ETF's expense ratio of 13 basis points (0.13%) makes it cheaper than 89% of its peers, and I suspect those that are cheaper than Vanguard High Dividend are actually other Vanguard products. If we look at competing offerings from Vanguard's two largest competitors, we find that the iShares High Dividend Equity Fund (NYS: HDV) has an expense ratio of 40 basis points, with the SPDR S&P Dividend ETF (NYS: SDY) not far behind at 35 basis points.
I actually prefer the underlying index of the iShares ETF, which is the Morningstar Dividend Yield Focus Index. However, I'm not convinced the difference is worth paying triple the fee of HDV. Besides, Morningstar's methodology means that the iShares ETF is closer to an actively managed fund, relative to a broad market fund, than the Vanguard ETF is; the iShares ETF's top 10 holdings account for more than 60% of its assets. There is nothing necessarily wrong with that, but one needs to be aware of it. My inclination when selecting a no-fuss, long-term wealth accumulation vehicle is to favor the lower-cost option. The burden of proof is on the costlier product.
Let the compounding magic begin!
Vanguard High Dividend is a terrific IRA choice (and it's superbly suited for a taxable account): Eliminating the tax penalty allows your wealth to continue compounding at the highest possible rate. If you're looking to put your portfolio on a solid footing, this is an excellent foundation. However, you're not building a cathedral; you don't want lay the foundation once, never to touch it again. The Vanguard ETF is a keystone you'll want to add to regularly over years and decades.
You always want to be aware of broad valuations -- particularly when they reach extremes -- but Vanguard High Dividend is one of the most hands-off products you can invest in over long periods. The nice thing about buying regular amounts of this fund on a monthly basis is that the same amount buys more shares when it is cheaper, which lowers your average cost over time. In the business of investing, it's "lowest average cost wins," as Bill Miller likes to quip.
I gave it my best shot, but perhaps I still haven't convinced you to consider this index fund. If that's the case, and you want to buy individual stocks, you will definitely want to know the name of these "3 Stocks That Will Help You Retire Rich."
See what else our Foolish writers would add to an IRA; click back to the series intro for links to the entire series.
At the time this
article was published Fool contributor Alex Dumortier holds no position in any company mentioned. Click here to see his holdings and a short bio. You can follow him on Twitter. The Motley Fool has a disclosure policy.
We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.