Is Vanguard Dividend Appreciation ETF a Buy?

The Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) was basically created because of the huge demand for the Vanguard Dividend Growth Fund. There are similarities between the two pooled investment products, but there are also very important differences. And, if you are a dividend investor, there's one fact that you have to understand about both of these investment options before you buy them.

What does Vanguard Dividend Growth Fund do?

The Vanguard Dividend Growth Fund is an open-end mutual fund. It is actively managed, so there's no set in stone approach to stock selection. However, the general theme is that the managers are looking to buy stocks that have the potential to grow their dividends over time. But there's a telling statement on the fund's website, in that it only attempts to provide investors with "some income." Basically, the Vanguard Dividend Growth Fund is a growth fund that uses dividends as a screening tool.

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The fund's dividend yield is only around 1.7%. To be fair, that's higher than the yield of the S&P 500 index (SNPINDEX: ^GSPC), which is only around 1.3%. But for most income-focused investors that's going to be a let down.

What does Vanguard Dividend Appreciation ETF do?

The Vanguard Dividend Appreciation ETF basically exists because of the Vanguard Dividend Growth Fund. But the Vanguard Dividend Appreciation ETF isn't actively managed, it just passively tracks an index. The index in question is the S&P U.S. Dividend Growers Index.

The S&P U.S. Dividend Growers Index is pretty simple. First, all of the U.S. companies that have increased their dividends for at least a decade are pulled out. Then the lowest-yielding 25% of the companies on the resulting list are eliminated. What's left gets put into the index, and the ETF, with a market cap weighting. This, very clearly, isn't focused on maximizing income, since the highest-yielding stocks are purposely removed from consideration.

VIG data by YCharts

The Vanguard Dividend Appreciation ETF has a yield of 1.8%. To be fair, that's slightly more attractive than what's on offer from the Vanguard Dividend Growth Fund, but it still won't interest most income-focused investors. Which brings us to the very real problem with both of these Vanguard "dividend" investments.

What kind of dividends are you looking for?

Dividends can be used in different ways when it comes to investing. The Vanguard Dividend Growth Fund and the Vanguard Dividend Appreciation ETF both use dividends to identify growing companies. The income the investments generate, while a part of the investment goal of each product, is really just incidental to the larger goal of capital growth. There's nothing wrong with what these two products are doing, but it is very different from what many dividend investors are trying to achieve.

If your real goal is to generate a substantial income stream, you probably won't be happy owning the Vanguard Dividend Growth Fund or its ETF-inspired sibling, the Vanguard Dividend Appreciation ETF. A better choice, sticking with the Vanguard family, would be the Vanguard High Dividend Yield ETF, which has a 2.9% yield, or the Schwab US Dividend Equity ETF, which has a yield of 4% and better combines the growth and income approaches into one investment.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Dividend Appreciation ETF and Vanguard Whitehall Funds-Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.