Diversification is crucial for dividend investors. You don't want to depend on only a few companies for your dividend income, because it can be painful if something goes wrong.
That's where exchange-traded funds (ETFs) can make life much easier. The Vanguard Dividend Appreciation ETF (VIG -0.40%) and Schwab U.S. Dividend Equity ETF (SCHD -0.38%) are two popular dividend stock ETFs. Both offer investment exposure to a bucket of blue chip dividend stocks and have gradually paid investors increasingly larger dividends.
But which of these ETFs should investors buy right now? This Fool dove deep, and what I found is fascinating. Here is what you need to know.
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Stacking up a decade of head-to-head performance
The Vanguard Dividend Appreciation ETF tracks the S&P U.S. Dividend Growers Index, while the Schwab U.S. Dividend Equity ETF follows the Dow Jones U.S. Dividend 100™ Index. Both ETFs deal primarily in large-cap dividend stocks, and the individual companies in these ETFs and their respective weightings change over time.
So, to compare these two funds, I looked at which ETF has grown its dividend more over the past 10 years. You would probably guess it was the Vanguard Dividend Appreciation ETF given its name and its focus on dividend growth. What's more, its 1.8% yield is roughly half that of its rival's 4% yield, and generally speaking, faster-growing dividend stocks yield less.
VIG Dividend data by YCharts.
Surprisingly, investors have gotten better dividend growth from the Schwab U.S. Dividend Equity ETF. It's hard to keep raising a dividend without sufficient underlying business growth, so given the Schwab ETF's robust dividend growth, you'd probably expect it to have better total investment returns over the past decade.
Guess again! The Vanguard Dividend Appreciation ETF is the winner in price appreciation and total returns. It's a bit confusing why this is until you dig deeper. What's going on?
The DNA in one of these ETFs seems to have changed
Here are the current top holdings for each ETF, along with their recent dividend yields:
Vanguard Dividend Appreciation ETF
| Company | Percentage of ETF | Dividend Yield |
|---|---|---|
| Broadcom | 4.20% | 1% |
| Microsoft | 4.12% | 0.7% |
| Apple | 3.77% | 0.5% |
| Eli Lilly | 3.72% | 0.8% |
| JPMorgan Chase | 3.62% | 1.9% |
| Visa | 2.98% | 0.6% |
| ExxonMobil | 2.44% | 3.8% |
| Mastercard | 2.36% | 0.6% |
| Costco Wholesale | 2.31% | 0.5% |
| Walmart | 2.22% | 0.9% |
Source: Chart by author using data from the ETF's prospectus page.
Schwab U.S. Dividend Equity ETF
| Company | Percentage of ETF | Dividend Yield |
|---|---|---|
| Coca-Cola | 4.34% | 2.7% |
| Verizon Communications | 4.31% | 6.2% |
| Altria Group | 4.25% | 6.7% |
| Cisco Systems | 4.24% | 2.5% |
| Lockheed Martin | 4.20% | 2.7% |
| ConocoPhillips | 4.14% | 3.6% |
| Home Depot | 4.05% | 2.5% |
| Texas Instruments | 3.94% | 3% |
| Chevron | 3.84% | 4.9% |
| AbbVie | 3.69% | 3.5% |
Source: The author created this chart using data from the ETF's prospectus page.
A decade ago, the Vanguard Dividend Appreciation ETF yielded approximately 2.1%. Now, it's 1.8%, which makes sense when you look at its top holdings. Outside of ExxonMobil, these companies have strong earnings growth and low dividend yields. Investors generally pay more for growth, which is why the yields would be lower.
The Schwab ETF's yield increased from 2.7% to 4% over 10 years. As shown in the second list, nearly every top holding yields 2.7% or higher today. These stocks mostly feature lower growth and higher dividend yields. Over time, the Schwab U.S. Dividend Equity ETF seems to have shifted to slower-growing, higher-yielding dividend stocks. This helps explain how an ETF's yield and dividend amount could increase, as Schwab's did, without the accompanying growth and price appreciation.
Which ETF is the better buy right now?
Understanding this divergence in the two ETFs should help you determine the better investment for your portfolio.
If maximizing your immediate income is your primary goal, it's hard to go wrong with the Schwab U.S. Dividend Equity ETF and its 4% yield. You'll still get a little bit of price appreciation, too. However, I wouldn't anticipate another decade of such strong dividend growth. The ETF's holdings seem to have a lower growth baseline now.
The Vanguard Dividend Appreciation ETF's current composition is clearly more growth-oriented. Therefore, investors should expect it to grow the dividend faster and generate better total returns over the long term. So, for most investors who aren't retirees, the Vanguard Dividend Appreciation ETF is the better buy today.
