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Comparing these ETFs is mostly about assessing the potential of dividend growth versus a high-yield strategy.
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The Vanguard ETF’s methodology currently emphasizes tech at the top (for better or worse), while Schwab’s looks for durable companies with healthy balance sheets.
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I’ve always liked Schwab’s strategy, which considers dividend growth history, yield, and balance sheet quality.
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Dividend income investing usually isn’t as simple as just picking the best dividend stocks. Your personal goals and income requirements can have a big impact on whether you focus on dividend growth or high yield.
Dividend growth stocks tend to have greater durability and sustainability, but can come with low yields. High yield stocks can help solve the income problem, but they can also turn into yield traps that damage total returns. That makes the argument between the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) and the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) an interesting one.
Is the current market environment built more for classic dividend growth or one that focuses on high yield with a quality tilt?
The Vanguard Dividend Appreciation ETF tracks the S&P U.S. Dividend Growers Index. It targets large-cap stocks that have grown their annual dividend for at least 10 consecutive years. It eliminates the top 25% of yields in order to avoid some of those potential yield traps and weights the final portfolio by market cap.
There’s good and bad in this strategy. On the plus side, the elimination of high-yielders makes this more of a pure dividend growth play, even if it comes at the expense of income. On the downside, the market cap-weighting gives preference to the biggest companies regardless of yield or dividend history.
The Schwab U.S. Dividend Equity ETF follows the Dow Jones U.S. Dividend 100 Index. It targets companies of all sizes that have paid (but not necessarily grown) dividends over the past decade and scores them using metrics such as return on equity (ROE), cash flow to debt, dividend growth rate, and yield. The 100 stocks with the best combination of these factors make the final cut.
This methodology produces a portfolio heavily tilted toward the yield factor, but filled with higher-quality stocks. This is, in my opinion, an advantageous way of building the portfolio. Selecting purely by yield can be dangerous because it gives no consideration to sustainability. By selecting stocks only backed by quality balance sheets helps address that problem.