Why I Made 3.4% Yielding SCHD My Largest ETF Holding (NYSEARCA:SCHD) (2024)

The Schwab U.S. Dividend Equity ETF (NYSEARCA:SCHD) continues to make a compelling value proposition for passive income investors even after the latest inflation update suggested that inflation may be more stubborn than anticipated.

The Schwab U.S. Dividend Equity ETF has a long history of providing growing stream of income to the ETF’s investors which is what ultimately backs up the value of an investment in the exchange-traded fund.

The Schwab U.S. Dividend Equity ETF provides stable and predictable dividend income in both low- and high-interest rate periods and has an impressive long-term net asset value growth record.

Though the ETF underperformed in a shorter time frame, the Schwab U.S. Dividend Equity ETF is worthy of a portfolio overweighting, in my view.

My Rating History

I evaluated the Schwab U.S. Dividend Equity ETF as a Buy in December 2023 because the exchange-traded fund produced 12% plus annual NAV returns in the long run and offered passive income investors a diversified portfolio that included some of the biggest U.S. corporations.

I think that the central bank’s evolving approach to rate cuts does not change the investment proposition for the Schwab U.S. Dividend Equity ETF.

Inflation, Interest Rate Expectations And Equity Posture

Recent inflation numbers have led to renewed questions about the central bank’s rate cut timeline. With inflation coming in at 3.2% in February, reflecting an acceleration over the 3.1% rate reported for January, inflation is stubbornly holding up above 3%, potentially causing the central bank to be a lot more reluctant to slash short-term interest rates in the coming months.

This could be a headwind for the Schwab U.S. Dividend Equity ETF’s net asset value as the exchange-traded fund’s portfolio consists mainly of large U.S. companies and thereby maintains a pro-cyclical posture.

According to the CME FedWatch Tool, the market overwhelmingly expects the central bank to keep short-term rates steady at its next meeting in March. The odds for a 25 basis point rate cut increase for the June meeting stand at 55% with the majority of market participants anticipating that the short-term interest rate will drop from a range of 5.25-5.50% today to 4.50-4.75% by the end of the year.

In this climate of increasing uncertainty about the short-term interest rate path, investment vehicles like the Schwab U.S. Dividend Equity ETF could be a stabilizing force in a passive income portfolio, in my view.

For one, the ETF has a track record of paying a growing dividend that lasts more than a decade.

Second, the portfolio consists of some of the largest U.S. companies that themselves have a history of growing their dividend payouts over time.

In a moderate inflation environment, one that could see 3-4% annual inflation, I think the ETF’s core industries telecom, pharmaceutical, and energy could perform rather well as they have growing pricing power and can pass on price increases to their consumers.

The Schwab U.S. Dividend Equity ETF’s portfolio is made up of some of the top names in the U.S. economy including Broadcom (AVGO), AbbVie (ABBV), Chevron (CVX), Verizon Communications (VZ), and Cisco Systems (CSCO). The fund’s top five holdings account for nearly one-quarter (22.41%) of the fund’s entire portfolio.

Short-Term Underperformance

In the long-term (since 2011), the Schwab U.S. Dividend Equity ETF produced 13% annualized returns, but the ETF achieved less than half of this return in the last year which is when SCHD gained only 4.6% in value. This short-term underperformance is related to considerable short-term interest volatility and inflation concerns.

Over the long term, however, these disruptions in the macro environment should get smoothed out, and I anticipate that SCHD will return to its long-term NAV growth path in 2024.

Small Premium To NAV

The Schwab U.S. Dividend Equity ETF is an exchange-traded fund and as such trades around net asset value. Small discounts or premiums to net asset value are therefore the norm for the Schwab U.S. Dividend Equity ETF. The ETF had a net asset value of $78.82 as of 03/14/2024 and passive income investors presently pay a discount of 0.01% for SCHD.

A Potential Short-Coming Of The Investment Thesis

The Schwab U.S. Dividend Equity ETF has produced passive income for investors ever since its inception in 2011. With that being said, though, the exchange-traded fund is concentrated in US equities which makes the Schwab U.S. Dividend Equity ETF a pro-cyclical, equity-focused investment vehicle that might see substantial net asset value declines if the U.S. economy were to fall into a recession.

As such, I think the Schwab U.S. Dividend Equity ETF might not be the best choice for some safety-minded investors due to the ETF’s concentrated equity posture.

My Conclusion

The Schwab U.S. Dividend Equity ETF produced solid passive income for investors and has done so for a long time, and, thus, I made SCHD my largest portfolio holding.

With more uncertainty about short-term interest rates present in the market after the inflation update for February, I think that those investment vehicles with consistent pay-outs, like SCHD, have a good chance to outperform moving forward.

The ETF has also managed to grow its net asset value at impressive rates since 2011, during both low- and high-interest rate periods. Though the exchange-traded fund has underperformed in the short run, the long-term performance history is rather good which also backs up my claim that the Schwab U.S. Dividend Equity ETF could perform well in a medium-inflation environment with inflation running between 3-4% annually.

As long as the U.S. economy doesn’t have to grapple with a recession, I am confident that the Schwab U.S. Dividend Equity ETF can make a positive portfolio income contribution.

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