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Comparing these ETFs is primarily about evaluating dividend growth potential versus a high-yield strategy.
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Vanguard’s ETF methodology currently emphasizes technology 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 is usually not as simple as choosing 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 have low yields. High-yield stocks can help solve the income problem, but they can also become performance traps that hurt total returns. That makes the discussion between Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) and the Schwab US Dividend Stock ETF (NYSEMKT:SCHD) an interesting one.
Is the current market environment designed more for classic dividend growth or one that focuses on high yield with a quality bias?
The Vanguard Dividend Appreciation ETF tracks the S&P US Dividend Producers Index. It targets large-cap stocks that have increased their annual dividend for at least 10 consecutive years. Eliminate the top 25% of returns to avoid some of those potential return traps and weight the final portfolio by market cap.
There are good and bad things about this strategy. On the plus side, eliminating high-yield companies makes this more of a purely dividend growth strategy, even if it comes at the expense of income. On the negative side, market cap weighting gives preference to larger companies, regardless of their performance or dividend history.
The Schwab US Dividend Equity ETF follows the Dow Jones US Dividend 100 Index. It targets companies of all sizes that have paid (but not necessarily increased) dividends over the past decade and rates 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 weighted toward the yield factor, but filled with higher quality stocks. This is, in my opinion, an advantageous way to build the portfolio. Selecting solely for performance can be dangerous because it does not take sustainability into account. Selecting stocks backed only by quality balance sheets helps address that issue.