ETFs: What Financial Advisors Might Overlook
Many financial advisors frequently recommend ETFs, but those suggestions don’t always align with the best options out there. There’s a whole network of ETF wholesalers whose job it is to connect directly with advisors. This involves everything from lunches to golf outings, slick brochures, and complex backtesting that justifies why a certain ETF deserves a spot in a client’s investment strategy.
So, if someone from a big asset management firm meets your advisor for a dinner at Red Lobster and shares a flashy presentation along with impressive performance data, it’s quite possible that a new, lesser-known ETF could be suggested the very next day.
I find this situation frustrating. It seems like individual investors often miss out on solid funds while clients working with advisors rarely see these gems mentioned. Take, for instance, the Schwab U.S. Dividend Stock ETF (NYSEARCA:SCHD).
This ETF has gained a good following, even among Bogleheads who generally prioritize total return. Its appeal largely comes from its low cost. The expense ratio for SCHD is just 0.06%, meaning if you invest $10,000, your annual fee would only be $6.
But there’s more to it than just the low cost. SCHD boasts several other appealing features. Although it currently has a respectable SEC 30-day yield of 3.31%, the dividend yield isn’t the entire story. Ultimately, it’s the total return that really counts. What I appreciate about SCHD is how effectively it intertwines quality and value.
Understanding SCHD
Before diving into my fondness for ETFs, it’s important to grasp how they function. SCHD is a passive ETF that follows the Dow Jones U.S. Dividend 100 Index. This isn’t merely a market-cap weighted benchmark, meaning it doesn’t just favor the largest stocks in a portfolio.
The criteria for inclusion start with companies that have consistently paid dividends for at least ten years. From there, selected stocks undergo an evaluation process based on a composite ranking system that looks at four key factors: free cash flow to total debt, return on equity, dividend yield, and five-year dividend growth rate.
The final 100 companies that pass the checks are included in the ETF. The portfolio is adjusted quarterly, with a full reconstitution happening annually, where companies that no longer qualify are removed, and new eligible firms are introduced.
This method leads to a substantial turnover rate of 43.17% for SCHD. However, unlike mutual funds, ETFs have certain structural benefits. Because shares are issued and redeemed through authorized participants, SCHD can sidestep many of the capital gains distributions that investors in mutual funds often face.
Reasons for Favoring SCHD
Once again, what draws me to SCHD is not so much its dividend yield or even its low fees. What I truly value is the depth of exposure that this screening creates beneath the surface. Effectively, SCHD behaves like a high-quality large-cap value factor ETF dressed up as a straightforward dividend strategy.
For instance, by the end of April, SCHD had a P/E ratio of just 18.98x and a cash flow ratio of 10.83x, both considerably lower than the S&P 500. Despite these seemingly low ratings, the ETF showcases solid quality metrics, boasting an impressive average return on equity of 26.64%. This year, that quality and value tilt has proven beneficial, with SCHD achieving a total return of 17.9% from the start of the year through April.
We also recognize the tax advantages of ETFs like SCHD. Most of its distributions qualify as qualified dividends because the methodology excludes real estate investment trusts (REITs), which can often yield less tax-efficient income. So, the next time your advisor suggests higher-priced dividend strategies pitched by wholesalers, it’s worth asking about SCHD first. You might be surprised at how rarely it gets mentioned.
