Dividend investors face a challenging landscape today, with the S&P 500 index (SNPINDEX: ^GSPC) yielding a paltry 1.2%. For those relying on dividend income, this can feel frustrating. However, all is not lost—opportunities to enhance your portfolio’s income exist, particularly through well-constructed exchange-traded funds (ETFs).
Two standout options for boosting income are the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) and the SPDR Portfolio S&P 500 High Dividend ETF (NYSEMKT: SPYD). These funds offer high yields, solid strategies, and access to a range of dividend-paying stocks. Let’s explore why the S&P 500’s yield is so low, how these ETFs can help, and how you might leverage them to create a robust income-generating portfolio.
Understanding the S&P 500’s Low Dividend Yield
The S&P 500's dividend yield, currently at a historically low 1.2%, reflects broader market dynamics rather than a flaw in the index itself. Understanding the reasons behind this low yield can help investors position themselves for better income opportunities. Here are two key reasons:
1. The Broad Mandate of the S&P 500
The S&P 500 is designed to track the U.S. stock market by including a broad range of large-cap companies across various industries. Its goal is to reflect the overall economy, not to maximize income for investors. As such:
- It includes stocks that don’t pay dividends, such as growth-focused tech companies.
- Many stocks within the index offer low dividends, reducing the overall yield.
If you’re searching for income, this broad mandate may not align with your goals.
2. Market Concentration in Growth Stocks
A small group of large-cap companies—often referred to as the "Magnificent Seven"—has driven much of the index’s performance in recent years. These include tech giants like Apple, Microsoft, and Amazon, which tend to reinvest profits rather than pay dividends.
This trend has skewed the index's composition, reducing its overall yield. While these companies may deliver impressive capital gains, they are not ideal for income-focused investors.
The Case for Dividend-Focused ETFs
For those seeking higher yields, dividend-focused ETFs are a simple yet effective solution. These funds concentrate on dividend-paying stocks, screening and weighting them based on specific criteria to maximize income potential. Two of the most compelling options today are the Schwab U.S. Dividend Equity ETF and the SPDR Portfolio S&P 500 High Dividend ETF.
Schwab U.S. Dividend Equity ETF (SCHD): High-Quality Income
The Schwab U.S. Dividend Equity ETF (SCHD) offers a yield of approximately 3.6%, significantly higher than the S&P 500’s yield. This ETF focuses on quality dividend-paying companies, combining yield with financial strength.
Key Features
Dividend Growth Screen
SCHD requires companies to have increased dividends for at least 10 consecutive years. This ensures a focus on financially stable companies with a history of rewarding shareholders.Quality Composite Score
Stocks are ranked using metrics like:- Cash flow to total debt (financial strength)
- Return on equity (business performance)
- Dividend yield (current income)
- Five-year dividend growth rate (future income potential)
The top 100 companies based on this score are included in the ETF.
Low Expense Ratio
SCHD has an expense ratio of just 0.06%, making it an affordable option for long-term investors.
Why SCHD Stands Out
SCHD emphasizes quality, ensuring that investors gain exposure to reliable, high-yielding stocks. Its focus on dividend growth offers the potential for rising income over time, making it ideal for conservative investors who prioritize financial stability alongside yield.
SPDR Portfolio S&P 500 High Dividend ETF (SPYD): Yield Above All Else
The SPDR Portfolio S&P 500 High Dividend ETF (SPYD) takes a different approach, focusing solely on maximizing yield. It currently offers a yield of approximately 4.3%, making it one of the highest-yielding ETFs tied to the S&P 500.
Key Features
Yield-First Strategy
SPYD ranks all S&P 500 stocks by dividend yield and selects the top 80 highest-yielding stocks.Equal Weighting
Unlike market-cap-weighted funds, SPYD gives each stock an equal weighting, ensuring no single stock dominates the portfolio.Low Expense Ratio
Similar to SCHD, SPYD offers an attractive expense ratio of 0.07%.
Pros and Cons of SPYD
Pros:
- High yield: An excellent choice for investors prioritizing income.
- Simple selection process: Focuses purely on dividend yield.
Cons:
- Sector Concentration: SPYD’s holdings are heavily weighted in high-yield sectors like real estate, financials, and utilities, increasing exposure to sector-specific risks.
- Stock-Specific Risk: By focusing on yield, SPYD may include stocks that are unpopular or underperforming for broader reasons.
Comparing SCHD and SPYD
Both ETFs are excellent tools for income generation, but their different strategies make them suitable for different types of investors.
Building a Portfolio with SCHD and SPYD
To optimize your income portfolio, consider holding both ETFs. Here’s how they can complement each other:
1. Diversify Income Sources
By combining SCHD and SPYD, you gain exposure to both high-quality dividend growers (SCHD) and high-yield opportunities (SPYD). This reduces the risk of over-concentration in any single sector or strategy.
2. Balance Risk and Reward
- SCHD provides stability and the potential for income growth over time, appealing to conservative investors.
- SPYD delivers immediate income but carries higher risks due to its sector concentration and lack of quality screens.
3. Adapt to Market Conditions
Owning both ETFs allows you to adjust your allocation based on market conditions. For example:
- In a bear market, you might favor SCHD for its defensive qualities.
- In a low-rate environment, SPYD’s high yield can provide a much-needed income boost.
Passive Income: A Real Opportunity
Despite the S&P 500's low yield, income investors can still achieve attractive returns by leveraging dividend-focused ETFs. The Schwab U.S. Dividend Equity ETF and the SPDR Portfolio S&P 500 High Dividend ETF offer complementary approaches to income generation, making them powerful tools for building a diversified, income-focused portfolio.
By understanding their strategies, weighing their strengths and weaknesses, and considering your personal risk tolerance, you can create a portfolio that meets your income needs while managing risk effectively.
Whether you prioritize quality (SCHD), yield (SPYD), or a blend of both, the opportunity to generate passive income is there for the taking. As with any investment, be sure to review your financial goals, perform due diligence, and consult with a financial advisor if needed.