1 No-Brainer High Yield Dividend ETF to Buy Right Now for Under $500

Some exchange traded funds (ETFs) are easy to understand. Others are more complex. One is not necessarily better than the other, but sometimes adding complexity allows you to do more with a portfolio and can lead to an exceptional fund structure. This is the case with Schwab US Dividend Equity ETF (SHD 0.15%).

Unlike many high-yield ETFs, this Schwab offering takes dividends to the next level and is worth buying even if you only have $500 for an initial position.

Would you do this if you were looking to buy dividend stocks?

When it comes to ETFs, the biggest issue to consider is the portfolio methodology. That’s not to say that returns don’t matter or that return is irrelevant. But these are mutual investment products where you are effectively giving your money to someone else to invest on your behalf. You need to know what is being done with your money and why.

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As an example, the ETF Vanguard High Dividend Yield (VYM 0.12%) has a dividend yield of 2.8%. Meanwhile, the SPDR Portfolio S&P 500 High Dividend ETF (SPYD 0.02%) has a yield of 4%. Why are the returns so different when both aim to generate income? The reason is that they invest very differently.

The Vanguard High Dividend Yield ETF tracks all dividend-paying stocks except real estate investment trusts (REITs). Dividend-paying stocks are listed, organized by dividend yield. The top-performing half of the list goes into the fund using a market capitalization weighting. This results in a very large portfolio as the starting fund consists of all stocks. Having such a large portfolio means that lower-yielding stocks enter the list and drag down the ETF’s overall return.

The SPDR Portfolio S&P 500 High Dividend ETF, on the other hand, starts with S&P 500 list of stocks and selects the 80 stocks with the highest return, equally weighting his holdings. With a smaller starting list and a smaller final portfolio, higher returns dominate and the final portfolio provides more income.

While this shows two different ways to create dividend portfolios, you probably wouldn’t follow either of these approaches on your own. That’s where the Schwab US Dividend Equity ETF comes in.

The Schwab US Dividend Equity ETF: More Complex and Easier to Understand?

The Schwab US Dividend Equity ETF starts by looking at companies that have increased their dividends for at least 10 consecutive years, eliminating REITs from contention. This is a fairly typical screen for dividend investors, who often want to make sure they own companies that are committed to paying them dividends. None of the ETFs above take this factor into account, but you probably would.

After obtaining the list of reliable dividend payers, the Schwab US Dividend Equity ETF then creates a composite score and uses it to rank stocks from best to worst. The score looks at cash flow to total debt (which highlights financial strength), return on equity (which highlights business strength), dividend yield and the company’s five-year dividend growth rate. Basically, the Schwab US Dividend Equity ETF looks for financially strong, high-yielding companies that have a history of growing dividends.

That’s exactly what most dividend investors will be trying to find as well. To be fair, the methodology here is much more complex than any of the ETFs mentioned above. But it makes logical sense to do what the Schwab US Dividend Equity ETF does. The trailing dividend yield falls between the other two dividend ETFs at 3.3%. That’s still much more than the miserly 1.2% offered by the S&P 500 index.

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One more little nuance: You get all the extra effort that the Schwab US Dividend Equity ETF offers for the very low expense ratio of 0.06%. That’s the same cost as the Vanguard High Dividend Yield ETF and less than 0.07% of the SPDR S&P 500 High Dividend ETF portfolio. If you’re looking for a high-yield dividend ETF, the Schwab US Dividend Equity ETF should be on your short list.

Sometimes adding a little complexity can be a good thing

The Schwab US Dividend Equity ETF is not as simple to understand as other popular dividend ETFs. But that’s not a bad thing. When you break it down, the Schwab US Dividend Equity ETF does basically the same thing you would if you wanted to invest on your own — buying good companies with strong dividend records and attractive yields.