Schwab US Dividend Equity ETF looks beyond dividends to help create its portfolio, an extra step that should interest most income investors.
If you like to keep your investment life as simple as possible, then exchange-traded funds (ETFs) should be on your radar screen. However, you can't just look at an ETF's name and assume anything, since each one is a little different.
When it comes to dividend stocks, Schwab US Dividend Equity ETF (SCHD 0.88%) takes the dividend story an extra step forward, and that could make it the best dividend ETF for you. Here's what you need to know.
What does Schwab US Dividend Equity ETF do?
A lot of dividend-focused exchange-traded funds look just at dividend yield. For example, SPDR Portfolio S&P 500 High Dividend ETF (SPYD 1.07%) buys the 80 highest-yielding stocks in the S&P 500 index. It doesn't matter if the stocks are financially strong or weak, or if they have a history of operating at a high level or are industry laggards.
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That may be fine for some investors, but others may want to be a bit more discerning. That's where Schwab US Dividend Equity ETF comes in.
First, the ETF required holdings to have at least 10 years of annual dividend increases behind them. Then it creates a composite score based on cash flow to total debt, return on equity, the dividend yield, and the five-year dividend growth rate. The ETF then ranks stocks from best to worst on its composite score, selecting the top 100 names, weighted by market cap, for inclusion in Schwab U.S. Dividend Equity ETF. (Note that real estate investment trusts are specifically removed from consideration for the portfolio.) In effect, the ETF is attempting to find a balance between quality and yield.
Is Schwab U.S. Dividend Equity ETF right for you?
The unique portfolio construction here has material implications for dividend investors. For starters, it is highly likely that you will be able to find an ETF with a higher yield. As noted, SPDR Portfolio S&P 500 High Dividend ETF's sole focus is on high-yield stocks, and it has a dividend yield of 4.6%. That's more than a percentage point higher than Schwab US Dividend Equity ETF's 3.4% yield. If all you care about is yield, then Schwab US Dividend Equity ETF might not be a good fit for you.
However, if you want to own high-quality dividend stocks, your focus shouldn't be on dividend yield alone. You need to consider other factors, which is exactly what Schwab US Dividend Equity ETF is designed to do. But a couple of stats will help here.
SPDR Portfolio S&P 500 High Dividend ETF's largest sectors are real estate (26% of assets), financials (20%), and utilities (18%). That's nearly two-thirds of the portfolio in just three sectors. Schwab US Dividend Equity ETF's top sectors are finance (17% of assets), healthcare (15%), consumer staples (13%), industrials (13%), and energy (12%), which together make up roughly 70% of the portfolio. There's a huge diversification difference here, and Schwab's approach puts more of the fund into sectors with a growth orientation.
Dividends are great, but focusing only on dividend yield can bias your portfolio in ways that you may not want. Schwab US Dividend Equity ETF tries to find a better approach by bringing yield, dividend growth, and company quality into the mix.
If you care about more than yield...
There's nothing wrong with buying an ETF that only looks at dividend yield, but you have to be sure that this approach is actually what you want. For many investors, factoring in quality will be a more attractive way to go about investing in dividend stocks. And if that sounds like something you would want, Schwab US Dividend Equity ETF could easily end up being the best dividend ETF for you.
Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
