S&P 500 Index Funds Yield Just 1.3%. Consider Buying These 2 Low-Cost Vanguard ETFs to Generate More Passive Income.

The heaviest weighted components of the S&P 500 are companies like Apple, Microsoft, and Nvidia — tech leaders that tend to reward their shareholders largely through their rising stock prices rather than by distributing dividends.

The growing influence of tech stocks on the overall behavior of the large-cap index has dropped the S&P 500’s yield down to just 1.3%. So investors seeking both diversification and a passive income stream that’s a bit more robust will need to look beyond the basic S&P 500 index funds — perhaps to some dividend-focused exchange-traded funds (ETFs).

Here’s why I think the Vanguard Dividend Appreciation ETF (VIG 0.88%) and the Vanguard High Dividend Yield ETF (VYM 0.88%) are worth buying now.

Balancing growth, value, and income

Vanguard offers more than 80 ETFs with ultra-low fees. The Vanguard S&P 500 ETF (VOO 1.39%) has the lowest expense ratio at just 0.03%, but the Dividend Appreciation ETF and High Dividend Yield ETFs are also dirt cheap with expense ratios of just 0.05% and 0.06%, respectively.

Those slight differences won’t make a noticeable impact on your longer-term returns unless you’re investing millions of dollars in ETFs. Consider that if you had $100,000 invested in an ETF with a 0.03% expense ratio, you’d pay just $30 a year in fees. But at a 0.06% expense ratio, you’d still only pay $60 a year.

The list of top holdings in the Dividend Appreciation ETF’s portfolio has some overlap with the S&P 500’s highest-weighted stocks because it focuses more on companies that are growing their payouts rather than on those with impressive yields. In contrast, the High Dividend Yield ETF holds positions in companies that distribute sizable dividends even if they don’t have impressive earnings growth.

Comparing the top holdings in each fund

The following table provides a good overview of the differences between the three funds.

Data source: Vanguard.

Companies like Nvidia, Amazon, Alphabet, Meta Platforms, Tesla, and Berkshire Hathaway that don’t pay dividends, aren’t growing their payouts, or only recently began paying dividends won’t be found in the portfolios of the Dividend Appreciation ETF or the High Dividend Yield ETF.

Apple, Microsoft, Visa, Mastercard, Costco Wholesale, and Walmart all pay dividends with low yields at their current share prices and distribution levels. However, these companies are steadily growing their earnings and payouts, making them ideal candidates for the Dividend Appreciation ETF.

The High Dividend Yield ETF naturally excludes most companies with yields that are too low. Broadcom is an exception. It now yields around 1.2%, but that’s because its stock price has been on fire in the past couple of years.

Differences in sector concentration

More than half of the value of the Vanguard S&P 500 ETF is in tech, consumer discretionary, and communication services. The Dividend Appreciation ETF also includes a lot of tech, but it has far heavier weightings in financials and consumer staples than the S&P 500. A whopping 65.8% of the High Dividend Yield ETF is invested in financials, industrials, healthcare, consumer staples, and energy — a much different balance than the S&P 500.

These sector weighting differences are reflected in the respective valuations and yields of the funds. The S&P 500 ETF sports a price-to-earnings (P/E) ratio of 27.5 and a yield of 1.2% compared to a P/E of 25.7 and a yield of 1.7% for the Dividend Appreciation ETF and a yield of 2.5% and P/E ratio of just 19.8 for the High Dividend Yield ETF.

Stocks in lower-growth sectors like energy, healthcare, utilities, and consumer staples tend to sport valuations that are lower than the market average because investors are less willing to pay premiums for companies with relatively limited growth prospects. In contrast, they’re apt to pay extra for tech stocks that have tremendous potential for cash flow growth.

In this vein, the Dividend Appreciation ETF offers a bit more value and income than the S&P 500, while the High Dividend Yield ETF has more passive income potential at a better value although that comes at the expense of some growth potential.

VOO Total Return Level data by YCharts.

Over the past decade, the S&P 500 has proven to be a better source of wealth creation than either dividend ETF. This makes sense, given that mega-cap growth stocks have been instrumental in leading the index to new heights.

Two ETFs worth considering now

When it comes to the Dividend Appreciation ETF or the High Dividend Yield ETF, it’s best to approach your investment with the idea that you aren’t picking them with the goal of beating the S&P 500. Instead, you’re putting capital to work in the market in a way that suits your risk tolerance and investment objectives.

Because they hold value stocks and passive income providers, both funds could prove less volatile than the broad market — a proposition that investors worried about a stock market sell-off or bear market may find particularly appealing. However, overhauling your investment strategy based on emotion is never a good idea.

With that in mind, risk-tolerant investors who have long time horizons may be better served to put their money into an S&P 500 index fund or even a growth-focused ETF like the Vanguard Mega Cap Growth ETF (MGK 1.79%).