The Smartest High Yield Dividend ETF To Buy With $500 Right Now

The S&P 500 the index is nearing all-time highs, pushing the index’s dividend yield to a paltry 1.2% or so. By contrast, the Schwab US Dividend Equity ETF (SHD 0.80%) it has a yield of around 3.4%, making it a relatively attractive income option. But the really interesting part about this exchange-traded fund (ETF) is how it gets that return.

Here’s why this might be the smartest ETF to buy if you have $500 (or more) to invest right now.

Wall Street goes up and down

If you’re a student of Wall Street history, you know that stocks can be very volatile at times. Often the worst downdrafts start from periods of extreme excitement. Moments when the stock market approaches record levels. That’s pretty much the market story today, with the S&P 500 at highs and the index’s dividend yield at historic lows.

Image source: Getty Images.

In this environment, investors need to ensure that they have a core portfolio of financially strong companies. If there’s a bear market or a recession (or worse, both!), the companies with the strongest finances are likely to be the best able to survive the blow.

While you can’t eliminate the risk of a major market or economic correction, you can try to prepare for those outcomes. And if you’re working with exchange-traded funds and not trying to pick stocks, then you want to lean toward funds with a focus on quality. That’s why dividend investors should be drawn to the Schwab US Dividend Equity ETF right now, given its dual focus on income and quality.

What does the Schwab US Dividend Equity ETF do?

The first cut for the Schwab US Dividend Equity ETF is related to dividends, as it only looks at companies that have increased their dividends for at least a decade. (real estate investment trusts don’t count for ETFs.) However, even here, there is a quality angle, as only well-run companies tend to achieve this kind of dividend streak. So, from the start, this fund tries to weed out stocks that have high returns because they might be risky to own.

The next step in the process is a bit more complex as it involves the Schwab US Dividend Equity ETF creating a composite score. It’s a bit of a black box of its own, but the ETF discloses that the score includes cash flow-to-debt ratio, return on equity, five-year dividend growth rate and yield.

The first two are based on quality, cash-debt flow focused on balance sheet strength, and return on equity, taking into account the strength of a company’s management. The five-year dividend growth rate is kind of a combination of the two and an extension of the 10-year streak, but it’s really focused on trying to highlight the strongest growing dividend stocks.

And the yield is pretty basic. That part of the screen wants to make sure you get paid well for owning the shares in the ETF.

The first 100 shares go into the Schwab US Dividend Equity ETF. They are weighted by market capitalization, ensuring that the largest companies have the biggest impact on the fund’s performance, as weighted by the S&P 500. You get all this work for an expense ratio of 0.06%, which it’s a pretty modest price.

SCHD Total Return Price Data by YCharts

As mentioned, the yield is a relatively attractive 3.4%. Yes, you can find higher yielding ETFs, but they usually only focus on yield. Only buying the highest-yielding stocks inherently opens investors up to owning lower-quality companies. For investors looking to add a hedge against broader market adversity, the Schwab US Dividend Equity ETF is a much better bet.

An ETF that errs on the side of caution

If you look at the chart above, you’ll probably notice that the S&P 500 easily beats the Schwab US Dividend Equity ETF. However, the Schwab US Dividend Equity ETF basically tracks along with the equal-weighted version of the S&P 500. This is a sign of risk in the broader market, as a small number of very large companies drive the S&P weighted market cap growth right now.

In the current market environment, now is the time to appreciate the value of the quality screens that the Schwab US Dividend Equity ETF uses to create its unique portfolio.