Dividend stocks are a great way to earn passive income. Companies that make enough cash to consistently pay (and raise) a dividend often outperform the broader market. For instance, dividend aristocrats produced an annualized total return of 10.8% over the last 15 years, beating the 8.5% return of the broader S&P 500, according to S&P Global.

Moreover, high-quality dividend-paying stocks tend to be less volatile. For instance, the dividend aristocrats collectively declined about 9% through the first 10 months of 2022, but the S&P 500 dropped 18% during that time period. In a nutshell, a well-chosen dividend stock can beat the market while sparing investors the anxiety that comes with huge fluctuations in their portfolios.

However, there is a downside. Passive income investors must diligently monitor the financial performance of each stock in their portfolio to ensure the dividend is sustainable. Payout ratio — the percentage of net income paid out in dividends each year — is one of the most critical metrics to watch. According to Hartford Funds, stocks with a dividend payout ratio of around 40% tend to outperform the S&P 500 most frequently, while those with a higher payout ratio are more likely to cut their dividends at some point.

Fortunately, index funds allow investors to sidestep that complexity by taking a basket approach. Here is one index fund you can buy with confidence in a bear market.

A basket approach to buying dividend stocks
The Vanguard Dividend Appreciation ETF (VIG) seeks to track the S&P U.S. Dividend Growers Index, which measures the performance of U.S. companies that have consistently increased their dividends for at least 10 years. The index excludes the top-25% highest-yielding companies, which helps eliminate stocks that have unsustainable payout ratios.

The Vanguard Dividend Appreciation ETF represents a diversified blend of value stocks and growth stocks, and its 289 constituents span 10 of the 11 stock market sectors. The real estate sector is absent. The top five holdings include healthcare companies UnitedHealth Group (UNH) and Johnsons & Johnson (JNJ), tech titan Microsoft (MSFT), financial giant JPMorgan Chase (JPM), and consumer staples stalwart Procter & Gamble (PG).

As of Oct. 31, 2022, the Vanguard ETF had a dividend yield of 1.92%, meaning a $10,000 portfolio would produce about $192 in dividends each year. That may not seem like much, but reinvesting those dividends can snowball over time. For instance, the Vanguard ETF produced a total return of 165% over the past decade, or 10.2% on an annualized basis. That falls short of the 13.4% annualized return of the broader S&P 500, but the Vanguard ETF has been less volatile, as evidenced by its five-year beta of 0.86.

The combination of a reliable dividend and limited volatility is particularly valuable during a market downturn. High inflation and rising interest rates have many investors worried about a recession, and that concern has sent the stock market tumbling this year. The S&P 500 delivered its worst first-half performance since 1970, and it currently sits 16% off its high. Meanwhile, the Vanguard ETF has dropped just 11%

That makes the Vanguard ETF an attractive option for risk-averse passive income investors that prefer to avoid the complexity of tracking individual stocks. And with a low expense ratio of just 0.06%, investors will pay just $6 per year on a $10,000 portfolio.

As a final thought, risk-tolerant investors looking for a little more upside potential should consider buying an S&P 500 index fund. Warren Buffett has long been a proponent of that investment strategy.

— Trevor Jennewine

Where to Invest $99 [sponsor]
Motley Fool Stock Advisor's average stock pick is up over 350%*, beating the market by an incredible 4-1 margin. Here’s what you get if you join up with us today: Two new stock recommendations each month. A short list of Best Buys Now. Stocks we feel present the most timely buying opportunity, so you know what to focus on today. There's so much more, including a membership-fee-back guarantee. New members can join today for only $99/year.

Source: The Motley Fool