JamesBrey
Schwab U.S. Dividend Equity ETF (NYSEARCA:SCHD) is an outstanding dividend growth ETF, which I have highlighted as my favorite in a recent article. In fact, if I were limited to owning just one dividend growth ETF, SCHD would be my choice. Despite its many strengths, however, SCHD does have a few shortcomings for income-focused investors, especially those looking to retire on passive income from dividends. In this article, I will outline a simple strategy involving four blue-chip, high-yield dividend growth stocks that can complement SCHD to create a well-rounded portfolio that effectively mitigates its weaknesses.
Why SCHD Is A Great Dividend Growth ETF
Let’s first revisit why SCHD is such an attractive core holding for a dividend growth portfolio. It boasts the highest yields among leading dividend growth ETFs, notably outperforming competitors like Vanguard Dividend Appreciation Index Fund ETF (VIG), Vanguard High Dividend Yield Index Fund ETF (VYM), and WisdomTree U.S. Quality Dividend Growth Fund ETF (DGRW), which offer yields of 1.8%, 2.9%, and 1.7%, respectively, while SCHD boasts a dividend yield nearly reaching 3.5%. This positions investors close to achieving the 4% rule in retirement from their starting dividend income alone. Additionally, SCHD has demonstrated robust dividend growth over the long term, with a five-year dividend compound annual growth rate of 11.8% and a ten-year dividend CAGR of 10.87%. Moreover, it has consistently increased its dividend payout annually, with a 12-year dividend growth streak.
On top of that, SCHD features one of the lowest expense ratios among dividend growth ETFs, charging only 0.06% annually. This low fee allows investors to retain more of their earnings, which can compound significantly over decades, compared to ETFs with higher expense ratios.
As a result, SCHD’s attractive total return performance relative to other high-yielding dividend ETFs should not be surprising:
Another appealing aspect of SCHD is its extensive diversification across sectors: the financials sector represents 17.21% of its portfolio, health care comprises 15.52%, consumer defensive accounts for 14.64%, industrials make up 13.75%, energy holds 13.10%, consumer cyclical is at 10.55%, and technology constitutes 8.82%. In addition to its healthy sector diversification, SCHD has significant diversification amongst its individual holdings as well. It has 103 total holdings, with no single holding exceeding 4.4% of the portfolio. Its top holdings include well-diversified companies across various sectors, such as Amgen (AMGN) (4.4%), Texas Instruments (TXN) (4.3%), Lockheed Martin (LMT) (4.2%), and PepsiCo (PEP) (4.15%), with Chevron (CVX) rounding out the top five at 4.1%. This diversification contributes not only to the fund’s resilient dividend growth through varying macro conditions over the years, but also to more consistent long-term total returns.
4 Stocks To Complement SCHD
However, SCHD’s primary weaknesses include a relatively low dividend yield for those seeking to live off passive income and limited exposure to key income-producing sectors like infrastructure, utilities, basic materials, mining, real estate, and communications. To address these shortcomings, income investors nearing retirement could benefit from strategically adding large, well-diversified blue-chip stocks in these sectors alongside SCHD to enhance the overall dividend yield and diversification of their portfolios. In particular, by sizing these positions appropriately, investors can create a more diversified overall portfolio by sector rather than simply investing in SCHD.
For example, since there is no exposure to real estate in SCHD, investing in a well-diversified, blue-chip company like Realty Income (O), which offers a 5.6% forward yield, or comparable firms such as W. P. Carey (WPC) or Agree Realty (ADC), can provide diversified and defensive real estate exposure along with a similar yield. These investments have strong investment-grade balance sheets and solid dividend growth profiles. By allocating about 5% of the portfolio to one or more of these stocks, income investors can substantially enhance their real estate exposure and boost overall yield.
Another opportunity can be found in the basic materials sector with one of the world’s largest blue-chip diversified miners, Rio Tinto (RIO), which offers a projected 6.3% dividend yield over the next 12 months backed by a high-quality portfolio and very strong balance sheet.
Although the SCHD currently has a 4.55% exposure to communications stocks, including a 3.82% position in Verizon (VZ), adding an additional 1 to 2% exposure to either VZ or even Cogent Communications (CCOI) could increase the portfolio’s overall communications sector allocation to between 6% and 7%. Given both VZ’s and CCOI’s recently reaffirmed commitment to dividend growth and their promising 6-7% dividend yields, this small addition can help enhance the overall yield of the portfolio while also slightly improving its overall diversification.
Finally, for greater exposure to utilities and infrastructure – which the fund has a meager 0.03% exposure to at the moment – Brookfield Infrastructure Partners (BIP)(BIPC) is an excellent option, with a 5.5% distribution yield forecasted for the next 12 months and a strong mid to high single-digit annualized distribution growth outlook. It provides diversified exposure to midstream, utilities, and transportation infrastructure while also potentially augmenting the portfolio’s overall exposure to the communications and technology sectors due to its significant investments in towers and data centers.
Investor Takeaway
SDHD is an excellent choice for those seeking a well-diversified, low-cost option for dividend growth and long-term total return compounding. By adding some real estate, communications, infrastructure, and basic materials blue chip high-yield stocks like O, CCOI, BIP, and RIO, investors can create a more diversified portfolio with an enhanced dividend yield, making it feasible to live off the 4% rule alongside attractive long-term dividend growth.
In conclusion, while SCHD is a strong choice for a diversified, low-cost, dividend growth, and total return compounding portfolio, incorporating a few strategic investments in other high-yield stocks in sectors where it lacks meaningful exposure can create an even more diversified portfolio with an attractive dividend yield, facilitating a sustainable income stream for living off of the 4% rule and enhancing long-term dividend growth prospects.
