Key Points
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Some ETFs, such as Vanguard High Dividend Yield ETF, simply buy high-yield stocks and call it a day.
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Other ETFs, such as Schwab U.S. Dividend Equity ETF, use complex screens to assemble a dividend portfolio.
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How an ETF constructs its portfolio is more important than its yield.
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Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) has an attractive 3% yield and a history of both capital appreciation and dividend growth. Its strong performance has resulted in net assets of $120 billion, as of this writing, making it a very popular exchange-traded fund (ETF). But it isn’t the only dividend-focused ETF to consider. You could also buy Vanguard High Dividend Yield ETF (NYSEMKT: VYM), iShares Core Dividend Growth ETF (NYSEMKT: DGRO), Vanguard Dividend Appreciation ETF (NYSEMKT: VIG), iShares Core High Dividend ETF (NYSEMKT: HDV), or iShares Dividend Select ETF (NASDAQ: DVY).
It can get confusing. And before you buy any of these ETFs, you should make sure you understand what they do. It isn’t enough to look at the dividend yield. Here’s why.
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1. Schwab U.S. Dividend Equity ETF
Schwab U.S. Dividend Equity ETF is the perfect example of why yield doesn’t tell you enough to make an investment decision. The yield is roughly 3% as of this writing, compared to the broader market’s roughly 1%. But the big story is that the ETF owns a curated list of 100 stocks.
It creates that list by first looking at only companies that have increased their dividends annually for 10 years, excluding partnerships and real estate investment trusts. Then, a composite score is created using free cash flow-to-total debt, return on equity, dividend yield, and dividend growth. The 100 top-ranked companies are included in the ETF using a market-cap-weighted approach.
The goal is to identify good businesses that are growing and offer attractive yields, backed by rising dividends. This is what many dividend investors are trying to do, too, which helps explain why the ETF is popular. It is a solid balance between dividend yield and growth that will satisfy many investors.
2. Vanguard High Dividend Yield ETF
Vanguard High Dividend Yield ETF takes a dramatically different approach to dividend investing. Despite the name, the yield is only 2.2%. Before you pass it by, it is actually a solid choice for investors who focus on broad indexes. The ETF takes all U.S. dividend-paying stocks, excluding REITs, and lines them up by yield. Then it effectively buys the top 50% of the list by yield. There are nearly 600 stocks in the portfolio, making it a potential alternative to an S&P 500 index (SNPINDEX: ^GSPC) ETF. The S&P 500’s yield is, as noted above, only around 1%.
3. iShares Core Dividend Growth ETF
iShares Core Dividend Growth ETF has a yield of 1.8%. Like the two ETFs above, this one also excludes REITs. It takes U.S. dividend-paying stocks and eliminates the 10% with the highest yields. From there, it eliminates stocks that don’t have a positive consensus earnings forecast or have payout ratios above 75%. Only stocks with five or more years of consecutive dividend growth are included, and they are weighted by dividend payments. It is a bit complex, but if dividend growth is your approach, it could fit. The portfolio’s size will vary based on how many stocks pass the screen, but the ETF currently holds 391 investments and could also substitute for an S&P 500 index ETF.
4. Vanguard Dividend Appreciation ETF
Vanguard Dividend Appreciation ETF offers a yield of roughly 1.4% and is much simpler than iShares Core Dividend Growth ETF. Vanguard Dividend Appreciation ETF looks at stocks that increased their dividends for 10 years and eliminates the 25% of the list with the highest yields. It buys the rest using market-cap weighting. There are roughly 330 stocks in the portfolio. Like Vanguard High Dividend Yield ETF, it is a good option for a dividend growth lover who would otherwise look at an S&P 500 index.
5. iShares Core High Dividend ETF
iShares Core High Dividend ETF is constructed by focusing on U.S. dividend-paying stocks. Proprietary Morningstar statistics are used to select investments, including that data provider’s Economic Moat and Distance to Default metrics. Essentially, the ETF seeks to own financially strong companies with competitively advantaged businesses. There are only 73 stocks in the portfolio, so this is an even more restrictive approach than the one taken by Schwab U.S. Dividend Equity ETF. The yield is roughly 2.8%, which isn’t as high as you might expect given the ETF’s name. However, when you look at the strict selection criteria, the yield isn’t exactly shocking.
6. iShares Dividend Select ETF
iShares Dividend Select ETF has the highest yield on this list at roughly 3.3%. It holds roughly 100 stocks, making it about the same size as Schwab U.S. Dividend Equity ETF. Stocks must have paid dividends for at least five years to be considered. The dividend per share must be greater than or equal to its five-year average, and the dividend coverage ratio must be at least 167%. Also, trailing 12-month earnings must be positive. The 100 highest-yielding stocks get into the portfolio. It is an alternative to the Schwab ETF, but it leans more toward dividend yield while Schwab U.S. Dividend Equity focuses more on a company’s quality and growth prospects.
There’s no right answer
Investing is a very personal endeavor, so there’s no single dividend ETF that will fit every investor perfectly. That said, before you simply buy a popular ETF or the ETF with the highest yield, you really need to make sure you understand what you are buying. The variety in the designs of the ETFs above should highlight just how important this is and give you a head start in your search for the dividend ETF that is right for you.
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Reuben Gregg Brewer has positions in Schwab U.S. Dividend Equity ETF. The Motley Fool has positions in and recommends Vanguard Dividend Appreciation ETF and Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.
