It's time to talk about ETFs. In this article, I highlight two of the best ETFs money can buy.
While both are well-diversified US equity ETFs, one has a higher yield and high dividend growth.
Given my view on macroeconomic developments, I believe investors should be overweight value stocks in the years ahead.
Introduction
While I discuss a wide range of topics, I rarely talk about ETFs. The biggest reason is the fact that I'm a stock guy. I think that stocks are way more interesting. ETFs are a bit boring. Needless to say, that comes with tremendous advantages, as they are not supposed to be exciting. Reason number two is that a lot of niche ETFs are expensive. Covering them would lead to significant benefits for the managers of these ETFs. That doesn't feel right.
That said, there are some great reasons to buy ETFs and some great ETFs to get the job done. Two of them are the Schwab U.S. Dividend Equity ETF ( SCHD ) and the Vanguard Total Stock Market ETF ( VTI ) . While both offer diversified exposure to high-quality stocks, there is one major difference: the yield.
Therefore, in addition to featuring these two exceptional ETFs, I would also like to delve into this critical difference, which, in my humble opinion, gives SCHD the advantage over the next few years.
What's The Difference Between SCHD and VTI?
One person in my inner circle is an extremely conservative investor. He owns just two ETFs. They are European-listed ETFs, so I'm not mentioning them directly, as this article is about SCHD and VTI. One of them is focused on owning the S&P 500. The other is focused on high-quality dividend stocks. The strategy is extremely simple. While both tend to be highly correlated (there's a lot of overlap), he benefits in times of outperforming growth stocks due to the high exposure of growth stocks in the S&P 500. In times of value outperformance, the value stocks perform much better. Also, he keeps collecting a decent dividend along the way.
Buying It All With VTI
Incepted in May of 2001, the VTI ETF is one of the best-diversified ETFs in the world. With an expense ratio of just 0.03% , this ETF owns 3969 stocks with a median market cap of $118 billion , which shows that there's a big bias toward bigger companies.
The reasons behind this very low expense ratio are the size of the fund and the fact that management is passive: the ETF is tracking an index . In this case, it tracks the CRSP US Total Market Index . As the name already tells us, this ETF solely invests in US stocks, it is not a global ETF. It's not a dividend-focused ETF as its 30-day SEC yield is 1.5% . That's roughly 10 basis points below the S&P 500 yield.
Over the past ten years, the total assets in this ETF have grown to roughly $280 billion.
On a side note, on the Vanguard website , you'll see that the total fund net assets are $1.2 trillion. That's because other funds are tracking the same index.
That said, the index is well-diversified. Its largest sector is technology, which covers roughly a quarter of its assets. The ETF has four sectors with between 10% and 20% exposure, these are consumer discretionary, financials, health care, and industrials.
Vanguard
Moreover, its top 10% accounts for roughly 20% of its total assets . Apple ( AAPL ), Microsoft ( MSFT ), and Amazon ( AMZN ) have rather large weightings (compared to the average). After that, exposure per investment quickly drops toward 1%.
When Cash Flow Matters
While I don't have hard evidence to back it up, I think it's fair to say that the SCHD ETF has become one of the most popular dividend ETFs thanks to its ability to give dividend investors exactly what they want. Also, people keep bringing it up in almost every dividend-focused comment section.
The ETF is well-diversified, it has a more than decent yield, and enough companies with growth potential to deliver substantial long-term capital gains. In other words, you're not buying a pet rock with a high yield but zero or negative capital gains.
Established in October 2011, the SCHD ETF has grown to a dividend heavyweight with assets under management of roughly $47 billion . Prior to the pandemic, that number was below $15 billion, making SCHD one of the fastest-growing major ETFs in the US.
Like VTI, SCHD is a passive ETF , meaning it tracks an index. In this case, the ETF tracks the Dow Jones U.S. Dividend 100 Index . Thanks to passive investing and economies of scale (its size), the expense ratio is just 0.06% , which I believe is fair.
According to Schwab , the ETF has at least four major benefits:
A straightforward, low-cost fund offering potential tax-efficiency
The Fund can serve as part of the core or complement in a diversified portfolio
Tracks an index focused on the quality and sustainability of dividends
Invests in stocks selected for fundamental strength relative to their peers, based on financial ratios
The second point is especially important, as it highlights the benefits that come with adding diversified dividend exposure by buying just one fund - instead of multiple unique stocks.
The turnover of this ETF is 15%, which means it's focused on buy and hold - as one might assume, given the focus on dividends. A turnover rate of 100% would mean that an ETF buys and sells all of its securities within a year.
SCHD is mainly focused on large-value stocks. It owns 105 unique companies with a weighted average market cap of $127 billion . Its 30-day SEC yield is 3.4% , which is decent in my book.
When it comes to the breakdown of its assets, we see that financials and information technology account for roughly 20% each. Consumer staples have a weighting of 14%. In general, we see that SCHD is overweight in sectors that tend to have slower growth rates, yet higher yields. Given the focus on dividends, that makes sense.
Charles Schwab Asset Management
When looking at its top holdings, we see that the top 10 holds 40% of the ETFs assets. That's a lot, but not too much. Moreover, most information technology companies are mature companies with high yields. You're not buying companies like Alphabet ( GOOGL ).
Author (Raw Data: Charles Schwab Asset Management)
With all of this being said, what's better than a 3.4% dividend yield?
The answer is a high yield that comes with more than decent dividend growth. Using Seeking Alpha numbers, we see that the ETF had ten years of consecutive dividend growth and an average dividend growth rate of 14.1% per year over the past three years. While I expect that number to come down to single digits due to economic challenges, the company holds the best dividend stocks money can buy.
Seeking Alpha (SCHD Dividend Scorecard)
So, what about the key differences?
How Have VTI And SCHD Performed?
While both ETFs are well-diversified, cheap (low expense ratios), and focused on high-quality stocks, the key difference is the yield. One is a high-yield ETF, the other is an ETF used to track the broader stock market.
In other words, we're comparing two different "tools". It's like comparing a convertible to a family van. They both get you from A to B. However, if you're in the market for a van, you're unlikely to let a salesman talk you into buying a convertible.
When looking at the bigger picture (excluding dividends), we see that both are following each other in bigger trends. In bull markets, both ETFs go up. In bear markets, both ETFs go down. This is why my aforementioned client owns a dividend and S&P 500 ETF. They both let him benefit from the long-term uptrend in stocks while bringing unique benefits to the table.
When looking at the ratio between the SCHD/VTI stock prices (upper part of the chart below) and the total returns of the two ETFs (lower part of the chart below), we see that when reinvesting dividends, the SCHD ETF barely underperformed the VTI ETF until 2022. Compounding magic showed that buying mature dividend stocks allowed investors to keep up with the broader market.
Moreover, we see a steep surge in the SCHD/VTI ratio since 2022, as investors are rushing to buy quality stocks.
Is VTI or SCHD The Better Buy Going Forward?
As I already mentioned, the two aren't direct competitors. Investors can buy both with 50/50 exposure and call it a day.
However, to answer the question in the sub-title, I would go with SCHD.
At the end of 2022, I wrote an article titled "Thriving In 2023: My Outlook And Strategy".
In that article, I wrote that I believe in a prolonged period of value stock outperformance.
I believe that we're in a new long-term environment of above-average inflation, caused by secular changes like labor market dynamics, energy and commodity supply growth, and de-globalization (changing supply chains).
In that article, I quoted legendary investor Howard Marks' latest memo , which highlighted and compared major differences between now and the highly favorable period for stocks between 2009 and 2021.
Oaktree Capital
This is the part that stood out:
- While some recent inflation readings have been encouraging in this regard, the labor market is still very tight, wages are rising, and the economy is growing strongly.
- Globalization is slowing or reversing. If this trend continues, we will lose its significant deflationary influence. (Importantly, consumer durables prices declined by 40% over the years 1995-2020, no doubt thanks to less-expensive imports. I estimate that this took 0.6% per year off the rate of inflation.)
- Before declaring victory on inflation, the Fed will need to be convinced not only that inflation has settled near the 2% target, but also that inflationary psychology has been extinguished. To accomplish this, the Fed will likely want to see a positive real fed funds rate - at present, it's minus 2.2%.
- The Fed faces the question of what to do about its balance sheet, which grew from $4 trillion to almost $9 trillion due to its purchases of bonds. Allowing its holdings of bonds to mature and roll off (or, somewhat less likely, make sales) would withdraw significant liquidity from the economy, restricting growth.
So far, new evidence continues to strengthen my case.
For example, inflation continues to be persistent as we're seeing that inflation is not only hard to get down, but also re-accelerating due to commodity prices and related issues.
Bloomberg
There's now a 90% probability that the Fed funds rate ends this year above 5.00%, which means no pivot until at least 2024.
CME Group
While this could mean that stocks, in general, are in for a rough ride this year, I believe that SCHD investors remain in a good spot.
SCHD comes with a high yield, top-quality companies that will withstand any major storm, and decent dividend growth - even if it comes down.
Takeaway
In this article, we compared the VTI and SCHD ETFs. While both funds offer well-diversified stock market exposure, I believe that SCHD is the way to go for the next few years. This ETF has a high yield, a portfolio of top-tier dividend companies capable of delivering satisfying dividend growth, and macroeconomic tailwinds that make value stocks my favorite investments going forward.
It was also mentioned that investors can benefit from a buy-and-hold strategy by investing in both ETFs, providing a balanced long-term approach.
However, my preference for value stocks and belief in the current economic outlook led me to overweight my portfolio with such investments. Therefore, I recommend SCHD as the better buy for investors seeking dividend growth and exposure to value stocks.
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