The Schwab US Dividend Equity ETF (SCHD -0.37%) has around $68 billion in assets, which suggests it is a very popular exchange-traded fund (ETF). There are some good reasons for this, but sometimes what's popular on Wall Street isn't the best thing to buy.
Examples of fad investments that didn't work out over the long term are littered across investment history, from the Nifty Fifty to tulip bulbs. Is the Schwab US Dividend Equity ETF a buy now, or should investors tread with caution?
What does the Schwab US Dividend Equity ETF do?
The Schwab US Dividend Equity ETF is a pooled product, which means it allows multiple investors to "pool" their cash together so that one professional money manager can oversee it. In this way, ETFs are similar to mutual funds. There are some differences between the two, but the big difference is that ETFs trade all day long like a stock, while mutual funds can only be bought and sold at the end of each trading day.
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There are two broad varieties of ETF: actively managed and index tracking. The Schwab US Dividend Equity ETF is an index tracker. So, when trying to understand what it does, you really need to understand the index it tracks, which is the Dow Jones U.S. Dividend 100 Index. This index is fairly complex.
The Dow Jones U.S. Dividend 100 Index starts by looking at companies that have increased their dividends for at least 10 consecutive years. Real estate investment trusts (REITs) are eliminated from consideration. Once it has this starting pool of stocks, it creates a composite score for each stock being considered. The score looks at cash flow to total return, return on equity, dividend yield, and the company's five-year dividend growth rate.
The 100 stocks with the highest composite scores are included in the index. The index is market-cap weighted. By following the Dow Jones U.S. Dividend 100 Index, the Schwab US Dividend Equity ETF is effectively attempting to buy high-quality dividend growth stocks. The bias, however, is toward stocks with higher yields. With an expense ratio of just 0.06%, a lot of work is being done at little cost for investors. Meanwhile, the dividend yield is nearly 4% today, which is quite attractive relative to the S&P 500's (^GSPC -0.03%) comparatively tiny 1.2% yield.
Data by YCharts.
What has the Schwab US Dividend Equity ETF done?
In essence, the Schwab US Dividend Equity ETF attempts to do what most dividend investors are trying to do: Find good companies that pay reliable and growing dividends. That makes it rather attractive if you are a dividend investor looking to simplify your investment life. What it has not done, however, is match the performance of the S&P 500 index. As the chart above highlights, the Schwab US Dividend Equity ETF has lagged the S&P 500 index on both price appreciation and total return.
But dividend investors aren't always looking to maximize for total return or price appreciation. A lot of dividend investors are simply looking for a large and generally growing income stream and some modest capital appreciation. As the chart below shows, the Schwab US Dividend Equity ETF has done pretty well on those two points, with its price doubling over the past decade and the dividend trending steadily higher.
Data by YCharts.
Add in the roughly 4% dividend yield, and the story gets especially compelling for dividend investors. One important key here, however, is that the ETF's portfolio is rebalanced every year. In other words, it updates its portfolio regularly to ensure that it owns the "best" stocks, according to its screening system. So it is a set-it-and-forget-it type of investment.
The Schwab US Dividend Equity ETF is a good option today
At the end of the day, buying the Schwab US Dividend Equity ETF is really about buying the methodology behind the ETF. And that methodology has produced an attractive combination of income and capital appreciation. It is not perfect, but no investment is. The tradeoff is that you probably won't have the same total return potential here as you would with an S&P 500 index fund. But if what you are after is material income and modest capital growth, the Schwab US Dividend Equity ETF is likely to be an attractive buy for you today.
