The Australian share market is well-known for its big dividends. Is the Vanguard Australian Shares High Yield ETF (ASX: VHY) the best way to take advantage?
Australia’s big dividends
Australia has long been known as an income investor’s dream. While the ASX 200 and S&P 500 have had somewhat similar returns over the past few decades, the form of those returns looks very different.
The S&P 500 (US share market) is a more growth-focused market than Australia.
As of late 2023, the average payout ratio of the S&P 500 was about 38%. That means that US companies are holding onto more than 60% of profits to reinvest in the growth of the business.
The ASX 200 on the other hand had a payout ratio of more than 70%, meaning companies are paying out most of their profits as dividends.
This resulted in the S&P 500 delivering a 12-month yield of only 1.6% compared to nearly 4.3% for the ASX 200.
The reason for this difference is mostly due to the types of companies that make up each index. The S&P 500 is dominated by big tech companies like Apple Inc. (NASDAQ: AAPL) and Amazon.com Inc (NASDAQ: AMZN).
These companies have such strong growth prospects that it makes more sense for them, and their investors, to reinvest in the growth opportunities rather than payout dividends.
The ASX 200’s biggest companies are banks and miners like Commonwealth Bank of Australia (ASX: CBA) and BHP Group (ASX: BHP). These companies have lower growth prospects and tend to be cyclical, so investors demand the earnings be paid out as dividends.
The end result is that Australians are used to big dividend payments.
The VHY ETF
The Vanguard Australian Shares High Yield ETF (ASX: VHY) is an ASX-listed ETF that tries to take advantage of this trend.
A normal ASX 200 ETF like the Betashares Australia 200 ETF (ASX: A200) already has a high dividend yield (around 3.6% currently before franking credits). VHY increases this further by investing in a smaller group of companies (currently 66 holdings) with the highest dividend forecasts.
The result is that the VHY ETF is currently delivering a 5% dividend yield. Over the last 10 years VHY has returned 7.41% per year on average, including dividends.
So, who would this suit?
If your previous investments have all been income focused and you have little exposure to shares, this could be a good way to dip your feet in to gain some equities exposure while keeping the focus on income.
Similarly, if you’ve previously been invested in an ASX 200 ETF but are shifting your focus from growth to income, it could make sense to look at VHY over, say, A200.
A word of warning
The VHY ETF isn’t suitable for everyone.
It’s biggest drawback is the lack of diversification it offers. While the big banks already dominate the ASX 200, VHY doubles down with 40% of the portfolio in financial companies.
Nearly 20% is in just two companies, CBA and BHP. If you own another ASX 200 ETF already then be aware that adding VHY to your portfolio could leave you heavily exposed to the performance of just a handful of companies.
For an investor looking for income, VHY could be a smart choice, but don’t forget to pair it with other asset classes and sectors to keep your portfolio diversified.
