When markets turn volatile, the Vanguard High Dividend Yield Index Fund ETF has a track record of smaller losses than the S&P 500, but investors should weigh its long-term trade-offs before shifting their portfolios
After nearly two decades of strong gains for U.S. stocks, many investors are questioning where to put their money if the next downturn proves more severe than recent pullbacks. While the S&P 500 has rebounded quickly from events like the COVID-19 crash and the 2022 bear market, history shows that not all recoveries are so swift. For those seeking relative safety during market declines, the Vanguard High Dividend Yield Index Fund ETF (VYM) stands out for its resilience in past recessions and bear markets.
Yet, the decision to shift assets into defensive funds is not straightforward. Investors must consider not only how an ETF performs during downturns, but also how it fares when markets recover and expand. Understanding these trade-offs is essential for anyone looking to protect their portfolio without sacrificing long-term growth.
Dividend ETFs in Downturns
Dividend-focused funds like VYM invest primarily in large, established companies that pay regular cash dividends. These firms tend to have more stable earnings and are less likely to cut payouts during economic stress, which can help cushion share price declines. During the 2008 financial crisis, for example, VYM fell 31.9% from January 1, 2008, to January 1, 2009, compared to a 37% drop for the S&P 500. By the end of the Great Recession in June 2009, VYM remained ahead of the broader market by half a percentage point.
In the 2022 bear market, the difference was even more pronounced. VYM ended the year down just 0.5%, while the S&P 500 lost 18.1%. This pattern reflects the defensive nature of dividend stocks, which often attract investors seeking income and stability when growth stocks are under pressure. The ETF's built-in diversification also helps reduce the impact of any single company's struggles.
Trade-Offs in Bull Markets
While VYM's defensive qualities can limit losses in downturns, they also tend to cap gains during bull markets. Over the five years leading up to 2024, VYM's total return lagged the S&P 500 by less than two percentage points. But in periods of strong market growth, the gap can widen significantly. From January 2023 onward, VYM gained 65.5%, while the S&P 500 surged 102.8%-a difference that can compound over time for long-term investors.
This underperformance is not unique to VYM. Many dividend-oriented funds trail broad market indexes during extended rallies, as they are less exposed to high-growth sectors like technology. For investors with a long time horizon, consistently favoring defensive funds may mean missing out on the higher returns that typically accompany bull markets. As with any investment decision, the right balance depends on individual goals, risk tolerance, and time frame.
Comparing Defensive Strategies
For those weighing different approaches to portfolio defense, it's useful to compare how various funds respond to market stress. For example, some investors look to precious metals or sector-specific ETFs as alternative safe havens. A recent analysis of gold and silver funds, such as the SPDR Gold Shares and Global X - Silver Miners ETF, highlights the importance of understanding each product's risk profile, fees, and historical volatility. For a deeper look at how these funds stack up, see this comparison of precious metals ETFs.
According to Vanguard's published data, VYM's expense ratio is 0.06% as of 2024, making it one of the lowest-cost options among dividend ETFs. The fund holds more than 400 stocks, with top sectors including financials, healthcare, and consumer staples. Its yield fluctuates with market conditions but has generally ranged between 2.5% and 3.5% in recent years. Investors should note that dividend income is taxable in most cases, and the fund's performance can vary depending on interest rates, sector trends, and changes in dividend policy.
Understanding Defensive Investing
Defensive investing is about managing risk, not eliminating it. Even the most stable dividend stocks can lose value in a broad market selloff, and no ETF is immune to economic shocks. The key advantage of funds like VYM is their tendency to fall less than the overall market during downturns, providing a measure of downside protection. But this comes at the cost of lower participation in market rallies, which can affect long-term wealth accumulation.
Investors considering a shift to defensive funds should evaluate their own financial situation, investment horizon, and need for income. For some, a blend of growth and dividend strategies may offer a better balance between risk and reward. Others may prefer to stay fully invested in broad market funds, accepting short-term volatility for the potential of higher long-term returns. As always, diversification, cost awareness, and a clear understanding of each fund's strategy are essential to making informed decisions in any market environment.
