Vanguard Dives Into Dividends

April 27, 2006

Vanguard joins the dividend fund parade (and the mid-cap parade, too), while Dow Jones expands its dividend franchise in Europe.

Performance chasing?  Or giving investors what they want?  The answer is probably a little bit of both.

Vanguard jumped into two of the hottest areas of the market recently, launching its first ever dividend index fund and making plans to launch two funds into the red-hot mid-cap space.

Cheap Dividends

The big news is that Vanguard has finally joined the dividend indexing party.  The index giant rolled out a new low-cost fund called the Vanguard Dividend Appreciation Index Fund, which is designed to track  the Mergent Select Dividend Index.  The fund comes in two flavors - a traditional mutual fund (Investors shares only) and a VIPERs exchange-traded fund (ETF).  The ETF trades under the ticker symbol VIG, and comes with an expense ratio of just 28 basis points.  The traditional fund (VDAIX) charges 40 basis points.

Vanguard originally announced plans for the fund back in September of 2005. 

The Mergent Dividend Achievers Select Index is a "subset of the Mergent Dividend Achievers Index."  Vanguard spokesperson Michael Smith previously said that the fund would select stocks "essentially" from the same pool of stocks included in Mergent's Broad Dividend Achievers Index.   That puts it in direct competition with PowerShares' $121 million Dividend Achievers Index Fund (PFM), which explicitly tracks the Broad Dividend Achievers Index.

Given that similarity - and given that there are now more than a half dozen dividend ETFs on the market - many people (including this page) wondered how Vanguard would distinguish itself in the dividend-indexing field. The answer, however, should have been obvious: costs. Vanguard has always pushed the cost envelope, and this fund is no different. The Vanguard ETF charges just 28 basis points, compared to 50 basis points for the PowerShares fund, 40 basis points for the iShares Dow Jones Select Dividend ETF (DVY), and 45 basis points for the First Trust Morningstar Dividend Leaders Index Fund (FDL).

The elephant in the room with all these dividend funds is that Congress continues to waffle on extending the dividend tax cut.  That tax, passed in 2003, lowered the tax on dividends to 15 percent, and kicked off the dividend investing craze.  But without Congressional action, the tax cut will expire in 2007.  Although most experts expect the tax cut to be extended, there are no guarantees.

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