Which Dividend ETF Is Right For Your Income Strategy #NewsETFs

Choosing one investment over another is purely a matter of personal preference, governed by how well the investment aligns with the investor’s financial goals and risk tolerance. As the interest rate easing cycle kicks off, fixed income investments may gradually lose their charm, prompting investors who seek additional income to turn to dividend paying stocks and exchange-traded funds (ETFs). Dividend ETFs offer a streamlined approach to owning top dividend stocks, eliminating the hassle of building a portfolio through individual stock purchases.

While choosing a dividend ETF, it is important for investors to pay attention to the yield, growth and quality of dividends offered. Vanguard Dividend Appreciation ETF (VIG) and Schwab U.S. Dividend Equity ETF (SCHD) are two passive dividend ETFs tailored for income-seeking investors. Both VIG and SCHD hold high-quality, dividend-paying stocks and offer attractive benefits to investors, albeit with a key difference. SCHD follows an index that prioritizes stocks with higher dividend yields, while VIG tracks an index that includes stocks with a history of consistent dividend growth but excludes the top 25% of highest-yielding eligible companies. Below is a rundown on VIG and SCHD.

VIG Vs. SCHD: Which ETF Is Right For Your Dividend Strategy?

VIG ETF: What Dividend Investors Should Know

Overview: Vanguard Dividend Appreciation ETF offered by the Vanguard Group seeks to track the performance of the S&P U.S. Dividend Growers Index that includes U.S. companies with a history of consistently increasing dividends every year for at least 10 consecutive years, but excludes the top 25% highest-yielding eligible companies. VIG uses a full replication technique to mimic the index, and had 338 components as of September 30, the same as its benchmark index.

Top Sectors: VIG’s top three sectors by weight are:

1. Technology (24%)
2. Financials (20%)
3. Healthcare (15.5%)

VIG’s Top 10 Holdings: The fund’s top 10 holdings represent about 30% of total assets and include:

1. Apple (APPL)
2. Broadcom (AVGO)
3. Microsoft (MSFT)
4. JPMorgan Chase (JPM)
5. UnitedHealth (UNH)
6. ExxonMobil (XOM)
7. Visa (V)
8. Mastercard (MA)
9. Procter & Gamble (PG)
10. Home Depot (HD)

The significant exposure to the technology sector has contributed to strong historical price performance for VIG.

Performance: VIG is part of Morningstar’s Large Blend category, which by Morningstar’s definition is fairly representative of the overall U.S. stock market in size, growth rates and price. Although VIG has lagged the S&P 500, it still generated solid returns in the past years.

Source: Google

Expense Ratio: VIG has an ultra-low expense ratio of 0.06%, meaning investors pay Vanguard $6 for every $10,000 invested in the ETF. This compares favorably with the average expense ratio of 0.78% of similar funds. An expense ratio, or the cost of owning a fund, is a key consideration before buying into a fund, as a high expense ratio can significantly cut into returns over time.

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SCHD ETF: What Dividend Investors Should Know

Overview: Schwab U.S. Dividend Equity ETF offered by Charles Schwab aims to track as closely as possible, before fees and expenses, the total return of the Dow Jones U.S. Dividend 100 Index.

The Dow Jones U.S. Dividend 100 Index includes stocks of 100 high dividend-paying U.S. companies with a record of consistently paying dividends with no single stock representing more than 4% of the index and no single sector representing more than 25% of the index.

The index undergoes a daily check to ensure that no stock breaches the weight limits. If the sum of stocks with weights greater than 4.7% exceeds 22%, the index will be reweighted. Any adjustments resulting from this daily check will take effect two days after the threshold is breached.

As for stock selection, no REITs are included in the index and stocks are screened for minimum 10 consecutive years of dividend payments, minimum float-adjusted market capitalization of $500 million and minimum three-month average daily trading volume (ADTV) of $2 million.

The stocks resulting from these screens are then ranked in descending order of indicated annual dividend (IAD) yield. The IAD is a projection or estimate of the cash dividends anticipated over the next 12 months based on historical dividend payouts. Typically, IAD is derived from the most recent quarterly dividend, annualized. The top half of securities based on this ranking are eligible for stock selection.

The eligible stocks are then ranked based on free cash flow to total debt (companies with zero total debt are ranked first), return on equity (companies with negative equity are ranked last), IAD yield and five-year dividend growth rate. The four rankings are summed to create a composite score, and the 100 top-ranked stocks based on the composite score make it to the index. This exhaustive selection process ensures that the Dow Jones U.S. Dividend 100 Index includes the creme-de-la-creme, highlighting the quality and sustainability of dividends.

Portfolio Composition: The proof is in the pudding. SCHD, which tracks the index, has 62.6% of its portfolio represented by stocks with a market cap of $70 billion or more, and about 90% of its stocks have a market cap of $15 billion or more.

Top Sectors: SCHD’s top three sectors by weight are:

1. Financials (19%)
2. Healthcare (15.9%)
3. Consumer staples (13.4%)

SCHD’s Top 10 Holdings: The fund’s top 10 holdings represent about 40.9% of total assets and include:

1. Cisco (CSCO)
2. BlackRock (BLK)
3. Chevron (CVX)
4. Home Depot (HD)
5. Bristol-Myers Squibb (BMY)
6. Texas Instruments (TXN)
7. AbbVie (ABBV)
8. Verizon (VZ)
9. Amgen (AMGN)
10. United Parcel Service (UPS)

Dividend Yield: Schwab U.S. Dividend Equity has paid a dividend for more than 10 consecutive years, with increased annual payouts. SCHD’s ttm (trailing 12 months) distribution yield of 3.4% is 2x VIG’s distribution yield of 1.7%.

Performance: Although not a S&P 500 outperformer, SCHD has also produced solid returns for shareholders.

Source: Google

Expense Ratio: SCHD has a very low expense ratio of 0.06%, which is the same as VIG’s.

Recent Stock Split: In a rare move for an exchange-traded fund, SCHD executed a 3-for-1split, effective October 10. The ETF split makes it easier for smaller investors to establish a position, but that aside, the overall value for shareholders and the fund’s fundamentals remain unchanged.

Comparing VIG Vs. SCHD

Sources: Yahoo Finance, Google, Seeking Alpha.

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VIG Vs. SCHD: The Similarities

Passive Index ETFs

VIG and SCHD are passively managed index ETFs popular with dividend investors and retirees looking for supplemental income.

Focus on High-Quality Dividend Stocks

Both VIG and SCHD include high-quality dividend-paying stocks and pay dividends on a quarterly basis.

Low Expense Ratio

VIG and SCHD are both cost-effective with the same low expense ratio of 0.06%. This means investors will pay a $6 fee for every $10,000 invested. Minimized costs of owning a fund typically pave way for higher potential returns in the longer run.

Sector Exposure

VIG and SCHD include financial and healthcare sectors among their top three weightings. Both ETFs have about 20% exposure to financials and 15% exposure to the healthcare sector.

Diversification

Both VIG and SCHD are well-diversified with more than 100 stocks, reducing concentration risks.

Qualified Dividends

VIG and SCHD offer qualified dividends that will be taxed at a lower rate than ordinary income, subject to compliance with holding period requirements.

Valuation

Market prices of VIG and SCHD are closely aligned to their respective net asset value/per share.

VIG Vs. SCHD: Key Differences

Dividend Yield

SCHD has a dividend yield that is two-times higher than VIG’s. This may be attributed to VIG excluding the top 25% highest-yielding eligible companies that clear the 10-year dividend hike test, in alignment with its benchmark index, the S&P U.S. Dividend Growers Index.

Capital Appreciation

In terms of price performance, VIG has outperformed SCHD in the year-to-date, 1-year, 3-year and 5-year periods. This may be because of VIG’s higher weighting of the technology sector that represents 25% of its portfolio vs. SCHD’s 10.9% exposure.

VIG: Pros And Cons

Pros

• VIG provides a blend of income and capital appreciation as it tends to focus on companies with strong financials and reliable dividend growth.
• Low expense ratio makes a difference by generating significant savings for the investor when compounded over the long-term, thereby improving returns.

Cons

• Lower dividend yield vs. SCHD and other dividend-focused ETFs renders VIG unattractive for investors looking for high income in the immediate-to-near-term, especially retirees leaning heavily on dividend income.

SCHD: Pros and Cons

Pros

• SCHD has a relatively high dividend yield compared to VIG thanks to its diligent screening process to select its stock holdings. The steady income stream can be advantageous in a lower interest rate environment.
• A diversified mix of top-rated dividend stocks, and an exceptionally low expense ratio render it attractive for investors.
• SCHD’s track record of double-digit annualized returns for the long-term still render it appealing for long-term investing, although past performance is no guarantee for future returns.
• SCHD also fares well on dividend growth metrics. It has grown dividends for 12 years in a row at a 5-year growth rate of 12%.

Cons

• Lack of exposure to REITs limits the higher income potential of SCHD. REITs are dividend powerhouses because this asset class is required to distribute at least 90% of its taxable income to shareholders. However, it should be noted that most REIT distributions are considered non-qualified dividends, which will be taxed at normal income tax rates vs. lower rates for qualified dividends.
• SCHD’s dividend yield of 3.4% still compares less favorably to the 5%-plus annual percentage yield (APY) offered by some High Yield Savings Accounts (HYSA) where it’s still not too late to join the party. For reference, Pibank offers a 5.50% APY for a no-fee account that requires no minimum balance and is FDIC-insured (FDIC deposit insurance covers $250,000 per depositor).

VIG Vs. SCHD: Investor Suitability

VIG is more suited for investors with a focus on long-term capital appreciation combined with steadily growing dividends. For retired investors relying heavily on dividend income, VIG may not be a great fit because of its low dividend yield of 1.7%. The underlying index that VIG tracks has this criterion of excluding the top 25% highest-yielding eligible companies from its list meaning that the highest-yielding stocks that pass the 10-year dividend raise test are excluded from consideration.

Prima facie, the rule appears self-sabotaging, but the approach focuses on avoiding yield traps, where the risks of owning a high-yield stock may exceed the rewards. If a company struggles and investor sentiment sours, the stock price goes down pushing up yields. It would not be unreasonable to assume that such companies may be at the risk of cutting or even eliminating dividends.

SCHD delivers strong yields in the near term, making it an attractive option for income-focused investors and retirees. It’s also suitable for investors looking for long-term capital appreciation. SCHD appears well-positioned to benefit in a low interest rate environment, thanks to its focus on high-yield dividend payers.

Bottom Line

Both VIG and SCHD provide opportunities for capital appreciation and low-cost, diversified exposure to large-cap stocks with a strong history of paying and growing dividends. However, between these two ETFs, the choice ultimately depends on your financial goals.

I lean toward SCHD. Not only does it offer a higher yield than VIG, but it also delivers solid price performance and impressive dividend growth metrics.

While VIG is often touted as the dividend-growth ETF, it is interesting to note that SCHD has demonstrated consistent dividend growth for 12 years, with a 5-year growth rate (CAGR) of 12%. This surpasses VIG’s 10 consecutive years of dividend growth and its 5-year growth rate (CAGR) of 10.11%.

Besides, SCHD’s benchmark index runs a rigorous stock selection process emphasizing fundamental strength and prioritizing the quality and sustainability of dividends. All these factors, alongside the beginning of a shift to a lower interest-rate environment, should position SCHD more favorably with investors looking for strong yields, dividend growth and capital appreciation.

Please note that I am not a registered investment advisor and readers should do their own due diligence before investing in this or any other stock/ETF. I am not responsible for the investment decisions made by individuals after reading this article. Readers are asked not to rely on the opinions and analysis expressed in the article and encouraged to do their own research before investing.

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