Is This the Top ASX ETF for Generating Passive Income?

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The Vanguard Australian Shares High Yield ETF (ASX: VHY) stands out as one of the highest-yielding exchange-traded funds (ETFs) available in the Australian market. For income-focused investors, this fund offers an intriguing opportunity to generate passive income through dividends. Vanguard has built a reputation for providing a diverse range of ETFs, allowing investors to access various asset classes, including ASX shares, US shares, global shares, property, and bonds.

One of the key attractions of large-cap ASX shares is their potential to deliver substantial passive income. This is largely due to their relatively high dividend payout ratios and the benefits of franking credits. The VHY ETF specifically targets ASX companies that are expected to provide higher forecast dividends compared to their peers, making it a compelling choice for those seeking income.

How big is the VHY ETF dividend yield?

When evaluating the dividend yield of an ASX share, relying solely on past payments can be misleading, especially if a dividend cut is on the horizon. The Vanguard Australian Shares High Yield ETF takes a more forward-looking approach by focusing on forecast yields sourced from FactSet. As of the end of July 2024, the VHY ETF boasted a dividend yield of 4.8%, with a grossed-up yield of 6.4% when accounting for franking credits. This yield significantly surpasses that of other ASX-focused ETFs, such as the Vanguard Australian Shares Index ETF (ASX: VAS), which reported a dividend yield of 3.5% excluding franking credits.

What ASX shares is this fund invested in?

The VHY ETF is diversified across 66 different businesses, providing a reasonable level of diversification for investors. However, it is important to note that over 60% of the portfolio is concentrated in ASX financial and mining shares, which may limit its diversification compared to other ETF options. Some of the largest holdings in the VHY ETF include well-known companies such as Commonwealth Bank of Australia (ASX: CBA), BHP Group Ltd (ASX: BHP), National Australia Bank Ltd (ASX: NAB), Westpac Banking Corp (ASX: WBC), and ANZ Group Holdings Ltd (ASX: ANZ), among others. Additionally, the ETF includes holdings in Woodside Energy Group Ltd (ASX: WDS), Macquarie Group Ltd (ASX: MQG), Telstra Group Ltd (ASX: TLS), Rio Tinto (ASX: RIO), and Wesfarmers Ltd (ASX: WES), with around 50 additional companies also contributing to the potential for substantial passive dividend income.

Any downsides?

While the VHY ETF offers attractive dividend yields, it is essential to consider the potential downsides. The nature of high dividend payouts often means that these companies retain less profit for reinvestment in growth opportunities. Consequently, many of the companies within the ETF may be distributing a significant portion of their earnings to shareholders because they lack identified avenues for growth. This dynamic can lead to limited expectations for earnings growth or capital appreciation from the fund.

Since its inception in May 2011, the VHY ETF has delivered an average capital growth of just 3% per year, with the past decade reflecting an even lower average of 0.8% per year. This modest growth trajectory may be a concern for investors seeking both income and capital appreciation.

Is the VHY ETF the best option for passive income?

For those prioritizing passive dividend income, the VHY ETF may indeed be one of the leading high-yield ASX ETFs available. Its ability to generate a high level of dividend income, coupled with limited capital growth, aligns with the goals of many income-focused investors. However, it’s worth noting that there are alternative strategies for generating cash flow from investments. For instance, investing in ASX ETFs that focus on capital growth can also yield cash flow opportunities. By selling a small portion of a growing investment (such as 5%) each year, investors can create a cash flow stream while potentially increasing their overall portfolio balance over time.

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