Key Points
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The Schwab U.S. Dividend Equity ETF is built on companies with strong balance sheets, healthy cash flows, and a long history of dividend growth.
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IBM’s 25% drop after its second-quarter earnings warning shows that tech stocks may be hit hard if they signal slowing or reversing growth.
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Investing in quality companies from non-growth sectors that pay high yields is the better total-return alternative right now.
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The Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) is where I would be putting new money right now. But the investment case has nothing to do with the construction of the fund itself or its yield. In my opinion, it comes down to the Federal Reserve, interest rates, and inflation.
The Fed is holding its benchmark rate at 3.50% to 3.75%, and any cuts to that are likely off the table for the foreseeable future.
Even after June’s headline Consumer Price Index rate came in below expectations at 3.5% year over year, it’s still unlikely to move the Fed off its hawkish tilt. A core inflation rate of 2.6% is closer to the central bank’s target, but it’s still not nearly where it needs to be to bring rate cuts back into the conversation.
The other factor that’s giving me pause right now is tech concentration in the S&P 500. About 40% of the Vanguard S&P 500 ETF is in tech; 40% is also the level of concentration in the top 10 holdings. This creates some unappealing downside risk for the broader market.
I’m still a believer in the tech-earnings growth picture, but I’m concerned about what happened with International Business Machines this week. It fell around 25% after issuing a second-quarter earnings warning.
This has always been the big risk in tech: What happens to stocks when earnings growth peaks or reverses? IBM’s case shows that the risk might be substantial.
Why the Schwab U.S. Dividend Equity ETF helps solve today’s market problems
This brings me back to the Schwab ETF. Don’t give me more tech exposure right now. Give me an ETF filled with companies that have high-quality balance sheets, a history of long-term dividend growth, and a yield that can stay above the inflation rate.
The Schwab U.S. Dividend ETF currently yields 3.3% and has raised its annual payout every year since its inception in 2011. The annualized dividend growth rate has been around 10%, so the income generated has stayed well ahead of inflation, even in 2022.
At 19% each, consumer staples and healthcare are the fund’s biggest sector holdings. This gives the portfolio much more of a defensive lean. The tech sector allocation of just 11% is less than one-third that of the S&P 500. The focus on companies with strong balance sheets and plenty of cash flow helps to ensure the Schwab ETF can withstand whatever the economy throws at it.
That allocation may not sound terribly exciting, but it has also beaten the Vanguard S&P 500 ETF by roughly 9% year to date. Not bad for a “boring” portfolio.
If I’m adding $1,000 to my portfolio today, I’m staying away from concentrated tech or AI stock positions. Instead, I’m balancing it out with a quality defensive tilt that makes income a bigger component of total return.
In today’s market with tech stocks showing some signs of fatigue and investors punishing at least one stock that dared to miss expectations, the Schwab U.S. Dividend Equity ETF represents the better opportunity.
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David Dierking has positions in Schwab U.S. Dividend Equity ETF. The Motley Fool has positions in and recommends International Business Machines and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
