Where Will VYM Be in 2036? Here’s What the 2.4% Yield Is Hiding.

The Vanguard High Dividend Yield ETF (NYSEMKT:VYM) delivers on its name. The fund currently offers a 2.4% dividend yield, more than twice the 1.1% yield of the Vanguard S&P 500 ETF (NYSEMKT:VOO). Given that higher yield, you might expect it to deliver a higher total return.

However, that hasn't been the case over the last 10 years. While VYM has delivered a solid 11.3% annualized return, it has trailed VOO's 15.3%. The higher yield is hiding the fact that the fund produced a lower return.

Here's how that should frame investors' expectations on where the Vanguard High Dividend Yield ETF will be a decade from now.

Image source: Getty Images.

Where has VYM been

Before we look ahead, it's important to get some historical context. Here's a look at VYM's returns compared to VOO over the years:

Data source: Vanguard.

Despite a higher annual income stream, VYM has trailed VOO in each period. That's due to the different makeup of each ETF. VYM tracks the FTSE High Dividend Yield Index, which aims to measure the returns of stocks with high dividend yields (excluding REITs because they don't pay qualified dividends). The ETF currently holds 593 stocks spread across most market sectors (Financials has the largest weighting at 20.4%).

Contrast that with VOO's investment strategy. It tracks the S&P 500 Index (SNPINDEX:^GSPC), 500 of the largest U.S. stocks by market cap. That index weights holdings by market cap, meaning the largest companies have the highest weighting. Given the growth of the tech sector over the past decade, these stocks now account for 40% of VOO's holdings (compared to 14.3% for VYM). As a result, VOO's current holdings have grown their earnings much faster than VYM's over the past five years (24.5% vs. 8.9%). VYM's higher yield is hiding a much slower growth rate.

Where could VYM go by 2036

Past performance doesn't automatically mean VYM will underperform in the future. However, higher-yielding dividend stocks tend to be slower-growing companies, so it would seem likely that VYM's holdings will continue to deliver slower growth and lower returns.

There are a range of scenarios for VYM over the next decade based on its average annual return. Here is my base, bull, and bear case for what a $10,000 investment in the dividend ETF could be worth a decade from now:

Data source: Author's calculations.

My base case is that VYM's returns over the next decade will be slightly lower than what it has delivered over the past five- and 10-year periods. That 9% annualized rate is closer to its return since inception and the 9.2% average return of dividend-paying stocks in the S&P 500 over the last 50 years, according to data from Ned Davis Research and Hartford Funds.

A bear case would involve slower economic growth over the next ten years, which would drive slower earnings and dividend growth for VYM's holdings. Meanwhile, the bull case would be that stronger economic growth drives higher earnings and dividend growth for VYM's holdings, as well as multiple expansion (the ETF's holdings currently trade at 19.5x earnings, compared to 24.7x for VOO's holdings).

Why the base case seems about right

VYM's higher yield tends to hide the fact that the ETF delivers lower returns. It's why I think VYM's returns will be around 9% annualized over the next decade, likely under what VOO will deliver despite its lower yield. That aligns with both its historical average since inception and the returns of dividend stocks over the last half-century. However, that's not a bad outcome, especially for investors seeking higher income, greater diversification, and lower volatility than VOO.

Matt DiLallo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard High Dividend Yield ETF and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.