Better High-Yield Dividend ETF: VYM vs. SPYD

The Vanguard High Dividend Yield ETF (NYSEMKT: VYM) and the State Street SPDR Portfolio S&P 500 High Dividend ETF (NYSEMKT: SPYD) are two of the largest dividend exchange-traded funds (ETFs) with pure high-yield strategies. This is to say they select stocks for the portfolio based on dividend yield and nothing else.

There are positives and negatives to this approach. If you're an income investor and simply looking to maximize the dividends you receive from your investments, this would be the way to do it with a diversified equity fund. Yields of 4% to 5% using this strategy are regularly achievable.

On the flip side, if you're selecting stocks this way, you leave yourself vulnerable to yield traps. Those are stocks whose yields are artificially high due to a falling share price, and that could face a dividend cut in the future. In other words, stocks that may be in poor financial health.

Targeting large caps for this type of strategy helps mitigate, but not eliminate, some of that risk. As is the case with any ETF you're considering investing in, it pays to see how the fund operates to determine which one does the job better.

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VYM vs. SPYD: Core strategy

The Vanguard High Dividend Yield ETF chooses dividend stocks from a very broad starting universe. Companies are ranked by their forecast dividends over the next 12 months, and the top half are selected for the final portfolio. Qualifying components are weighted by market capitalization.

It produces a diversified portfolio, but one that lacks real conviction. This ETF holds over 600 stocks right now, and I'd argue that a yield which is only slightly above average doesn't belong in a "high-yield" fund. It's essentially a watered-down version of a high-yield ETF, and the 2.2% yield demonstrates that point.

The State Street SPDR Portfolio S&P 500 High Dividend ETF is a better example of a high-conviction strategy. It simply chooses the top 80 highest-yielding stocks from the S&P 500. Qualifying components are equal-weighted.

This is about as pure a high-yield strategy as you'll find. There aren't any quality or dividend history screens. It's simply all about yield, as is evidenced by the 4.4% rate. The equal-weighting helps diversify away some of the risk of any individual yield being vulnerable. But the strong focus on yield will ultimately produce a portfolio whose composition looks very different from that of the S&P 500.

VYM vs. SPYD: Portfolio composition

Neither of these ETFs has the tech-heavy weighting of the S&P 500. That makes them great additions to a core large-cap portfolio. But their comparative exposures at a sector level mean they will perform differently.

Data sources: Vanguard, State Street.

The Vanguard High Dividend Yield ETF looks more balanced from a sector perspective. Tech is still the second-largest sector holding, but it's surrounded by both cyclical and defensive sectors of similar weight. Again, that serves to create a portfolio that should limit some of the potential performance extremes due to its diversity.

The State Street SPDR Portfolio S&P 500 High Dividend ETF, on the other hand, leans heavily into the traditional sources of dividends. The biggest difference is at the top, where more than one-quarter of the portfolio is real estate investment trusts (REITs), compared to 0% for the Vanguard fund. Consumer staples and utilities add to the defensive tilt, while energy and financials often deliver some of the higher individual yields in the large-cap space.

VYM vs. SPYD: Which is the winner?

I've mentioned multiple times in the past about how I'm not a big fan of the Vanguard High Dividend Yield ETF's rather bland strategy. It includes too many stocks and doesn't offer the true high-yield exposure that many income investors would probably prefer.

The State Street SPDR Portfolio S&P 500 High Dividend ETF goes hard in the other direction. I get nervous about funds that select stocks based on yield only, especially those that specifically target the highest yields. But staying only within the S&P 500 should help ensure these are mostly financially strong companies.

Based on yield, strategy, and composition, I believe the State Street SPDR Portfolio S&P 500 High Dividend ETF is the better choice.

David Dierking has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.