VYM Is Great, but Vanguard Has Another High-Yield ETF That Pays Twice as Much

Shocker, I’m a big fan of the Vanguard High Dividend Yield ETF (NASDAQ: VYM | VYM Price Prediction), and not just because Vanguard recently lowered its expense ratio again to just 0.04% a year.

I like the benchmark. VYM tracks the FTSE High Dividend Yield Index, which takes a fairly straightforward approach. It removes real estate investment trusts, excludes companies that haven’t paid a dividend in the past 12 months or aren’t expected to pay one, and then ranks the remaining stocks by forward dividend yield, weighting them by market capitalization. That process results in a portfolio of about 550 companies.

The screen does more than just boost income. In addition to producing a respectable 2.29% 30-day SEC yield, it also gives the portfolio a natural value tilt. VYM trades at around 21.8 times earnings, cheaper than the broader market, while still maintaining solid quality with a 19.2% average return on equity.

Still, if you’re looking for higher income, VYM isn’t going to cut it. And within Vanguard’s lineup, you won’t find any covered call ETFs to boost yield. If you want more income, you’re going to have to take on different types of risk. One option is the Vanguard Emerging Markets Government Bond ETF (NASDAQ: VWOB).

With a slightly higher 0.15% expense ratio, it currently offers a 6.05% 30-day SEC yield with monthly distributions. But that extra yield comes from taking on credit risk. Before you invest, it’s worth understanding exactly what you’re getting into.

What Is VWOB?

VWOB holds government bonds issued by emerging market countries. An emerging market is generally defined as a country that is still developing economically, with lower income levels, less mature financial systems, and often higher political or economic instability compared to developed markets.

Based on FTSE index classifications and current exposures in descending weight, VWOB includes countries like Saudi Arabia, Mexico, Indonesia, Turkey, the United Arab Emirates, Argentina, Qatar, Brazil, Colombia, the Philippines, Chile, and more.

So geographically, it’s all over the world. But the common thread is credit quality. These governments are generally less creditworthy than developed nations like the United States, Canada, Japan, or Australia. That’s exactly why they have to offer higher interest rates to attract investors.

There’s a higher probability that some of these countries may struggle to meet their debt obligations, whether due to weak institutions, poor monetary policy, political instability, or external shocks. That’s where the higher yield is coming from.

It’s not free money. You’re effectively lending to governments that carry more risk than Uncle Sam does, and this is why a good portion of the bonds in VWOB are rated BB or lower, firmly in non-investment-grade territory.

Currency Risk and Tax Efficiency

Whenever you invest in international bonds, currency risk is usually a big consideration. Even if the bonds perform well, returns can be offset if the foreign currency weakens relative to your home currency. Interestingly, that’s not an issue with VWOB.

All the bonds in the fund are denominated in U.S. dollars. That means you don’t have to worry about fluctuations in foreign exchange rates impacting your returns. There’s enough global demand for U.S. dollar debt that these countries are willing to issue bonds in USD, largely because of the dollar’s status as the world’s reserve currency.

So, on the currency front, things are relatively straightforward. But taxes are a different story. Bond income is generally not very tax efficient, and VWOB is slightly worse than most.

Unlike U.S. Treasuries, which are exempt from state and local taxes, or municipal bonds, which can be exempt from federal taxes, the income from VWOB is taxed as ordinary income. That means it’s subject to your full marginal tax rate at both the federal and state level.

If you’re holding this in a taxable account, that can take a meaningful bite out of your yield. Vanguard estimates that after taxes on distributions, VWOB’s annualized three-year total return would have been reduced from 8.01% to 5.42%. The simple solution for many investors is to prioritize VWOB in a tax-advantaged account like a Roth IRA.