Why I Question SCHD's Role in My Portfolio -- Is There a Better Choice for Income and Growth?

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13 hours ago

Schwab's U.S. Dividend Equity ETF has underperformed other funds of late.
The funds being held in comparison aren't actually all that comparable.
The purpose of diversifying any portfolio is to limit the risk of inevitable but unpredictable change.
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Do you own the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD), and if so, have you been disappointed by its recent performance?
If your answer to both questions is yes, you're not alone. Plenty of people have been frustrated with its lack of progress versus the broader market. One of these disappointed investors recently asked an entire Reddit community about this fund's usefulness when there are so many other options available.
Why SCHD? It loses to both SPY and JEPQ in total returnsby u/Malevin87 in dividends
There's always more to the story than anyone can know through a single Reddit post. Since many investors are likely grappling with this very same question, however, some thoughts on the matter are in order.
First, you're not imagining things. As the original poster's math suggests, SCHD is trailing alternative exchange-traded funds (ETFs) like the JPMorgan Nasdaq Equity Premium Income ETF (NASDAQ: JEPQ) or the SPDR S&P 500 ETF Trust (NYSEMKT: SPY). Indeed, even adding its sizable dividend payments (its trailing yield is just under 4%) into the mix, the Schwab fund has consistently underperformed SPY and JEPQ since the middle of 2023.
This doesn't necessarily mean a fund like the Schwab U.S. Dividend Equity ETF doesn't belong in your portfolio, though.
Yes, Schwab's dividend fund is lagging. It has for a while. There's an underappreciated reason for that. The Dow Jones U.S. Dividend 100™ Index that it is meant to mirror holds a bunch of the market's very biggest dividend payers that have been out of favor for a couple of years now. The fund -- and index -- are highly exposed to consumer goods names like Altria, oil and gas giants such as Chevron, and industrial tech stocks like Texas Instruments.
These are all fine companies. But they've just not been what investors have been clamoring for over the course of the past few years. Investors are still mostly in love with technology stocks that are heavily exposed to the artificial intelligence (AI) revolution. That's a big reason the JPMorgan Nasdaq Equity Premium Income ETF has done so well since 2023, when the AI movement really took hold.
As the name suggests, JPMorgan's Nasdaq Equity Premium Income fund holds the same stocks you'll find in the Nasdaq-100 Index. They include Nvidia, Microsoft, and Broadcom, just to name a few.
There's a slight twist with JEPQ. Its primary purpose is to generate distributable income to its owners by selling "covered" call options against the stocks the fund holds. The strategy for achieving this usually works quite well, too. The ETF's current annualized dividend yield stands at an impressive 14.5%.
Make no mistake -- this strategy also ultimately means that this fund's performance trails the Nasdaq-100's. It's just an attractive investment because so much of the Nasdaq-100's gains are still able to be collected in the form of immediate and perpetual income.
It's a completely different kind of investment than the Schwab U.S. Dividend Equity ETF, so its net performance should be different.
The same can be said of SPY. This ETF is neither dividend-oriented nor growth-oriented. It's just meant to mirror the performance of the S&P 500, which encompasses 85% of the U.S. stock market's total market capitalization. That's why it's such a good market barometer.
Of course, the same AI-centric technology names that dominate the Nasdaq-100 also dominate the S&P 500. That's why it's also outperformed SCHD for the past couple of years.
So what? Performance is performance, after all, and JEPQ and SPY are performing when Schwab's U.S. Dividend Equity ETF isn't.
The reason you diversify isn't to capitalize on current leadership. You diversify because you have no idea what the future holds, and your job as an investor is to maximize your potential upside while minimizing your risk of the unknown. More to the point, although the JPMorgan Nasdaq Equity Premium Income ETF and the SPDR S&P 500 ETF Trust may be leading the Schwab U.S. Dividend Equity ETF right now, that could change in an instant.
That possibility is more real right now than you might realize, given the environment.
While selling (or "writing") covered call options on the Nasdaq-100's stocks has worked well enough since 2023, the market's somewhat choppy sideways to slightly bullish trend favors this strategy. That's especially true in an environment with above-average volatility and rising interest rates, as we've seen lately. This rise in interest rates also works against dividend stocks, since the market will adjust their prices lower to push their dividend yields closer to bonds' yields. Given this, it's not surprising that SCHD has underperformed of late.
But what if everything about this backdrop reverses? What if interest rates start to sink and/or the market's volatility starts mellowing out? Or what if a strong marketwide bull market takes hold? This situation would favor dividend stocks again, but also make JPMorgan's option-writing strategy even more difficult to execute, and relatively less productive than simply buying and holding.
You won't see this shift coming before it happens. You'll only see it after the fact, when SCHD starts to perform better, and JEPQ starts to perform worse.
This isn't to suggest that JPMorgan's covered call ETFs aren't worth owning, nor is it a guarantee that Schwab's dividend ETF is on the verge of recovery. That's the point. While an environmental shift is likely, we can't know when or to what extent it will take shape. That's why you remain diversified even when it's difficult to stick with a laggard and not double down on leaders. You're preparing for all possibilities by owning a little of everything, and not too much of anything.
It's also worth considering that one year's time isn't actually very long when it comes to stocks. It may be too soon to come to a sweeping long-term conclusion here.
That being said, in this particular instance, two of the three exchange-traded funds in focus are at the extreme opposite ends of the spectrum. There may be room for something else in between that isn't quite so dividend-oriented, but also not so tech-centric.
For instance, while its dividend yield may be a modest 1.7%, the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) is based on the S&P U.S. Dividend Growers Index, which makes a point of not including the highest-yielding stocks just because they're more likely to underperform. Sure enough, this dividend fund has easily outperformed SCHD for the past couple of years. Even if it hasn't quite kept pace with JEPQ, it's at least been respectably close.
High-quality dividend stocks do offer the capital growth that most investors also want. They do better in times of market weakness too, since their cash dividend payments usually remain unfazed.
VIG is just one of several other ETFs that might be worth considering here, however. The Vanguard Growth ETF (NYSEMKT: VUG) wouldn't be a bad bet either, if income isn't actually an immediate concern.
When a portfolio is well-diversified (as it should be) to protect an investor from the unknowable, the unexpected, and the unpredictable, one of those holdings is always going to lag. That's OK. That's the reasonable price you pay for the protection.
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JPMorgan Chase is an advertising partner of Motley Fool Money. James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron, JPMorgan Chase, Microsoft, Nvidia, Texas Instruments, Vanguard Dividend Appreciation ETF, and Vanguard Index Funds - Vanguard Growth ETF. The Motley Fool recommends Broadcom and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
Why I Question SCHD's Role in My Portfolio -- Is There a Better Choice for Income and Growth? was originally published by The Motley Fool