VUG: Low Current Income, But Possibly High Growth For Long-Term Investors

As an investor, I'm very interested in passive income. Whether it's from some funds stashed in a savings or money market account as a rainy day fund or it's from a stock or ETF that pays out dividends. I like to see cash hit my investing and retirement accounts. I worked hard over a period of years (actually decades) to buy the underlying assets that provide what is now passive income. My money is effectively working hard to make me a relatively small, but growing amount of money.

As I sock more away, I should see that amount of passive income grow to where it will hopefully provide an increasing amount relative to what I would normally make from my day job. However, that's not the only way to succeed by investing in the market. Investors can also choose to purchase stocks that are more likely to grow and provide sizable capital gains, and there are mutual funds and ETFs that have a strong record of providing an increase in net worth for those who choose to invest in them.

Vanguard's Growth ETF

The Vanguard Growth ETF (NYSEARCA:VUG) is one such fund that exists to provide growth for investors. Of course, there are market conditions that can led to losses for just about every asset class. The Great Recession should remind most people of just such an event, and while the official economic downturn lasted about 18 months (December 2007-June 2009), it occurred during what's called the "lost decade" in which stock prices basically returned nothing. In fact, the S&P 500 had a -0.9% return from December 31, 1999 to December 31,2009. It's important to remember that no investment is a sure thing. However, over the long run, the same S&P 500 index has returned about 10%-11% on average, and the vast majority of years will see a positive price return.

Vanguard attempts to secure outsized growth through VUG. The fund attempts to follow the CRSP US Large Cap Growth Index. That means that small-cap stocks are out, which will hopefully weed out some of the more risky investments. Once, or if, they are successful, it's likely they will eventually wind up on the index and as a component of VUG. This particular ETF, like many of Vanguard's funds as a very low expense ratio at just 0.04%, which means that investors will pay just $0.40 per every $1,000 invested in the fund.

As a fund focused on large-cap stocks, VUG has several massive tech stocks among its 222 stocks. Indeed, technology companies make up 52.2% of the fund's holdings, with the trifecta of Apple (AAPL), Microsoft (MSFT), and Amazon (AMZN) making up 30% of the fund alone.

Has VUG returned solid growth over the long run? Since its inception in 2004, that would be an unqualified yes. Since that time, annual returns have averaged 10.14%. That period includes the Great Recession. Over the past ten years, the average annual return has been 13.55%. When compared to Vanguard's S&P 500 ETF (VOO) and its Total Stock Market ETF (VTI), which have returned 11.86% and 11.22% annually, on average, over the past 10 years, respectively, VUG is the winner when it comes to growth. VOO and VTI are popular among index investors who just want to buy a broad market index and largely forget about their investments (at least on a relative basis). Yet, VUG has beat them both.

Income From VUG

VOO and VTI both beat VUG when it comes to income. The most recent 30-day yield for VOO is 1.56%, while VTI comes in with a 1.54% yield. VUG's yield is much lower, coming in at an anemic 0.57%. However, most people who are investing primarily for income would likely forget about VUG.

One thing that's interesting is the fact that the higher growth can actually offset some of that lower yield over time. A person investing $1,000 in VOO today might expect to get $15.60 in dividends over the first year. Another person could invest the same amount in VUG. Instead of getting $15.60 in income, they could only expect to get $5.70, about one-third of the income return of VOO.

Looking at this income from the long term, however, VUG does not actually lag as much as it might seem. Assuming that a person invested $1,000 in VOO 10 years ago, that amount would have bought 6.2 shares of VOO. Today, that investment would be worth $2,338.85. Given the 1.56% dividend yield, the hypothetical index investor should realize about $36.48 in dividend income after a 10-year period.

An investor in VUG who invested $1,000 10 years ago would have been able to purchase 11.3 shares. Today, those shares would be worth around $2,968.21. Assuming the current yield of 0.57%, the investor could anticipate $16.92 in dividend income. This is about one-half of the income realized by the investor in VOO, yet the realized income is closer to VOO's than it was 10 years ago because of the higher rate of growth in the stock price. This is despite VOO offering a much higher dividend growth rate. Over the past five years, VOO has increased its dividend by 6.1% on average. The dividend for VUG has actually declined by -0.66% on average over the same period.

If the same growth rates continue for the next 10 years, the gap between the income provided by the two funds would only narrow more at the 20-year mark. The investment in VUG would be worth $10,576 after 20 years given a continued average return of 13.55%, and the investment in VOO would be worth $7,174, assuming an annual share price growth of 11.86%. The dividend income from VOO would grow to $111.91, assuming the yield remained at 1.56%, while the income for VUG would grow to $60.28 with the anemic 0.57% yield. The dividend for VUG has grown to be more than one-half that of the investment in VOO. The income gap would narrow, and the investment would be worth about 32% more. Keep in mind that the initial investment in the example was only $1,000. You can add a zero or three to approximate a larger account value.

Conclusion

While I'm not likely to purchase VUG at this point, I can see its value for those with a long-term investing horizon. Because I'm pushing 50, I'm interested in more current income, rather than massive share price increases. Dividends tend to drop less than share prices during a recession. Yet, those looking to bank large total returns could benefit from focusing on growth for the long term. Depending upon where a person holds funds (tax-advantaged vs. taxable accounts), it might be possible to trade in a fund like VUG for an investment that pays a higher yield a few years down the road and increase dividend income at that time. Additionally, the income gap could narrow as the total growth leads to a similar yield on a much larger total investment value.