Monday, May 9, 2016

The Best Dividend ETF to Consider

I pick my own dividend paying stocks in my taxable accounts, and wouldn’t have it any other way. I know some of you have mentioned that they have absolutely no time to dedicate to picking stocks. It makes sense – if you are working 60 hours/week, and have a lot of other responsibilities, you might not have any time for picking stocks. I get it. I also know that some do not enjoy the process of developing and following their own plan. So when some readers have historically asked me for the best dividend ETF, I was unable to answer this question. And I was against dividend ETF's in general.

I have previously been unable to answer this question on the Best Dividend ETF, because most products out there had high expense ratios or have had dividend payments that were not growing overall. In my search for a good dividend ETF or fund I would be looking for something like:

- Look for consistently growing dividends

- Low portfolio turnover

- Low cost

- Some track record of regular dividend increases

For example, while I like the S&P Dividend Aristocrats index, the equal weight ETF based on it (NOBL) doesn’t have a long enough track record to consider, as it was launched at the end of 2013. I do like the fact that it was equally weighted. however, it has an annual fee of 0.35%, which is highway robbery if you ask me. An investor can easily create their own dividend ETF with Motif Investing and pay $9.95 in total to buy up to 30 individual stocks at once.

During my search, I found Schwab US Dividend Equity ETF (SCHD). This ETF includes 100 quality dividend growth stocks, and weights them by market capitalization. These companies are selected using measures of both fundamental strength and dividend performance. No company is allowed to have a weight higher than 4.50% - which is a good risk management procedure.

One of the requirements for companies in the fund is a 5 year history of annual dividend increases, and a ten year history of paying consecutive annual dividends. This should weed out some companies with inconsistent dividend payouts.

In addition, no sector is allowed to take more than 25% of the portfolio – which is another safety procedure to avoid concentration in one sector that goes bad. This is also the cheapest dividend ETF out there with an annual cost of 0.07%. This means that if you invest $100, you would pay 7 cents/year to the fund provider. If you purchase this ETF at broker Charles Schwab, you won’t pay a commission on the transaction.

The nicest thing is that the fund has managed to grow its annual dividends in 2012, 2013, 2014 and 2015. It is on track to have raised dividends for 5 years in a row by the end of 2016.

This is the description from Morningstar:

Schwab U.S. Dividend Equity is a passively managed exchange-traded fund that homes in on high-quality income-producing stocks. The fund's index is composed of large, liquid companies that have paid dividends in each of the past 10 years, and it requires constituents to earn high marks on four fundamental metrics: cash flow/debt, return on equity, dividend yield, and dividend growth. The resulting portfolio is one of the highest-quality among all large-cap dividend-oriented ETFs. Also, SCHD charges a 0.07% expense ratio, which makes it the least expensive dividend-oriented ETF available. This fund's high-quality portfolio and low cost make it a suitable core equity holding.

One downside that I see is the concentration of the largest ten holdings. The largest ten holdings account for almost 45% of the portfolio value. A few of them also have a weighting that is slightly higher than 4.50%. This diversification of the top holdings in most indexes, mutual funds or ETF’s is one of the reasons why I prefer to hold stocks directly, rather than pay money to someone else each year to hold them for me indirectly. These are well-known companies that I can easily purchase with a click of a button, and pay minimal if any commissions in the process. If you hold individual stocks directly in your account, you don’t pay any fees with most brokers out there.

Johnson & Johnson
Exxon Mobil
Procter & Gamble

The other downside is a 19% annual portfolio turnover. This means that the fund holds stocks for an average of 5 years. I have found that the higher the turnover, the higher the chances of making mistakes. One mistake could include selling future winners and buying something that does worse than the original component sold. Frequent churning of portfolio holdings also increases commission expenses and could result in realization of capital gains. Increasing your tax expenses is not a smart way to compound wealth – in fact some of the smartest investors out there hold on for decades in order to take advantage of the float like nature of deferred capital gains taxes.

The third downside is the fact that this ETF does not take into account valuations when it adds or removes portfolio components. This is another reason why I have not been a huge fan of passive investments or investment schemes which add investments without checking on valuations. This is because overpaying for an asset today could lead to terrible performance, even if the fundamentals improve as expected. In other words, it is better if you buy a stock that yields 3% and sells at 16 times earnings rather than buy a stocks that yields 1.50% and sells for 32 times earnings, if all else is the same in terms of actual fundamental performance ( fundamental performance = earnings per share growth and/or dividend growth)

Overall however, if an investor does not want to spend any time on their investments, the negatives would likely be offset by the instant diversification you receive. The portfolio today yields 2.90%, and sells for 18.70 times forward earnings.

As a side note, the Vanguard Dividend Appreciation ETF (VIG) was a second in line for the title of best dividend etf, but lost on a higher expense ratio of 0.10%/year and the fact that dividend income in 2013 was lower than the dividend income in 2012. In general, this ETF had dividend income that fluctuated more than it should have. My goal is to select a set-it-and-forget it ETF where my income will grow over time, and not fluctuate during a time of a general economic expansion.

Create your own dividend ETF with Motif Investing
Dividend ETF’s Are Bad for Investors: Here is Why
Dividend ETF or Dividend Stocks?
Does entry price matter to dividend investors?
What are your dividend investing goals?


  1. Hi There--I have been very happy with SPHD (high dividend, low volatility). It's up 14.8% since Nov 11, and has a pretty decent yield that's increased since then. I also have some SCHD, but it hasn't performed as well.

    Thanks for posting this: while I'm trying to do DGI, when I'm working I really don't have time to keep up and having an ETF seems much smarter than buying and hoping.

    1. I am not familiar with SPHD.

      It is very interesting to observe investors frame their conclusions.

      On one hand, you are stating that

      1) Holding 50 individual securities through one ETF and paying an annual fee of 0.30% for that and being subject to turnover

      is better than

      2) Buying those 50 individual companies outright, saving on all the fees and potentially costly turnover

      As a side note, building your own portfolio of 30 - 60 - 90 dividend paying companies is no more riskier than having someone else selling you an ETF/mutual fund that holds 30 - 60 - 90 dividend paying companies but charging you a fee in the process.

      Not sure why this misconception is so widespread.

  2. DG, Although I am an individual stock investor, I think you did a good service evaluating and describing your procedure for EFT performance. Lot's of people don't have the time or confidence to invest in individual stocks. Thanks and keep up the good work, you've done great job educating me over the years

    1. I think that people should educate themselves on investing. Noone has your best interests at heart, except for you. A lot of people purposefully try to make things complicated, because their income depends on it. A lot of "helpers" also sound overconfident in their abilities and tell you to get this fund, or that fund, etc in order to justify their high fees.

      To be honest here, a lot of investing is common sense so people should not be afraid. After all the secret sauce is to buy, hold, and let time compound the nest egg. So perhaps holding an ETF/fund should work for people. But finding the right ETF/fund is equally as important to your future results as finding the right mix of individual securities.

      I would go on the record as stating that if I were to simply buy an equal weighted position in the 100 or so dividend champions today, and hold tight to a static portfolio, I would do pretty fine over time living off those dividends. There would be no annual expenses, and almost no turnover except for spin-offs, acquisitions etc.

  3. Thanks...the question " which ETF " has bogged me down for months...on my short list i also had SCHD...I am also looking at IUSV..Do you have any views there...?

  4. I share the same opinion as the author of ETFs. I don't currently own any and have no plans to purchase in the foreseeable future but have studied them and compared their dividend histories. Several of them have done well in the current bull market but the vast majority of those that existed through the past recession severely underperformed the dividend aristocrat index. While close to 80% of dividend growth stocks raised or maintained their dividends through the great recession (2007-2009) not one dividend ETF followed suit (0%). If I were to choose one dividend ETF over the others I'd go with SPHD. Like SCHD it's dividend history is short but it has outperformed it's peers since inception in 2012.

    1. rather frightening what you say....These divdends etfs really are not as simple to track as one thinks....i looked at sphd and trouble is , it has a relatively short history..

    2. Bernie,

      I share your concern about ETFs and the bull market. It would be interesting to see how many of those etfs, including SCHD, do with their distributions during the next recession.

      I have not looked at SPHD.

      I personally believe that an individual investor could easily create their own ETF with 30 - 60 - 90 individual holdings, weight them equally, and just cash the dividend checks.

  5. Hi, did you include SPDR S&P US Dividend Aristocrats UCITS ETF too in your analysis? Although it also has a high expense ratio (0.35%), it is a lot more diversified than Schwab U.S. Dividend Equity.

    1. Not familiar with this product.

      Are you referring to ticker SDY?

      I don't like the high fee, and the fact that it is weighted by dividend yield.

      I also do not like the fluctuations in dividend income - there was a decline in 2013, probably due to high turnover.

      Perhaps an equal weighted SDY with a lower fee would be something I would like?

  6. What about Lexcx? You covered that one before. They seem to fit the bill, no?

    1. It is too expensive. I do like the idea of a static portfolio for decades.

    2. Thanks. Appreciate the reply.

  7. I like DGRO - it follows the Morningstar US Dividend Growth Index which essentially includes companies that have a payout ratio below 75% and have 5 years of qualified dividend growth on the books. The ETF itself is pretty new but the index has a 11.7% return in the last 5 years and isn't overly top(top 10% is 27% of overall portfolio) or sector(15.6% is top sector) heavy. The ETF also avoids the top 10% yield stocks in the market(to avoid dividend cut risk) and requires stocks to have a positive earnings consensus. These two may be a good or bad thing depending on your investing strategy as the overall yield will be lower(due to avoidance of the very highest yield cases) and the turnover might be higher(47% turnover) due to sell offs when earnings sentiment shifts. These sell offs might also happen after the stock price has dropped so the ETF might be effectively selling low and buying high at times as is the risk with a lot of passive investments.

    Expense ratio is .12% and it's free trades if you have a fidelity account so I do pick up some shares here and there as I find a lot of the other dividend ETFs are either a bit too expensive or have too much sector/stock exposure for my liking.

    1. I do not want the ETF to do too much tinkering with the portfolio. Perhaps this is why I prefer to build my own portfolio and hold on to it. I am also skeptical of back-tested results.

      Perhaps I do not understand why someone cannot simply buy the holdings directly, and just hold on tight and avoid the fee? On a $100,000 portfolio, this is $120/year.

      But let's see if DGRO can get a 5 year track record.

  8. Interesting artcile. I am investigating some EUR dividend ETFS as well. For now, I am not happy with my results. At the outside, the current yield looks nice. Looking into some more details like you mention, I conclude that it is not what I am looking for. There indeed needs to be dividend growth and capital increase for me.

    1. I prefer to build my own customized ETF that fits what I need, and then hold on to its components forever.

  9. A very important unquantifiable benefit of ETF funds like SCHD is the simplicity of getting cash from the account. You may be thinking that getting cash from individual stocks is pretty easy. And it is for you. But what happens when you die? What happens when the spouse takes over managing the accounts. What happens if you become less or incapable of managing the accounts. Selling shares of SCHD is a WHOLE LOT EASIER than deciding which and how many of the many stocks in one's portfolio. This simplicity has its costs but it has its benefits as well.

    1. We have already discussed this:

      If you have to sell investment to live off in retirement, you are setting yourself up for failure. That's why you live off the dividends, and not touch the investments.

      If you do not educate your spouse on finances, the bigger problem is they fall prey to unscrupulous advisers.

  10. I have individual stocks at the moment but an advantage of purchasing the SCHD (or SPHD) is that I would not be spending $8.95 to purchase each stock, it would be free (as my account is with Schwab). Should I wish to purchase a small amount every month to dollar cost average I could buy as little as one share of SCHD if I wanted (for free) and in the process get a basket of stocks. Whereas to purchase 10+ companies individually every month in small increments would be ludicrous because of the cost.
    I wouldn't buy just one share of SCHD of course but perhaps I would buy $100 or $200 worth each month.
    Am I missing something or do you agree that this is a big advantage? Thanks.

    1. Dividend Growth InvestorMay 13, 2016 at 9:25 AM

      It all depends on what you ultimately want to achieve, how knowledgeable you are, if money is in taxable vs tax def acct etc

      If i were starting from scratch today and had $100-$200 to put to work today, I could use Robinhood. It offers commission free trades.

      But for others with small initial amounts, the instant diversification and simplicity at a cost might be more appealing

      Of course, if i had to decide between 200 going into my 401k that gives me an employer match and tax benefits invested in say s&p 500 or the money going into schd, i would pick the 401k any time. I would also pick the 401k over building my own portfolio with individual stocks in this scenario of employer match and tax benefits of reduced tax upfront and tax deferred compounding.

  11. Hi!

    I hold both SCHG and NOBL. I agree that 0,35 percent fee is a bit too much. On the other hand NOBL has outperformed SCHD with quite some margin since its start in 2013. 29 vs 18 percent if I'm not wrong.

    With this kind of performance, don't you think it's worth paying a bit more?

    - RG

    1. Dividend Growth InvestorMay 13, 2016 at 7:58 AM

      NOBL would likely be a better choice once it gets a longer official track record to say 5 years and if they decrease the fee. I want to make sure it does well in real time, with real money first - so lets wait for 3 more yrs

      The problem with your statement about performance is that we do not know what future performance will be. But we do know what the cost is.

      I am also curious about how much that quarterly rebalancing costs in taxes for NOBL.

      I do like the equal weighted nature of NOBL however, as opposed to the overweighting of a few holdings for SCHD.

  12. ETF is truly an amazing investments especially Vanguard and ishare ones. I started investing with ETFs and transitioned to dividend stocks and thinking of moving back to ETFs again. :) The instant diversification without wasting my time on monitoring individual stocks is tempting.

  13. DI,
    Yeah it is so easy to buy stocks these days that you could easily mimic any EFT or fund you wanted.


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