If you have $1,000 available to invest and are looking to buy a high-yield dividend exchange-traded fund (ETF), you need to tread carefully.
ETFs are simple to buy and sell, but investors need to dig into the ETF's stock selection process so they know what they are really buying. Right now, one of the best high-yield dividend ETFs available is the Schwab US Dividend Equity ETF (SCHD 0.60%). Here's why.
What does the Schwab US Dividend Equity ETF do?
When you buy the Schwab US Dividend Equity ETF, you are basically giving your $1,000 to someone else to manage for you. That's the point of an exchange-traded fund -- it is a pooled investment product, similar in nature to a mutual fund, only ETFs have a far more liberal trading policy. You shouldn't just give money to someone else without understanding exactly what they are doing with it and why.
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The Schwab US Dividend Equity ETF tracks the Dow Jones U.S. Dividend 100 Index. This is good information to know, but it doesn't go deep enough into an exchange-traded fund's approach. The next question you have to ask is, what does the index do?
The Dow Jones U.S. Dividend 100 Index starts by looking at companies that have increased their dividends for at least 10 consecutive years. It removes real estate investment trusts (REITs) from consideration. And then it creates a composite score for each of the remaining businesses using financial metrics like cash flow to total debt, return on equity, dividend yield, and a company's five-year dividend growth rate. The 100 companies with the highest composite scores are put into the index (and, by extension, the Schwab US Dividend Equity ETF) and weighted by market cap.
This is actually a pretty complicated approach that requires some effort to manage, but the ETF still maintains a very modest expense ratio of just 0.06%. The portfolio is updated yearly, so the best candidates are always in the ETF.
Why is the Schwab US Dividend Equity ETF a great choice?
If you are looking for a dividend ETF, you probably care about dividend yield. Right now, the Schwab US Dividend Equity ETF is yielding around 4% or so. That's roughly three times the 1.3% average yield of the S&P 500 index. So the yield is fairly attractive, though you can find ETFs with higher yields. This is where the selection approach comes into play.
Each of the factors that go into picking stocks for the ETF has a purpose. Cash flow to total debt is a way to look at financial strength. Return on equity is a way to gauge a company's quality. Dividend yield looks at the income an investor will collect. And the five-year dividend growth rate offers a look at how well the income stream from a stock will keep up with inflation, among other things.
Data by YCharts.
Look at that list -- these are all things that a dividend investor would be considering if they were buying individual stocks. Simply put, the Schwab US Dividend Equity ETF is doing the work you would likely be doing if you were investing on your own. It is a bit complex, but in a good way. And the performance has been strong. Note in the graph above that the value of the ETF has grown over time, and so has the dividend it pays. If you have $1,000 or more, that's the kind of story you want to see.
There are no magic bullets on Wall Street
The Schwab US Dividend Equity ETF is a solidly built and well-thought-out ETF. It is the kind of investment you can use as the foundation of a larger income-focused portfolio. That said, it is still a portfolio of stocks that go up and down over time. So you don't avoid normal market dynamics, but you do approach the market in a way that makes sense for a dividend investor, focusing on good companies with growing dividends and attractive yields.
