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ETF Specialist

The Quality Dividend ETF

It's not Warren Buffett in a box, but it's close.

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In mid-November last year, when Warren Buffett revealed that  Berkshire Hathaway (BRK.A) (BRK.B) had taken a massive 5.4% stake in  IBM (IBM),
 Vanguard Dividend Appreciation ETF (VIG) held four of its top five holdings in common with him. This was no fluke. VIG focuses on quality dividends, demanding that companies increase them for 10 consecutive years just to make the cut. It then imposes further tests for liquidity and financial strength. The exact formula is secret but seems to weed out companies with high leverage and poor cash flow. The result is quality rather than high yield, so income-hungry investors might be surprised by a dividend yield that just matches the market. Whereas many dividend-focused funds concentrate in smaller value companies, this fund shades slightly toward growth. While we like dividends (more on that later), we think the fund's emphasis on safer yields justifies its average yield. VIG is a great choice for a core allocation.

Back to dividends. There's a lot to recommend dividend investing. For one, dividends, or the promise of them, are the soundest reason to buy equities--any other rationale relies on Ponzi thinking. Dividend investors also buy the main driver of historical stock returns, income today instead of the promise of capital appreciation tomorrow. According to the excellent Credit Suisse Global Investment Returns Sourcebook 2011, from 1900 to 2010 the U.S. stock market experienced 6.17% annualized real growth. About 4.24 percentage points of the market's return came from dividends, 1.37 percentage points from real per-share dividend growth, and a paltry 0.56 percentage points from price/dividend expansion (also known as the speculative return).

Samuel Lee does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.