Finally a free lunch! Or maybe not.

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When one basket of stocks pays a 2 percent dividend yield, and another, seemingly very similar one pays 6 percent, which one do you want to own? In today’s one percent bond yield world, it’s not a hypothetical question. Two popular ETFs, both comprised of some of the world’s best known companies, present this puzzle. Let’s sort it out.

SPY is State Street’s S&P 500 index ETF and VGK is Vanguard’s European index ETF.  Both hold hundreds of stocks and have razor thin management costs: 9 basis points for SPY and 14 for VGK.  Almost nothing.

The stocks they contain are literally household names – the biggest US- and European-based companies, true global competitors.  You can be sure that Exxon Mobil and BP are always squaring off for the best oil and gas deals, and that Pfizer and Sanofi and Roche are doing the same in pharmaceuticals.

Major holdings of SPY and VGK.

With similar contents, the dividend yields seem to be from completely different planets. SPY yields 2.01 percent as of this writing and VGK 6.33 percent (source: Yahoo Finance).

Look closer

All other things being equal, that 6 percent yield makes VGK much more desirable. But other things are rarely equal, and they’re definitely not in this case.

The obvious difference is geography. With VGK holdings all based in Europe, they are more susceptible to the uncertain future of the euro and any real or rumored national defaults. Further, the results for any US investor buying VGK will be filtered through ever-changing exchange rates for the dollar versus the pound, euro, and Swiss franc. (See “Ignore currencies at your peril”)

The companies in VGK also face different political environments, toil in different central bank territories, and pay different tax rates than their US counterparts.

Six percent, but at what cost?

So the big dividend gap…does it make sense?  We can’t answer that, but we can tell you that VGK is up 7.75 percent over the last 12 months. SPY is up 22.6 percent (source: Google Finance). Maybe European companies are selling at some kind of a “fear discount” that investors demand for stomaching the extra uncertainty hanging over Europe these days. Viewed another way, the big yield may be a “fear premium,” a reward for the extra risk.

Our point is not to anoint one of these ETFs the winner. We just want to draw attention to the many other things not being equal in any comparison of different securities. Before you leap for something you like, such as a big yield, make sure you understand there are other variables that come with the package.

As for that free lunch? We’re still on the lookout.

 


 

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This article may include forward-looking statements. All statements other than statements of historical fact are forward-looking statements (including words such as “believe,” “estimate,” “anticipate,” “may,” “will,” “should,” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.

Nothing in this article is intended to be or should be construed as individualized investment advice. All content is of a general nature. Individual investors should consult their investment adviser, accountant, and/or attorney for specifically tailored advice.

Any references to third-party data or opinions are listed for informational purposes only and have not been verified for accuracy by the Adviser. Adviser does not endorse the statements, services or performance of any third-party vendor without specifically assessing the suitability of a third-party to a client’s or a prospective client’s needs and objectives.

Performance is not indicative of any specific investment or future results.  

An investment cannot be made directly in an index. The performance of SPY and VGK shown for illustrative purposes. These securities may or may not be held in client accounts.  

Dividend yields as of 12-11-12. One year ETF returns through 12-11-12.  Dividend yields change over time. 


 

 

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