1 Vanguard ETF to Buy and 1 to Hold for Passive Income Investors

Vanguard offers dozens of low-cost exchange-traded funds (ETFs). These investment vehicles can be simple yet effective tools for achieving diversification and investing in a compelling theme or sector.

Here's one Vanguard ETF that may be due for a cool-off, and another that stands out as a buy now.

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This power play has delivered big gains this year

Wedged between the Vanguard S&P 500 Growth ETF and the Vanguard Mega Cap Growth ETF for best-performing low-cost Vanguard fund in 2024 is the Vanguard Utilities ETF (NYSEMKT: VPU) with a whopping 30.1% year-to-date gain.

The utility sector isn't known more for its stability than for its market-beating gains. But 2024 was a perfect storm for the sector to soar higher.

For starters, the sector was undervalued heading into 2024. Even after its surge, the Vanguard Utilities ETF still sports a price-to-earnings ratio under 25 because it was so beaten down heading into the year. From 2020 to the end of 2023, the Vanguard Utilities ETF declined 4.1% compared to a 47.6% gain in the S&P 500.

Regulated electric utilities work with government agencies to set prices. Federal and state policies and subsidies can influence fuel types in a utility's energy mix. Pressure to transition from coal and natural gas toward renewable energy led utilities to pursue costly projects with uncertain timelines and profitability. Taking on those expenses on top of existing debt left many utilities overleveraged. And to make matters worse, higher interest rates made it challenging to take on new debt at attractive rates or refinance existing debt.

Time has been kind to utilities like Southern Company, which has found an excellent balance between fossil fuels, nuclear energy, wind, and solar. Earlier this year, Dominion Energy began construction on one of the largest offshore wind energy projects in North America. On Oct. 22, it closed its sale of a noncontrolling equity interest in the project to investment firm Stonepeak to reduce project risk and alleviate cost pressures.

The utility sector is positioned to continue doing well, especially now that interest rates are coming down and the industry is getting more experience operating renewable assets. However, the valuations of many utilities aren't nearly as attractive as they were heading into the year. What's more, the yield of the Vanguard Utilities ETF is now 2.8%, whereas it was closer to 4% at the beginning of the year.

Valuations and dividend yields matter, especially for low-growth sectors like utilities. Over 62% of the Vanguard Utilities ETF is in electric utilities -- many of which are regulated. These companies can't unlock explosive growth by releasing a new cutting-edge product or service. Rather, many achieve slow and steady results over time through disciplined spending and population growth.

Add it all up, and the Vanguard Utilities ETF seems like a decent ETF to hold for passive income, but it is no longer a screaming buy.

A comparable yield with better diversification

The Vanguard High Dividend Yield ETF (NYSEMKT: VYM) is a better buy than the Vanguard Utilities ETF. The High Dividend Yield ETF has a slightly lower yield at 2.7% and a lower expense ratio at 0.06% compared to 0.1% for the Vanguard Utilities ETF.

Instead of focusing solely on one sector, the High Dividend Yield ETF targets companies across every stock market sector -- including utilities. The fund's top holdings are well-known names like Broadcom, JPMorgan Chase, ExxonMobil, Procter & Gamble, and Home Depot. No single holding has a higher than 4.4% weighting, and no sector has above a 21% weighting -- ensuring the fund is well diversified.

The High Dividend Yield ETF has put up a good year, with a 17.5% year-to-date gain. But like the Vanguard Utilities ETF, it also hovers around an all-time high. As are many of its top holdings.

Several low-cost ETFs are structured to assign the highest weightings to the largest companies by market cap. Since mega-cap companies have been leading the broader market higher, many ETFs are hovering around all-time highs no matter their area of focus.

For example, the Vanguard Growth ETF and the Vanguard Value ETF target completely different market themes and, in many ways, are opposite sides of the same coin. But because mega-cap growth and mega-cap value have done so well in recent years, both funds have soared to new heights.

A hands-off way to invest in quality companies

Investors looking to put new capital to work in low-cost, diversified ETFs should know why many of these funds have increased by so much. Instead of trying to time the market and buy top companies on the dip, a far better use of time is to find the low-cost ETF or ETFs that are best for you and then invest in those funds through periods of volatility. Over the long term, investing in quality tends to be a winning strategy because even expensive companies can grow into their valuations over time.

So, even at an all-time high, the Vanguard High Dividend Yield ETF stands out as a solid choice due to its diversification across various companies and sectors and its attractive yield.

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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Home Depot, JPMorgan Chase, Vanguard Index Funds - Vanguard Growth ETF, Vanguard Index Funds - Vanguard Value ETF, and Vanguard Whitehall Funds - Vanguard High Dividend Yield ETF. The Motley Fool recommends Broadcom and Dominion Energy. The Motley Fool has a disclosure policy.