The Schwab US Dividend Equity ETF (SCHD), a popular choice for income-focused investors with nearly $70 billion in assets, is delivering a high dividend yield of 3.9%. However, its total return has remained flat this year, significantly underperforming broader market indices like the S&P 500, which has gained 14%.
This performance gap highlights structural issues within the fund, including rules that limit exposure to its best-performing stocks and the inclusion of several lagging companies. While the income stream is attractive, the fund's total return has not kept pace during the recent market rally.
Key Takeaways
- The Schwab US Dividend Equity ETF (SCHD) has nearly $70 billion in assets under management and offers a 3.9% dividend yield.
- Despite its high yield, the ETF's year-to-date total return is approximately 0.0%, while the S&P 500 is up 14%.
- Over the past five years, SCHD has returned 39%, compared to the S&P 500's 93% return over the same period.
- The ETF's methodology caps any single stock at 4% of the index's weight, forcing it to trim its top performers during rebalancing.
- The fund also holds significant positions in underperforming stocks, such as Target and UPS, which have declined over 30% year-to-date.
The Appeal of a High-Yield ETF
For many investors, particularly retirees and those seeking steady income, dividend-focused exchange-traded funds (ETFs) are a cornerstone of their portfolio. The Schwab US Dividend Equity ETF (SCHD) has become a leader in this category, attracting substantial capital due to its focus on high-quality, dividend-paying U.S. companies.
With nearly $70 billion in assets under management, SCHD is one of the largest and most popular ETFs in the world. Its primary attraction is a dividend yield that currently stands at an impressive 3.9%.
Yield Comparison
SCHD's 3.9% yield is more than triple the approximate 1.25% yield offered by ETFs that track the S&P 500, such as the SPDR S&P 500 ETF Trust (SPY) and the Vanguard 500 Index Fund ETF (VOO). This significant income advantage makes it a go-to option for investors prioritizing cash flow.
This strategy is designed to provide a stable income stream, which can be particularly valuable in volatile markets or for those who rely on their investments to cover living expenses.
Performance Gap Emerges in a Bull Market
While the income from SCHD has been consistent, its total return performance has been a source of disappointment for investors in the current market environment. In a year where major indices have reached new highs, SCHD has remained stagnant.
Year-to-date, the S&P 500 has surged by 14%, and the tech-heavy Nasdaq Composite has performed even better, with an 18% gain. In stark contrast, the Schwab US Dividend Equity ETF has delivered a total return of approximately 0.0%, effectively moving sideways.
This isn't a short-term issue. Looking at a longer timeframe, the performance disparity becomes even more pronounced.
Over the last five years, SCHD has generated a total return of 39%. While respectable in isolation, it is less than half of the 93% return delivered by the S&P 500 over the same period.
This prolonged underperformance suggests that the fund's conservative, high-yield focus has come at the cost of significant capital appreciation, especially during periods of strong market growth.
Analyzing the Structural Constraints of SCHD
The reasons for SCHD's lagging performance can be traced back to the specific rules and methodology used to construct its underlying index, the Dow Jones U.S. Dividend 100™ Index. These rules, while designed to ensure diversification and stability, can also limit the fund's upside potential.
The 4% Weighting Cap
A key structural element of the ETF is a rule that no single stock can exceed 4% of the index's total weight at the time of rebalancing. This rule is intended to prevent over-concentration in a few large companies.
However, it has an important side effect: when a stock performs exceptionally well and its weighting grows beyond the 4% threshold, the fund is required to sell a portion of that holding to bring it back in line. In essence, the ETF is forced to trim its winners.
Consider some of the fund's top holdings and their recent performance:
- AbbVie (ABBV): Up approximately 31% year-to-date.
- Cisco Systems (CSCO): Up approximately 16.5% year-to-date.
- Lockheed Martin (LMT): Up approximately 5.2% year-to-date.
As these stocks outperform, their weight in the fund increases. During the next rebalancing, SCHD will likely have to reduce its positions in these successful companies, capping their potential contribution to the ETF's overall return.
The Impact of Rebalancing
Rebalancing is a standard practice for index funds to maintain their target asset allocation. For SCHD, this process occurs annually. While it enforces discipline, the 4% cap rule can systematically limit exposure to momentum and strong growth trends within its own portfolio.
Exposure to Underperforming Companies
In addition to trimming its winners, the ETF's portfolio also includes several companies that have performed poorly, acting as a significant drag on returns. The fund's selection criteria, which focus on factors like dividend yield and consistency, do not always filter out companies facing fundamental business challenges.
Several holdings have experienced substantial declines this year:
- Target (TGT): The retailer's stock is down approximately 35% year-to-date.
- United Parcel Service (UPS): The logistics giant has seen its shares fall by around 31%.
- PepsiCo (PEP): The food and beverage company's stock has declined by about 6.3%.
Holding these lagging stocks has weighed heavily on the fund's performance, offsetting gains from its more successful positions and contributing to its flat overall return.
Is the High Yield Worth the Trade-Off?
For investors, the central question is whether SCHD's high dividend yield compensates for its significant underperformance in total return. The fund successfully delivers on its primary goal of providing a robust income stream.
However, the opportunity cost has been substantial. An investor focused solely on the S&P 500 would have seen their capital grow at more than double the rate of an SCHD investor over the past five years, even before considering the reinvestment of dividends.
The structural limitations of the ETF, particularly the 4% cap, combined with its holdings in several underperforming companies, have created a challenging environment for growth. While the 3.9% yield is appealing, the fund's inability to keep pace with the broader market suggests that income-seeking investors may be sacrificing too much in potential capital appreciation.
