Should You Buy the Schwab US Dividend Equity ETF Instead of Picking Individual Stocks?

Key Points

• The Schwab US Dividend Equity ETF currently has an attractive yield of around 3.9%.

• The exchange-traded fund's dividend has trended generally higher since its inception.

• The ETF's value has also trended generally higher.

• 10 stocks we like better than Schwab U.S. Dividend Equity ETF ›

Picking stocks is hard work -- and your job isn't done after making the buy decision. Then you have to keep track of the companies you've chosen to own to make sure that the reasons why you picked them continue to apply. However, dividend investors don't have to put in all of that work if they don't want to. All they have to do is buy the Schwab US Dividend Equity ETF (NYSEMKT: SCHD) and let this fairly complex fund do all the work for them. Here's what you need to know.

What does the Schwab US Dividend Equity ETF do?

The Schwab US Dividend Equity ETF is an index-tracking exchange-traded fund (ETF), so, technically, its managers don't actually do anything other than buy whatever stocks are included in the index it tracks: the Dow Jones U.S. Dividend 100. To understand the ETF, you really need to understand the index.

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The Dow Jones U.S. Dividend 100 index starts its selection process by creating a list of stocks that have increased their dividends for at least 10 consecutive years. It removes real estate investment trusts (REITs) from that list to create a final pool from which to fish for investments. The real work here comes next, as the index creates a composite score for each stock in the selection pool.

The metrics that go into that composite score include the cash-flow-to-total-debt ratio, return on equity, dividend yield, and five-year dividend growth. The 100 companies with the highest scores get included in the index and the ETF, using a market-cap weighting methodology. The index's list of components is reviewed and updated annually.

Each metric on that list serves a different purpose, but overall, the ultimate goal is to identify financially strong companies backed by well-run businesses. And, of course, the stocks that get selected for inclusion in the index also habitually reward their shareholders with generous and growing dividends. These are the types of features that most dividend investors would be looking for in a stock.

Is the Schwab US Dividend Equity ETF right for you?

There are clearly investors who won't find the Schwab US Dividend Equity ETF appealing -- most notably, those who are only interested in growth or value investments. But for most other investors, there's a lot to like here, even though you can easily find ETFs with higher dividend yields than its roughly 3.9%. The most obvious benefit of buying it is that the fairly complex ETF is probably doing something similar to what you would do if you were to build your own portfolio of individual dividend stocks.

However, that alone isn't enough to justify putting your money into this fund. The fact that its payout has trended generally higher over time and that the price of the ETF has also generally risen is the next big piece of the story. Investors are getting both income and growth in one investment with a fairly well-diversified portfolio. It could realistically be the only stock investment you need to buy.

SCHD data by YCharts.

Of course, you have to pay for the investment services being offered here. But even on this front, the Schwab US Dividend Equity ETF stands out, with a tiny expense ratio of just 0.06%. Sure, there are cheaper ETFs to own, but given all of the screening work being done on your behalf, and the performance of the ETF, that's a bargain-basement fee. In the end, if you are a dividend lover, the Schwab US Dividend Equity ETF should definitely be on your radar.

The Schwab US Dividend Equity ETF is good, but not perfect

That said, no investment is perfect. For example, the latest update of the Schwab US Dividend Equity ETF's portfolio has left it out of step with the market. But just because the ETF is materially lagging the S&P 500 (SNPINDEX: ^GSPC) index right now doesn't mean you shouldn't buy it.

The real question is, would you have been doing any better if you had bought individual stocks? If you are a dividend-focused investor, the answer is probably no, since most of the S&P 500's gains lately have been driven by a small number of large technology companies. And most of those stocks don't offer particularly attractive yields. So if you are an income investor looking for a well-designed ETF product to buy so you can stop worrying about picking stocks, the Schwab US Dividend Equity ETF could be the perfect solution for you.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.