It can be a little discouraging to be a dividend investor today, given that S&P 500 index (SNPINDEX: ^GSPC) it has a low yield of 1.2%. That doesn’t mean, however, that you can’t find simple ways to increase the income your portfolio generates. The two best ways right now are Schwab US Dividend Equity ETF(NYSEMKT: SCHD) and SPDR portfolioS&P 500 High Dividend ETF(NYSEMKT: SPYD). Here’s why.
The S&P 500 Index the dividend yield is extremely low today, but it is important to understand why this is so. The big picture problem is that the index is designed to track the broader market with a portfolio of US stocks that are large and representative of the broader economy.
There are two conclusions from that.
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First, the mandate of the index is not income. In fact, the mandate is so broad that the index inherently owns stocks that pay no dividends and others that pay very low dividends. So the first step in finding a better choice for yield seekers is to move to exchange-traded fund (ETF) that tracks an income-oriented index.
Second, few large companies are currently driving performance, leading to some strange dynamics in other areas. Given that the so-called “magnificent seven” have low or no yields, a market-cap-weighted index such as the S&P 500 is bound to have a low dividend yield.
This does not mean that the S&P 500 index is flawed and that investors should stay away from it. It just needs to be emphasized that if you are looking for income, you should have a more nuanced approach.
With a roughly 3.6% yield, the Schwab US Dividend Equity ETF offers about three times the income of the S&P 500 index. That’s a good start, but this ETF really strives to provide investors with a list of high-quality, high-yielding companies. It’s the epitome of fine-tuning, and it shows on the very first screen it’s applied to — consider only stocks that have increased their dividend for at least 10 consecutive years (real estate investment trusts are excluded from consideration).
From there, the Schwab US Dividend Equity ETF creates a composite score that examines a company’s cash flow against total debt (financial strength), return on equity (operating strength), dividend yield (yield, obviously) and five-year dividend growth rate (income growth potential). The combined scores are ranked from highest to lowest and the top 100 companies enter the ETF. Shares are weighted by market capitalization.
The result is an attractive yield backed by high-quality companies. And, just as attractive, the expense ratio is a very modest 0.06%. The Schwab US Dividend Equity ETF is an excellent option for investors who want more than just high-yield stocks.
At the other end of the spectrum is the SPDR Portfolio S&P 500 High Dividend ETF. This ETF takes all the stocks in the S&P 500 index and ranks them by dividend yield. It then selects the 80 highest-yielding companies for the index and gives them equal weight, so that each stock has the same impact on overall performance. Compared to the Schwab US Dividend Equity ETF, the SPDR Portfolio S&P 500 High Dividend ETF is based only on yield. And just about the yield.
There are good and bad aspects to this approach. If you are interested in the highest possible return with a product linked to the S&P 500, the SPDR Portfolio S&P 500 High Dividend ETF offers an attractive 4.3% yield. It also has a modest expense ratio of 0.07%. However, the ETF ends up owning a large number of stocks from just a few sectors, such as real estate, financials and utilities. So there is more concentration risk here than you might first expect.
Moreover, the ETF may invest in stocks that are not currently very popular, introducing stock-specific risk. Therefore, the high yield here must be considered in a broader framework. You might want to pair it with a more diversified ETF or another dividend ETF that takes a more nuanced approach, such as the Schwab US Dividend Equity ETF.
There are exchange traded funds for almost every type of investor, including those trying to create passive income. The hard part is finding the ones that make the most sense for your personal approach to investing. Investors focused solely on yield will likely find the SPDR Portfolio S&P 500 High Dividend ETF appealing, while those who prefer to include quality screens in the mix will like the Schwab US Dividend Equity ETF. The optimal solution, however, may be to own both of these high-yield ETFs.
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Reuben Gregg Brewer has no position in any of the listed stocks. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
