Investing

Using Index Funds For Income – Vanguard Total Stock Market ETF (NYSEARCA:VTI)

Just about two years ago, I started investing for dividend income after having investigated the process for about a year. I liked the idea that my investments could produce income which could then be reinvested into more shares of more companies.

Ideally, these shares and the income they produce will compound over time and lead to a nice stream of cash flow in the future. I’ve noticed that many dividend growth investors tend to be attracted to companies like Johnson & Johnson (JNJ) and AT&T (T) that have a long history of growing dividend income.

Most Dividend Investors Purchase Dividend Aristocrats

JNJ has an unbroken streak of more than 50 years (54 to be exact), and AT&T has increased its annual payout for more than three decades straight. These are only two of the current Dividend Aristocrats, and they are attractive companies to be sure.

I currently own both of them and have no plans to sell them anytime soon unless they cut dividend payouts.

I’ve been buying dividend growth stocks for two years, and I’ve tracked the progress of my Slowly, But Surely Fund. At times, especially before the loss of Loyal3 as a vehicle that allowed for very small investments, I’ve been ahead of the S&P. Today, I’m quite a bit behind it in terms of capital gains.

I’m not too concerned because I have some solid companies that should provide dividend income into the future. Even if one of them goes belly-up, I doubt that all of them will (and there would probably be bigger problems than portfolio value at that point).

These Dividend Aristocrats tend to pay solid dividends that grow over time. They can also provide a bit of price appreciation over time (JNJ more so than T over the past several years). This is the main reason that dividend growth investors focus on the Aristocrats.

Index Funds Seem To Get Ignored

Outside of their work-based retirement funds, most of the dividend growth investors that I read ignore index funds. They tend to purchase only individual companies. Taxes probably play a role in this decision, as many invest primarily in taxable accounts.

Mutual fund and ETF distributions that do not come from investments in tax-advantaged accounts are taxable in the year they are paid.

There is quite a bit of control over this process of buying individual companies, but there is also a bit more (possibly a lot more) risk associated with it. For those investing in tax-advantaged accounts like IRAs or 401k plans, index funds can provide dividend income while also allowing for a great deal of diversification.

Dividend-focused ETFs and mutual funds like the Vanguard High Dividend Yield ETF (VYM) can pay out a yield of more than 3 percent at this date. There are also dividend appreciation funds that focus on dividend growers. One of the leading options is the Vanguard Dividend Appreciation ETF (VIG).

I Bought My First Index Fund

Today, I sold out of my position in General Electric (GE). The performance has been poor. The sentiment is poor. The company slashed dividend payments in the Great Recession and has not grown them much in recent years. I took the cash and bought an index fund with part of the proceeds.

Based upon my interest in dividend income, one of the funds mentioned above might have been on my radar, and they were. However, I decided to go another route.

In looking at the Dividend Appreciation fund yield, I noticed that Vanguard advertised it at 1.93 percent (as of July 28, 2017) as of the latest payout. If we add up the distributions for the past year, the yield on the current price is slightly below 2.1 percent.

I then looked into the Vanguard Total Stock Market ETF (VTI). This fund has a very low expense of 0.04 percent. It also yields 1.86 percent according to the Vanguard site’s analysis of the last distribution.

If we add up the total distributions of the past year and compare them to the current price, the yield is still right around 1.87 percent. (I realize this is not a perfect computation, but it is a ballpark indicator).

This fund includes companies of every size from the US market. The dividend funds do not include non-dividend payers like Facebook (FB) or Amazon (AMZN) because they focus on dividend payers. VTI holds these companies in fairly large quantities. This allows for some investment, and hopefully, price appreciation in some great companies that do not pay dividends.

The Vanguard Total Stock Market Fund also includes solid dividend payers that I already hold, such as Johnson & Johnson. When looking at the very small difference in the dividend yield, I think it makes sense to invest in the broader fund. I’ll still realize some dividend income while also holding a small sliver of high-growth companies.

There’s Still Dividend Growth

The following chart from dividendchannel.com shows that the distribution for VTI has grown from $0.14 in June 2001, just after the fund’s inception to $0.575 in June 2017. This is some pretty good growth to be sure.

The growth has been uneven at times, and there have been occasions that have seen negative growth in the distribution. However, it’s easy to see that the general trend has been an upward trajectory, which is something that’s good to see if you’re interested in dividend income (or income from distributions). Even dividend growth investors are not immune from dividend cuts – think Kinder Morgan (KMI), which cut income for many investors.

While VTI would not qualify as a Dividend Aristocrat, it has seen quite a bit of income growth over time while providing a good deal of diversification at the same time. There has also been some price appreciation, with a $10,000 investment 10 years ago growing to more than $20,300 today, according to Vanguard’s fact sheet.

Looking at this information, I decided to take a small bite of VTI with some of the proceeds from my sale of GE (at a loss). I may also purchase some shares of VIG or VYM in the future as well, as I’m currently investing in a tax-advantaged account that allows for my investments to grow without paying taxes on distributions in the current year. I like dividends and I like diversification. All of these Vanguard funds provide both and are worth consideration. I’m not going to stop investing in individual companies, but I’m now open to ETFs as well.

Disclosure: I am/we are long T, VTI, JNJ.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not a licensed financial professional. This article is only for educational/entertainment purposes and should not be construed as a recommendation to buy or sell any securities. As losses up to and including all capital invested can occur, be sure to do due diligence and check with a financial professional before investing in securities.

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