Boost Your Income! Why This Closed-End Fund Surpasses Vanguard's High Dividend Yield ETF

Vanguard High Dividend Yield ETF (NYSEMKT: VYM) is a fairly easy to understand exchange-traded fund (ETF) with an income focus. There's just one glaring problem with the ETF: Its yield isn't exactly huge at just 2.6%. For dividend investors looking for a diversified portfolio of dividend stocks to buy, Gabelli Dividend & Income Trust (NYSE: GDV), a closed-end fund, could be a good alternative. Here's why.

What does Vanguard High Dividend Yield ETF do?

Vanguard High Dividend Yield ETF keeps things simple, which is a huge plus when it comes to index-based ETFs. The first step in creating the portfolio is to take the list of U.S. stocks and eliminate any stocks that don't pay a dividend. The second step is to include the highest-yielding 50% of dividend-paying stocks in the portfolio. Very easy to understand, and the approach is clearly aligned with the ETF's name.

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This approach, however, has some notable impacts, both good and bad, on the portfolio. On the plus side, given that Vanguard High Dividend Yield ETF is looking at all stocks, it has a very large portfolio. The list is more than 500 stocks long, which means it holds as many stocks as the S&P 500 index (SNPINDEX: ^GSPC). They aren't the same stocks, obviously, but if you like to have a diversified portfolio, this Vanguard ETF has you covered.

On the negative side, Vanguard High Dividend Yield ETF's dividend yield is a somewhat modest 2.6%. While that's much higher than the S&P 500 index's 1.2%, it isn't a number that will likely attract most income investors. The reason for the low-ish yield is pretty simple; with such a large portfolio of stocks the ETF has no choice but to include a large number of lower-yielding companies, and that drags down the overall yield.

If you are trying to maximize the income your portfolio generates, this ETF will be a tough sell. There's another option, if you are willing to take on a little more risk.

VYM data by YCharts

What does Gabelli Dividend & Income Trust do?

The first thing to know about Gabelli Dividend & Income Trust is that it is a closed-end fund (CEF). This is very different from an ETF. While the structure of ETFs means they generally trade very close to their net asset value (basically the value of the portfolio), CEFs can, and usually do, trade at a different price. This is because CEFs are technically companies with a set share count and there is no opportunity to arbitrage an emotionally driven price gap. (It's a bit complex, but a large ETF shareholder can ask to be given the underlying stocks in the ETF in exchange for their shares.)

The second big thing to understand is that Gabelli Dividend & Income Trust is actively managed. While the goal is to buy dividend stocks, there's no set approach. The managers are simply buying what they like, noting that the Gabelli team generally has a value bias. One more nuance here is that the CEF can use leverage, and usually does to some extent. That can increase returns in good times but it can also exacerbate losses in bad times. This is not an investment for ultra-conservative investors.

However, there is one very interesting similarity between Vanguard High Dividend Yield ETF and Gabelli Dividend & Income Trust. Both have large and diverse portfolios, noting that Gabelli Dividend & Income Trust's portfolio also contains more than 500 stocks. So, for investors that are looking for diversification, this Gabelli CEF could be a good alternative to Vanguard High Dividend Yield ETF. But the big reason to make the switch, noting there is an increase in risk, is Gabelli Dividend & Income Trust's lofty 6.8% dividend yield.

Gabelli Dividend & Income Trust's attractive yield needs a bit more explanation. The CEF has a managed distribution policy, which means that it pays a set monthly dividend no matter what is going on with the market. It can change the policy, and has during uncertain times, but it tends to remain static for extended periods. Note, too, that the CEF's dividends are often supported by capital gains, which can limit upside potential. There is definitely more risk here, noting the use of leverage, but for income-focused investors the extra yield could be well worth it.

Gabelli Dividend & Income Trust isn't perfect, but it's a good alternative

No investment is perfect, so there are always trade-offs that have to be made. Vanguard High Dividend Yield ETF's trade-off is a relatively low dividend yield in exchange for a diversified dividend stock portfolio. If you want a higher yield and a still-large and diverse portfolio, the trade-off with Gabelli Dividend & Income Trust is additional risk. But given that it has a yield that's more than twice that of the Vanguard High Dividend Yield ETF, that is likely to be a reasonable trade-off to make for a lot of income investors.

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Reuben Gregg Brewer has positions in Gabelli Dividend & Income Trust. The Motley Fool has positions in and recommends Vanguard Whitehall Funds-Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.