1 Great Reason to Buy the Vanguard Dividend Appreciation ETF (Hint: It's Not for the Income)

Many investors, especially younger ones, don't fully appreciate dividend stocks. Since they don't need the income (like retirees do), they figure they don't need to invest in dividend-paying stocks. There's a big problem with this view: Dividend stocks are proven wealth builders. Over the last 50 years, dividend stocks have outperformed non-payers by more than two-to-one (9.2% average annual-total return to 4.3%, according to data from Ned Davis Research and Hartford Funds).

The data on dividend-stock returns makes the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) a great investment. The exchange-traded fund (ETF) focuses on a particular group of dividend stocks that have historically delivered the highest total returns.

Appreciating the benefit of dividend growth

Vanguard Dividend Appreciation ETF is a passively managed fund that aims to track the performance of the S&P U.S. Dividend Growers Index. That index strives to measure the performance of companies that have increased their dividends annually for at least 10 straight years (excluding the top 25% highest yielders). The index focuses more on dividend growth than income.

That emphasis on dividend growers is noteworthy. That's because the same data from Ned Davis Research and Hartford Funds found a notable difference between the returns of dividend stocks by their dividend policy:

Data source: Ned Davis Research and Hartford Funds.

That data shows that dividend growers delivered the highest returns among dividend stocks by a significant margin.

It's also noteworthy that the index excludes the top 25% of stocks by dividend yield. Companies with higher-dividend yields tended to have higher-payout ratios, putting them at higher risk of being unable to grow their dividends if they faced financial challenges. So, by excluding the highest yielders, the fund has an increased focus on companies likely to continue growing their dividends.

Like the index it tracks, the Vanguard Dividend Appreciation ETF holds 338 stocks that have delivered at least a decade of consistent dividend growth. That focus on dividend growth has paid off for fund investors over the years. The fund has delivered a double-digit average annual-total return over the last one-, three-, five-, and 10-year periods. Meanwhile, the average annual-total return since its inception is just under 10%.

The ETF currently offers a dividend yield of around 1.7%, slightly more than the S&P 500 (around 1.3%). So, it's not the best fund if your primary desire is to generate dividend income. However, it's a great investment if you hope to steadily grow your wealth by earning above-average total returns.

A look at some of the top holdings

While the Vanguard Dividend Appreciation ETF holds shares of more than 300 dividend stocks across all sectors, it has a higher allocation to its top holdings. The top 10 comprise more than 30% of its total assets. Those top holdings are some of the top dividend-growth stocks.

For example, its largest holding is Apple (NASDAQ: AAPL) at 4.8%. The consumer-technology giant has increased its dividend for 13 straight years, growing its payout at an 8% annual rate over the last decade. Apple is one of the strongest companies in the world. It had $60 billion in cash and marketable securities on its balance sheet at the end of its fiscal third quarter and generated $91 billion in operating cash flow through the first nine months of the year. With its dividend only costing about $4 billion a quarter and its profits growing (11% in the last quarter), Apple has ample room to continue growing its dividend. Apple's growing dividend has helped drive robust total returns (25.7% annualized over the last 10 years).

Another notable holding is Visa (NYSE: V). The credit card giant has increased its payout for 16 straight years, including recently raising it by another 13.5%. The company has grown its dividend at a 17.9% compound annual growth rate (CAGR) over the last decade. That has helped drive similarly robust total returns (19% annually over the past 10 years). Visa's revenue and earnings are going at a double-digit clip these days. With strong cash flow and a cash-rich balance sheet, Visa is in an excellent position to continue increasing its payout.

Dividend stocks can be terrific investments

Vanguard Dividend Appreciation ETF focuses on companies that have historically increased their dividends. That's a smart place to focus, given the historical performance of dividend growers. It should enable the fund to continue producing attractive total returns, which is a great reason to invest in the ETF.

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Matt DiLallo has positions in Apple and Visa and has the following options: short November 2024 $250 calls on Apple. The Motley Fool has positions in and recommends Apple, Vanguard Dividend Appreciation ETF, and Visa. The Motley Fool has a disclosure policy.