Introduction
ETFs are incredibly popular, which makes sense, as they are extremely handy tools. Good ETFs are like an investment autopilot. Over the past twenty years, investors have increasingly figured out how ETFs can help them achieve their financial goals.
In 2003, the world had 276 ETFs. That number has grown to 8,754 in 2022.
In other words, the number of ETFs has grown by 19% per year in the 2003-2022 period.
Personally, I have a bit of a love/hate relationship with ETFs.
I like ETFs because they allow both inexperienced and experienced investors to invest money without having to be bothered with stock picking. Especially for inexperienced investors, this is key. After all, I believe that inexperienced investors should not pick their own stocks.
ETFs also allow us to invest in certain sectors, industries, and themes without having to pick single stocks. If you’re bullish on energy, you can just buy an energy stock. Bearish on consumers? Short a retail stock. Looking for exposure in Brazil? Just buy a Brazil-focused ETF. And so on.
Also, even if investors do not care for ETF investing, ETFs can still be used as benchmarks. I often use ETFs to assess how well single stocks are doing.
Reasons why I dislike ETFs include my own ego. I believe I’m good enough at stock picking to avoid ETFs. I also dislike paying other companies for a service that I can do myself. I’m talking about the expense ratio here.
This brings me to another reason why I dislike (some) ETFs. So many ETFs have elevated expense ratios. They are often offered by smaller companies that require higher expense ratios to cover costs. Also, a lot of funds simply underperform the market. They don’t add value. The only value they deliver is for the people who are on the receiving end of the expense ratio.
With all of this in mind, I do like some of the thousands of ETFs that have flooded the market.
Two of my all-time favorites are:
- Schwab U.S. Dividend Equity ETF (NYSEARCA:SCHD)
- Schwab U.S. Large-Cap Growth ETF (NYSEARCA:SCHG)
In this article, I will explain why it may make sense to combine both ETFs, creating a two-stock portfolio that allows investors to reach their financial goals.
So, let’s get to it!
The Best Of The Best
SCHG and SCHD are very different, yet similar. Comparing them usually does not make sense. After all, one of them is a high-yield dividend ETF. The other is a large-cap growth ETF.
Comparing them is like choosing between an SUV and a sporty two-seater. You either need a practical car or a sports car that’s fun to drive.
These ETFs have a few things in common. For example, both are owned by The Schwab Corporation (SCHW). Both are focused on companies listed in the U.S. Also, both have very low expense ratios. The SCHG expense ratio is 0.04%. The SCHD expense ratio is 0.06%. This is extremely fair.
Furthermore:
- Both ETFs enjoy five-star ratings from Morningstar.
- Both ETFs have top scores from Seeking Alpha’s quant system, especially in the areas that matter most.
SCHG has top scores for liquidity, risk, and momentum. SCHD has top scores for expenses, dividends, and liquidity.
The poor momentum score for SCHD is caused by the fact that high-yield stocks have been struggling lately. This isn’t an issue that makes SCHD a less attractive dividend stock.
SCHD scores A+ for dividends, which is what matters most. It yields 3.7% with terrific dividend growth, as I will show you in this article.
The same goes for SCHG. It scores poorly in the dividend category. That is no surprise, as its yield is 0.5%. SCHG isn’t about dividends. It’s about owning the fastest-growing large-cap companies in the U.S., which excludes the risky small-cap players.
To summarize:
- SCHD has a 3.7% yield and a 10-year dividend CAGR of 11.1%. While I expect this growth rate to come down due to economic challenges, it needs to be said that Schwab has found the perfect mix between dividend growth and high yield, which explains why the ETF has such great ratings!
- SCHG has a 0.5% yield and NO dividend growth. This makes sense. In this article, I’ll show the largest positions of both ETFs. SCHG puts the best growth stocks in its top holdings. In other words, the moment a stock starts to become more mature and grow its dividends, odds are its exposure is not large enough anymore to boost the overall dividend yield of the ETF.
Having said that, SCHD has a top-tier portfolio. It owns 105 different stocks with a weighted average market cap of $148 billion. The average P/E ratio is 13.9x.
Top holdings include some of my favorite dividend growth stocks like Amgen (AMGN), AbbVie (ABBV), Chevron (CVX), Texas Instruments (TXN), and PepsiCo (PEP).
Its biggest holding has a 4.5% weighting.
SCHG is different. Incepted in 2009, this ETF has 254 holdings with a weighted average market cap of $1.1 trillion!
That makes sense, as a quarter of the entire ETF consists of Apple (AAPL) and Microsoft (MSFT).
What’s important to remember here is that while a quarter of AAPL/MSFT exposure is a lot, SCHG does not invest in small companies with high-risk growth.
This is a large-cap ETF that won’t subject its owners to small companies that highly depend on 1-2 breakthrough products/services.
Essentially, SCHG is SCHD with companies in much younger growth stages, minus the size risk.
Why Combining Both Makes Sense
SCHD isn’t a traditional dividend growth ETF. It focuses on a mix of yield and growth, which is even better in most cases. After all, by going 50/50, investors have a 2.1% yield with 50% solid and consistent dividend growth and 50% outperforming earnings growth.
Going with dividends makes a lot of sense. Dividends have been a big part of the market’s total return. Since 1960, the S&P 500 total return was so high that it turned $10,000 into $4.1 million. Without dividends, that number would have been $640 thousand.
Also, while the 2010s and 2020s were highly favorable for growth stocks, periods of lower total returns often favored dividends.
Since 1930, 41% of the S&P 500’s total return came from dividends!
In other words, while growth stocks may perform better in certain periods of low inflation and low rates, long-term investors will go through periods of subdued capital gains, making solid dividend stocks so much more important.
Also, and this is very important, the best-performing dividend stocks were not the highest-yielding stocks but the stocks with yields in the bottom three quintiles! While SCHD is a high-yield ETF, it does service these segments, as it doesn’t have high exposure in ultra-high-yield categories.
When combining SCHD and SCHG in a 50/50 portfolio, we get a terrific performance.
- Since December 31, 2011, this 50/50 portfolio has returned 14.2% per year. The S&P 500 has returned 13.0% per year during this period.
- The standard deviation of the SCHD/SCHG portfolio is slightly lower at 14.1% (versus 14.3%).
- As a result, the risk/adjusted return (Sharpe Ratio) of this portfolio is higher than that of the market.
Even better, the performance of the 50/50 portfolio was better in almost every single year since 2012!
- Over the past three, five, and ten years, SCHD/SCHG has beaten the S&P 500 with lower volatility!
- During the pandemic in 2020, SCHD/SCHG performed much better.
- It also performed better during the sell-off that followed!
While we can only backtest slightly more than ten years, we see that even in different economic situations (high inflation versus low inflation and high growth versus slow growth), investors buying a mix of income and growth have a clear benefit.
Also, on a long enough timeline, investors requiring income are unlikely to be put in a position where they have to sell a lot of assets, which can come with capital gains taxes. SCHD is very likely to offer investors a very juicy yield on cost over the next few decades.
SCHG is likely to perform so well that investors can sell their profitable position and buy a ton of high-income investments if they have to.
Based on everything said so far, I do believe that SCHG/SCHD has unbeatable benefits for long-term investors – almost regardless of their age.
If I invested in ETFs, my portfolio would likely resemble this structure.
Takeaway
In a world flooded with investment options, ETFs have emerged as the unsung heroes of financial planning. Over the past two decades, their numbers have skyrocketed, offering investors a diverse range of choices.
I have a love/hate relationship with ETFs, but two stand out for their exceptional qualities: Schwab U.S. Dividend Equity ETF and Schwab U.S. Large-Cap Growth ETF.
While these two ETFs cater to different investment philosophies, their common attributes make them a dynamic duo.
Both boast low expense ratios and stellar ratings, but where SCHD excels in dividends, SCHG dominates in growth. Combining them in a 50/50 portfolio offers a balanced approach with a 2.1% yield, steady dividend growth, and outperforming earnings growth.
Historically, dividends have been a cornerstone of market returns, and this blend ensures resilience during various economic climates. Together, SCHD and SCHG have outperformed the S&P 500 with lower volatility, even during turbulent times.
With the potential to provide a juicy yield on cost and robust growth, this ETF pairing offers unbeatable benefits for long-term investors of any age.
If I were to invest in ETFs, this portfolio structure would be my top choice.
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