Experienced investors understand that steering a portfolio is ultimately about trade-offs. For instance, the trade-off for above-average growth is often greater volatility; the trade-off for reliable dividend income is usually lower capital appreciation. Even income investors know that dividend growth is typically achieved by stocks with more modest dividend yields.
There is an exchange-traded fund, however, that doesn't necessarily force dividend-seeking investors to make such a sizable compromise. The Schwab U.S. Dividend Equity ETF (SCHD -1.14%) boasts a strong track record of rising dividend payouts, capital appreciation, and a strong dividend yield for anyone just now stepping in.
Here's how the exchange-traded fund achieves such an unlikely feat.
Stronger than it seems like it should be
The Schwab U.S. Dividend Equity ETF's trailing-12-month dividend yield stands at just under 3.5% -- or more than double the S&P 500's current yield of 1.4%. Often, a yield this high might be associated with a stock that doesn't grow its dividend payments all that well or produce tremendous capital gains.
That's not the case with this particular ETF, though. Over the course of the past 12 months, it's dished out $2.61 worth of dividend payouts. That's 70% more than it was paying just five years back, and 175% better than a decade ago. This fund's dividend payments have compounded at an annualized growth rate of a little over 10% per year, easily outpacing inflation.
Now, there's no denying that the Schwab U.S. Dividend Equity ETF hasn't quite kept up with the S&P 500. It's not exactly floundering when it comes to performance, though. The ETF's price is up more than 110% over the past decade versus a 180% gain from the S&P 500. And, had you reinvested its dividends in more shares of Schwab's dividend fund, your total return for this timeframe would be an impressive 190%. The S&P 500's equivalent return for the same span would be a bit higher at 230%, but you wouldn't have collected nearly as much in dividends during this time.
Quality counts in the end
These numbers beg the question: How does this ETF achieve its results? In simplest terms, this ETF (along with the Dow Jones U.S. Dividend 100 Index it's built to mirror) is winning out due to the proven quality of the stocks it holds.
That's not just an assumption. Mutual fund company Hartford crunched the numbers, verifying that U.S. stocks with the near-highest -- but not quite the highest -- dividend yields consistently outperformed the S&P 500 going all the way back to the 1930s. The fund company's research further verifies that stocks of companies initiating or regularly raising their dividends since 1973 boast an average annual return of just over 10%, edging out stocks that don't do the same.
This makes sense after some thought. That is, while highly touted growth stocks are often expected to produce greater returns than your average dividend-paying stock, many of them often end up failing to do so. Think of GoPro or electric vehicle maker Lucid. Investors had high hopes for both stocks at one point. Not every company is the next Amazon.
But why aren't the highest-yielding dividend payers also the market's highest-performing stocks? It's got a great deal to do with sustainability. Hartford finds that the highest-yielding stocks were of companies using an uncomfortably high average of 75% of their profits to fund their payouts. That doesn't leave much left over to invest in growth, and certainly leaves no wiggle room when things get fiscally tight.
The very best-performing dividend stocks, conversely, were of companies only committing about 40% of their bottom lines to their dividend payments. This more conservative dividend policy allowed them to spend more money on building their businesses, or didn't force these organizations to borrow during tough times just to maintain their payouts.
Eventually, these higher-quality, more-dependable organizations ended up becoming or remaining the names behind the market's most desired stocks. Quality wins out in the end! And the Dow Jones U.S. Dividend 100 Index that Schwab's U.S. Dividend Equity ETF is built to mimic holds many of these reliable, well-managed companies.
Lots of balance without lots of trade-offs
Although the Schwab U.S. Dividend Equity ETF is certainly capable of producing growth, if your only goal right now is growth and you don't care about dividend income, the Vanguard Growth ETF (VUG -1.54%) remains your better bet. Or, if instead you're looking to maximize your current yield and aren't too concerned about dividend growth, consider the SPDR Portfolio S&P 500 High Dividend ETF (SPYD -1.59%) instead.
But if your goal is a balance of current income, dividend growth, and capital appreciation, the Schwab U.S. Dividend Equity ETF somehow scores surprisingly high in all three categories, minimizing the trade-offs you'd normally expect to see with such a holding.
The only trick is being willing to hold on to it for a few years and letting its above-average quality holdings do their job. Even so, that's still more than a fair trade-off.
