Sometimes dividend investors get so caught up in dividend yields that they fail to see the big picture. Often the mistake involves taking on more company-specific risk than expected, but sometimes the problem is more subtle. The risk of a lower total return is what investors need to consider when comparing SPDR Portfolio S&P 500 High Dividend ETF (SPYD -0.15%), which has a yield of 4.6%, to Schwab U.S. Dividend Equity ETF (SCHD -0.10%) and its 3.5% yield.
Taking the simple approach isn't so simple
From a big-picture perspective, investors buying broad-based exchange-traded funds (ETFs) like SPDR Portfolio S&P 500 High Dividend ETF and Schwab U.S. Dividend Equity ETF are looking for simplification. In this case, instead of trying to build a portfolio of dividend-paying stocks one at a time, you can simply buy a single investment that provides you with a prebuilt portfolio. That's great, but you need to understand what you're buying, and that can require a little bit of work.
SPDR Portfolio S&P 500 High Dividend ETF, for example, isn't just an S&P 500 index clone, which should be clear from the name. It is focused on the highest-yielding stocks in the S&P 500. But how does it actually go about creating that portfolio? Keeping things simple, it lines up the components of the index according to yield and pulls out the 80 highest-yielding stocks to populate its ETF. The index is equal-weighted.
There are a few takeaways. First, the S&P 500 index is selected to represent the broader U.S. economy. So stocks in the starting universe are there because of human intervention, and they may not actually be the best stocks in each industry but instead the most important from an economic perspective. Second, high-yield stocks are often out of favor for one reason or another. So SPDR Portfolio S&P 500 High Dividend ETF might be concentrated in value-oriented companies. Third, there are some sectors that tend to always have stocks with higher yields in them. Thus, the ETF is likely to be more heavily weighted in some sectors. And fourth, the fund is equally weighted. That ensures that each stock has the same opportunity to affect performance, but it also means the best-performing stocks, which are often the largest in a market cap-weighted index, won't have a disproportionate impact on performance.
Schwab U.S. Dividend Equity ETF is built off the Dow Jones U.S. Broad Stock Market Index, but real estate investment trusts (REITs) are specifically excluded. To be approved for the ETF, a company must have at least 10 years of consecutive dividend payments and meet minimum size and liquidity requirements. The resulting list is then ordered based on yield, with the top half eligible for inclusion in the ETF. The eligible securities are then ranked on a composite score that looks at free cash flow to total debt, return on equity, yield, and five-year dividend growth. The top 100 stocks from this ranking are added to the index based on market cap.
This evaluation is a lot more complex, but unlike the SPDR ETF, it is largely data driven without material human intervention. The starting universe is also larger. And the fundamental screens involved take into account company quality, which would probably weed out many value stocks. That, in turn, should lead to a more growth-oriented portfolio. Meanwhile, the market cap weighting means the largest stocks, which will probably be the best performing, will drive the ETF's performance. These are not trivial differences.
Highlighting some key differences
For example, there are only two overlapping securities in the top 10 holdings of these two funds: Verizon Communications and Amgen. In SPDR Portfolio S&P 500 High Dividend ETF, they account for around 3.2% of fund assets combined. In Schwab U.S. Dividend Equity ETF, those two stocks make up 8.4% of assets.
There are no banks in Schwab U.S. Dividend Equity ETF's top 10 holdings. Meanwhile, there are three banks in SPDR Portfolio S&P 500 High Dividend ETF, all of them regional. Regional banks as a group struggled in 2023 after a series of bank runs in the sector, leaving them out of favor right now.
From a bigger-picture perspective, the Schwab ETF has a higher average price-to-earnings ratio and price-to-cash flow ratio. Both of those facts make sense given that the index construction leans more toward growth than the SPDR index.
None of these differences is shocking, given the way the ETFs are constructed. But you need to take the time to understand the construction approach to each ETF to understand just how different the two ETFs are. But what do you do with all of this information?
Yield versus total return
If what you're looking to do is maximize the income your portfolio generates, SPDR Portfolio S&P 500 High Dividend ETF's 4.6% dividend yield easily wins out over Schwab U.S. Dividend Equity ETF's 3.5%. Given the construction of the SPDR ETF, this is exactly the outcome you would expect. To be fair, however, both are notably higher than the yield of the S&P 500 index, which is a scant 1.4%. But picking the highest yield here may miss the bigger picture.
SCHD Dividend Yield data by YCharts
In this comparison, the best way to look at long-term performance is through total return, which assumes dividend reinvestment. On a total return basis, Schwab U.S. Dividend Equity ETF is easily the better-performing ETF over the past five years, as the following chart shows. However, it still didn't manage to beat the S&P 500 index (as represented by the SPDR S&P 500 ETF), even though it got a lot closer than the SPDR ETF.
SCHD Total Return Price data by YCharts
From that last point, you have to go back to the purpose of your investment. If you're reinvesting the dividends, then why even focus on an ETF that highlights dividends? Just buy an S&P 500 index and be done with it. But there's a nuance for those looking to live off dividend income but who still want to see capital appreciation, something of a growth-and-income tactic.
As the chart above highlights, the price of SPDR Portfolio S&P 500 High Dividend ETF has basically gone nowhere for five years, meaning the dividend has represented most of your return. The price of Schwab U.S. Dividend Equity ETF, on the other hand, rose roughly 50%, leading to a mixture of growth and income for shareholders. And that's probably the biggest takeaway for investors comparing these two ETFs.
The better pick probably depends on your time horizon
If you're trying to maximize income over a shorter period, going with SPDR Portfolio S&P 500 High Dividend ETF probably makes sense. But if you expect to live for another 20 years in retirement, the more growth-oriented Schwab U.S. Dividend Equity ETF looks as if it would better protect you from the ravages of inflation. For many investors, that will be the winning call, even though it will mean less income upfront.
