Buying the S&P 500 index is a great wealth-building investment. One of the lowest-cost ways to do that today is with the Vanguard S&P 500 Index ETF, which has a tiny 0.03% expense ratio. But is this exchange-traded fund (ETF) the best option for all investors?
Maybe not, particularly if you are retired and looking to live off of the income your portfolio generates. Here are three better choices for income-focused investors to consider.
The S&P 500 index is great for building wealth
Before getting to the alternatives to the S&P 500 index, this broad-based market index needs to be given its due. As the chart below highlights, a $150,000 investment in Vanguard S&P 500 Index ETF at its founding in late 2010 would be worth over $500,000 today. It has been a powerful growth tool, and that's just the last 15 years or so.
VOO Total Return Price data by YCharts
If you go back to the first S&P 500 index ETF to be put out -- the SPDR S&P 500 ETF, which was created in early 1993 -- getting to $1 million would have only required an investment at its launch of around $45,000. (The SPDR S&P 500 ETF's expense ratio is 0.09%, so it isn't as cost effective an investment as the Vanguard S&P 500 Index ETF today.) Both of the graphs here are showing total return, which assumes dividends are reinvested. This is basically how an investor looking to build wealth would look at investing.
SPY Total Return Price data by YCharts
The problem is that not all investors are looking for big total returns. Some, particularly those who have reached retirement, are looking for income. Or, at the very least, a mix of income and capital growth. The goal for someone in retirement has likely shifted from building wealth to living off of the nest egg that they have created.
If that's the stage of life you are in, you might want to consider buying the Schwab US Dividend Equity ETF (SCHD -1.51%), SPDR Portfolio S&P 500 High Dividend ETF (SPYD -2.23%), or Vanguard High Dividend ETF (VYM -1.56%). Here's why.
Image source: Getty Images.
Focusing on dividends with ETFs
Shifting from a capital appreciation approach to one focused on generating passive income is probably easier today than at any time in Wall Street history thanks to exchange-traded funds. The problem is going to be figuring out which ETF will best fit your personal investment goals.
For example, the Schwab US Dividend Equity ETF attempts to find a balance between high-quality growing companies and yield. It does this by starting the selection process with companies that have at least 10 annual dividend increases. It then creates a composite score that includes cash flow to total return, return on equity, dividend yield, and five-year dividend growth rate.
The 100 stocks with the highest composite score get into the portfolio and are weighted by market capitalization. The yield is currently around 4% for this ETF, which basically does exactly what you would do (buying well-run companies with attractive yields) if you were trying to build a dividend stock portfolio from the ground up.
If you wanted a bit more yield than that, you might consider the SPDR Portfolio S&P 500 High Dividend ETF. It is a very simple ETF to understand because all it does is buy the 80 highest yielding stocks in the S&P 500 index. The yield is around 4.5% today. The one caveat here is that the SPDR Portfolio S&P 500 High Dividend ETF will usually have a heavy concentration in utility, real estate, and finance stocks because these are sectors that traditionally have high yields. It may also contain some out of favor and turnaround situations.
VOO Dividend Yield data by YCharts
So far, the portfolios have been getting smaller and more focused. But if you like the idea of owning a large number of stocks for diversification purposes, then you might consider the Vanguard High Dividend ETF. It takes the entire U.S. investing universe of stocks that pay dividends. It then, roughly speaking, buys the highest yielding 50% of the list.
There are two important outcomes from this broad approach. First, the ETF owns over 550 companies. Second, because there are so many companies it has to move down the yield spectrum and has "just" a 3% or so yield. That is, of course, more than twice the 1.3% yield of the S&P 500 index, but it is also lower than the other two ETFs noted above.
Pick what works best for you
In the end, there is no single investment that will be perfect for all investors. You have to consider your own personal situation and then attempt to find the investment that you believe will be the best fit. If you are building wealth, an S&P 500 index will be a great starting point. But if you are trying to live off of the wealth you have built, then you might want to consider dividend focused ETFs like the Schwab US Dividend Equity ETF, SPDR Portfolio S&P 500 High Dividend ETF, or Vanguard High Dividend ETF.
The Schwab US Dividend Equity ETF is probably a solid middle-ground choice touching on both income and growth. But there are good reasons why you might want to pick the SPDR Portfolio S&P 500 High Dividend ETF or Vanguard High Dividend ETF, instead.
