Dividend Growth Showdown: ETFs Vs. Stock Pickers

by: Dale Roberts

Dividend Growth investors, that is those who select their own companies, complain that there is no ETF that delivers on dividend growth and the phenomenon of rising dividends. That said, we shouldn't just take their word for it, since the statements have yet to be supported with any numbers or studies. So, let's have a look.

I will compare two popular ETFs to also-popular SA author David Van Knapp's hand selected portfolio. Because David started his portfolio with nearly $50,000, and has not added new monies to the holdings, we have a great test environment. And David's portfolio is also public, he lays it all out there and we thank him for that. I also thank David for encouraging me to leave the ranks of energetic commenter on SA and move into the role of Author. That was about one year ago.

Back to the Showdown.

In a recent series of articles, I began an exploration of Income Growth in a portfolio that combines two popular dividend ETFs from Vanguard (NYSEARCA:VIG) and (NYSEARCA:VYM) with two bond ETFs, the broad based (NYSEARCA:AGG) and the corporate ETF (NYSEARCA:LQD). You can find those first two articles here, and here. That exploration also allowed me to look at the bond and dividend components in isolation without dividend reinvestment (the drawdown stage) and in the accumulation phase.

I've well documented the fact that bond ETFs have most recently been providing a falling income source. Certainly active management might have a place within the bond income world. There are some Pimco funds that have delivered in the challenging environment.

But dividends from dividend growers offer a more reliable source of income - usually a growing source of income if the holdings are managed properly. But what happens in ETF form? I combined VIG, a dividend growth fund that also applies some proprietary value metrics, and tagged team it with VYM, a high yielder but certainly with its own dividend growth history. If you look at the top holdings you'll see many of the popular dividend growth companies discussed in SA dividend growth articles, and recommended by man of the most-read writers and commentators.

I thought that a combination of VIG and VYM would cover the spectrum of dividend growth and some higher yield that is often necessary to deliver on total income growth.

For the purposes of those articles and this study I took the total income from VIG and VYM and switched back and forth each quarter, investing in VIG one quarter, and VYM the next. Each ETF received an initial $10,000.

Here's the income stream from the Vanguard ETFs with dividend reinvestment. 2013 is an estimate.

Start date January 2007

ETF Dividends Growth
TOT 07 422
TOT 08 480 14%
TOT 09 330 -32%
TOT 10 441 34%
TOT 11 527 19%
TOT 12 641 21%
TOT 13 685 7%

From one of David's articles here is his dividend growth history.

The numbers from 2008-2012 are actuals. The dividend cash stream has increased each year as follows:

    • 2009: +57%
    • 2010: +15%
    • 2011: +9%
    • 2012: +11%
    • 2013: +18% est.

And here was DVK's screen capture.

David's portfolio was launched in June of 2008 meaning the first full year we can begin the comparison is the end of 2008. David had a half year of dividends in 2008, annualized that $998 would equal nearly $2000. DVK's income stream in 2009 was $1568, a 22% decrease from the annualized 2008 numbers. The Vanguard portfolio fell 32% from 2008 to 2009. David did post that he held GE and had to sell it at a loss. He will (and is certainly welcome to) explain the annualized decrease. Perhaps it was due to 2008 half year being exceptionally high? I will leave that to David and he might kind enough to share the challenges of navigating a portfolio through the Great Recession.

And most certainly the only fair and apples to apples comparison begins at the end of 2009. Let's look at 2010 through to the estimates of 2013.

The DVK portfolio had a 4-year average 13.25% rate of growth, and a 3-year average rate of growth 12.6% for 2011/12/13. The VIG/VYM had a 4-year average 20.25% and a 3-year average of 15.6%. The 4-year CAGR for DVK is 13.32%, the Vanguard's have a CAGR of 20.3%. That's if we use the base number of dividends paid in 2009.

And what about initial yield?

  • June 30th VIG 50.53 Dividend .28 1.12 annualized = YOC 2.2%
  • June 30th VYM 43.65 Dividend .37 1.48 annualized = YOC 3.4%
  • Average YOC for the two ETFs on DVK's start date was 2.8%. DVK's initial yield on cost was 2.2%.

On total return, and thanks to low-risk-investing.com we can click a couple of keys and get total return figures for stocks and ETFs. From June of 2008 we have a 48.6% total return to present for combined VIG and VYM with equal dividend reinvestment. VIG would be the top performer in total return with an increase of 49.5% to November 1, 2013. That's just below the DVK portfolio with a total return of 51%. The Vanguard ETFs and DVK portfolio all trailed the broader based ETF that tracks the dividend growers of the S&P 1500 (NYSEARCA:SDY). The ETF SDY has a total return of 63.1% from June of 2008 until Nov. 1 2013.

Here is the description of SDY from Morningstar.

SPDR S&P Dividend holds all the stocks in the S&P 1500 that have raised their dividends every year for the past 20 years. A rarefied group--there are only 80-something of them out of 1,500 names. Many of them are boring, quality names. If a firm has grown its dividend like clockwork for 20 years, chances are it has solid earnings and a sustainable business model. It also signals a strong commitment to intelligent capital allocation. Management is less likely to engage in reckless capital spending if its goal is to protect and grow the dividend.

I have to admit, when I began this exploration I thought it would be an exercise in determining how much the ETFs lag the stock pickers. If there is an arena where stock pickers have a chance, it's in the dividend growth area in my opinion. They're already picking from a rarefied group of companies that are nicely packaged and categorized thanks to the amazing work of David Fish, and his dividend growth lists.

Conversely, the greatest benefit to an ETF is certainly the fact that it is passively managed. It is unemotional. An investor in an ETF can then also be more unemotional and detached. An ETF investor is more likely to not watch the individual companies. They don't have to make decisions on which companies to add and which to eliminate from the portfolio. With emotion being the greatest enemy of investors, the detached component may turn the dividend tables in favour of the ETF-ers.

I don't know who will outperform over the next few years or decade. And honestly, I don't care. Many will think because I'm an indexer and ETF "champion" that I was rooting for the ETFs. I wasn't. I was just rooting for the truth.

I'm happy with my three stock picks too, (NYSE:TRP), (NYSE:ENB) and (THI). That threesome from 2007 has a total return over 135%, but I'm certainly not going to take that show on the road. And that's not going to lure me into more stock picks.


Well, draw your own. But of course this evaluation is just a starting point. Four to five years is a very short time frame to study and compare portfolios in the accumulation phase. The ETF numbers are skewed from 2009 because they each had a quarter with no dividend payment. That provides a low starting point. That said, if an investor did purchase those ETFs from that 2009 start date, those are the growth rates they would have experienced.

Throw out that 2009 number, and start in 2010 and we can see that the ETFs are still working just fine in the income growth department. I think we can draw the conclusion that dividend ETFs do work well in 'the good times'.

Can a dividend ETF portfolio keep pace with a handpicked dividend growth portfolio? Only time will tell - and this series of articles.

Disclosure: I am long VYM, DIA, TRP, ENB, THI. 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. Dale Roberts aka cranky is a Streetwise Coach at ING Direct Mutual Funds. Streetwise Portfolios offer the lowest-fee, index-based portfolios available to Canadians. Dale’s commentary does not constitute investment advice. The opinions and information should only be factored into an investor's overall opinion forming process. (