How Vanguard High Dividend Yield Protects Against Payout Risk

Dividend investors like stocks that pay high yields, and the Vanguard High Dividend Yield ETF (NYSEMKT: VYM) is designed specifically to appeal to investors who want to maximize the income they get from their stock portfolio. Yet high-yield dividend stocks can be dangerous, and often, the situations that push their dividend yields so high can result in their having to make painful dividend cuts. Vanguard High Dividend Yield hasn't been invulnerable to those cuts, but the ETF does take steps to lessen their impact. Through the diversification that the fund offers and the methodology that its investment managers follow, the negative impact from stocks that reduce their dividends isn't as great as it might otherwise be.

Vanguard High Dividend Yield aims to own shares of stocks with above-average dividend yields. The FTSE High Dividend Yield index that the fund tracks identifies stocks that have higher-than-average dividend yields based on an all-inclusive market index.

Inevitably, that process results in choosing some stocks that have unsustainable dividend yields. A couple of cases in point recently have come from the telecom sector. Earlier this year, Frontier Communications (NASDAQ: FTR) made a steep dividend cut, reducing its quarterly payout by more than 60%. Frontier's board determined that a better balance between paying down debt, investing in the business, and returning capital to shareholders demanded the reduction. Even after the cut, the stock yields more than 15%, as a reverse split has depressed share prices further. Vanguard High Dividend Yield owned shares of Frontier before the cut and still did as of June 30.

Source: Fool.com