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Your Money Is Worth More Than This 3.76% Dividend Yield

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Your Money Is Worth More Than This 3.76% Dividend Yield

Are you considering investing in the Schwab U.S. Dividend Equity ETF (NYSEARCA:SCHD) for a steady stream of dividend income? While it may seem like a good idea at first glance, there are several factors to consider that suggest SCHD may not be the best option for investors. In this article, we will explore these considerations and shed light on why your money might be worth more elsewhere.

Treasuries Offer Higher Yields

One of the most important factors to consider is how SCHD stacks up against Treasury securities. Currently, both short-dated and long-dated Treasuries offer higher yields compared to SCHD, and at lower risk. With the 10-year Treasury yield close to 5%, it easily surpasses the approximately 3.8% dividend benchmark expected from SCHD. This raises the question of whether SCHD truly offers a competitive value proposition relative to Treasuries.

Some investors may argue that equities have better value appreciation potential than Treasuries. While this may typically be the case, it is currently unlikely due to the potential for the Fed to cut rates by 100-125 basis points over the next 12 months. In this scenario, a portfolio holding 10-year Treasuries may appreciate close to 10% in value. This appreciation is not accounted for in SCHD’s dividend-focused strategy, making it a less attractive option in terms of value appreciation.

Furthermore, it’s important to note that unlike the yield on Treasuries, the yield on SCHD is not guaranteed. If the economy suffers and company earnings contract, dividends may be cut or even eliminated. This is especially relevant as economists continue to debate the likelihood of a prolonged economic downturn. Additionally, if a recession were to occur and stock prices decline, company executives may opt to cut dividends in order to buy back shares at lower prices. While this decision may make sense for the company, it could have negative implications for SCHD, as its rigid index methodology limits its options during such market conditions.

Lastly, the value of SCHD’s investment is dependent on the market’s perception of the underlying stocks. If investors lose confidence in the market or the economy, the value of SCHD’s investment may decline. This risk is something to consider in uncertain times.

SCHD’s Core Holdings Are Cyclical …

If you choose to invest in SCHD, it’s important to understand its investment strategy. The ETF focuses on slow-growing, cyclically exposed businesses, with over 60% of its portfolio allocated to industries such as consumer discretionary, financials, and industrials. While these sectors may perform well during economic expansions, they are likely to suffer during recessions. This raises questions about whether cyclical businesses, which make up the majority of SCHD’s holdings, deserve an implicit growth premium, especially in the current economic climate where the Fed aims to cool the economy.

… And Likely Not Deserve A Growth Premium

SCHD’s investment strategy, centered around slow-growing, cyclical businesses, comes with tradeoffs. The rigidity of its index methodology means SCHD may miss out on emerging growth trends or explosive growth opportunities that fall outside its criteria. This lack of flexibility restricts the ETF’s ability to take advantage of potential opportunities like the rapid growth potential of artificial intelligence. When comparing SCHD’s performance to growth-focused indices like the Nasdaq 100 (QQQ), it becomes clear that SCHD may not have the same growth potential.

Not Everything Is Bad

While SCHD may not be the best option for all investors, it’s important to acknowledge that there are still some positives to consider. SCHD can be suitable for long-term focused investors looking to benefit from the compounding effect of reinvested dividends and the potential for capital appreciation. Additionally, the diversification benefits offered by SCHD’s portfolio, which includes stocks from various sectors and industries, can help spread risk and reduce the impact of poor-performing stocks.

Investor Takeaway

To recap, investing in the Schwab U.S. Dividend Equity ETF may not be the best option for investors seeking steady dividend income. Treasuries currently offer higher yields at lower risk, and SCHD’s focus on slow-growing, cyclical businesses raises doubts about its growth potential. Furthermore, the yield on SCHD’s investment is not guaranteed, and complex relationships in the market can lead to potential value losses. While SCHD has its merits for certain long-term focused investors, it’s important to evaluate other alternatives in the market. With these considerations in mind, it’s clear that SCHD may not provide the value investors are seeking.