Investing - Schwab US Dividend Equity ETF

Investing - Schwab US Dividend Equity ETF

I am trying to organize a bunch of stray thoughts into a coherent presentation here. I hope this makes sense.

Since well before I retired in 2016 I was concerned about what to do with my retirement portfolio. I had enough money to retire but how could I protect it in case of a stock market crash. I took a pretty standard and conservative path - primarily 60/40 stock/bond mutual funds.

As retirement moved along, I knew there was a problem with this. Interest rates had been falling for many years, giving bond funds a nice boost. But rates were approaching 0. And it was obvious that something would happen eventually to restart inflation and force interest rates to rise. Not only would the stocks crash but bond values would drop as interest on new bonds went up.

Not knowing what else to do, I stuck with my strategy.

Covid came and set off a chain of events that crashed the stock market and induced inflation. The Fed pushed up interest rates and bond funds dropped. But bond funds dropped far more than predictions based on their average duration. Eventually stocks rose and my portfolio was not a complete disaster. But looking back, if everything was in an S&P 500 fund (not considered a particularly safe place for money in retirement), I would have done much better.

So back to the big question. Where should I put my retirement money so that I get regular income, the income rises with inflation, and economic events don't crush my strategy?

The graph below shows total return, NOT adjusted for inflation, since 2019, VOO (S&P 500 index ETF), SCHD (dividend index ETF), VBIAX (60/40 index fund), AGG (aggregate bond index ETF).  

Https://stockcharts.com/h-perf/ui?symbol=voo+schd+vbiax+agg 

if you want to play with the data. My graph can be replicated with Range - Select Start/End and Start YYYY-MM-DD - 2019-01-01.

 

Bonds (AGG in the graph) -

Bonds take two hits on inflation. The principal and interest lose buying power by the inflation rate. And the Fed raises interest rates to try to reduce the inflation, so new bonds issue with a higher rate, which devalues current bonds.

In the graph, bonds are dead flat over this period due to rising interest rates. And that assumes no withdrawals.

In better times, the interest rate is little better than the inflation rate. And the principal does not grow so there is no adjustment for inflation.

CDs -

CDs act just like bonds, at a lower interest rate in return for FDIC insurance (up to $250,000 per owner, per bank).

These will likely lose to inflation. If you distribute them properly you can get FDIC insurance on all of your assets. But will the FDIC survive an economic collapse? Well, it better or you can expect collapse of the banking system and our society.

60/40 or 40/60 Funds (VBIAX in the graph) -

In the graph, stocks crash and bonds don't grow. The bond portion contributed nothing to the total return.

Bonds do reduce the volatility of the investment. But in the graph example, after three years, the pure stock asset is so far ahead of the 60/40 fund that it covers any typical stock market crash.

Annuities -

These have big management fees, you lose control of your assets, you have nothing to leave to heirs. And in a severe economic collapse, the managing company may fail and the insurance may fail.

I looked up a typical distribution for an immediate annuity. 7% - about twice the distribution of SCHD. But it never increases. With inflation at 4%, a 7% distribution becomes, effectively, 5.1% in the eleventh year. For SCHD, at a growth rate of 10% minus 4% inflation, a 3.5% distribution becomes, effectively, 5.5% at eleven years. After that SCHD keeps going up and the annuity keeps going down. It is easy to manipulate the results by adjusting the inflation and growth rate.

Dividend Stocks (SCHD in the graph) -

So how about dividend stocks? ETFs for minimal effort, but some people prefer to choose individual stocks.

SCHD ETF seeks to match the S&P Dow Jones US Dividend 100 index, which screens for quality stock dividends (stocks only - no REITs). The expense ratio is .06% - that's $600 on a $1000,000 investment. (A typical expense ratio for a mutual fund might be .75%. That's $7,500 on a $1000,000 investment.) Historically, this is the best of the dividend ETFs.

SCHD pays about 3.5% in qualified dividends. That's income for you, taxed at the long term capital gains rate (after a short period of ownership). The payout ratio (dividends divided by earnings) is about 50% (as best I can find). That's 3.5% for the corporations to reinvest in growth, which helped the total return come close to the S&P 500. The dividend growth rate has been about 15% so the dividends grow faster than inflation. That's history, not prediction.

So this looks like a nice place to invest, especially for a tax unadvantaged account for people that need to get income from their investment. But is it safe?

It is certainly more volatile that CDs, bonds, and annuities. But it is somewhat less volatile than stocks in general because the dividends support the stock price. In the event of major economic problems, the money is (hopefully) in productive businesses. If money making businesses fail en mass, the whole economic system will collapse.

Compare the total return of SCHD versus AGG (aggregate bond ETF), starting 1,2,.. years ago, and then look forward. In every such period, after five years, SCHD is far ahead of AGG. Short term volatility can hurt, but long term, you are way ahead with SCHD. Furthermore, the dividends keep coming even when the stock price is down. That's history, not prediction.

So when looking at safety, I will take an investment that has a good record of beating inflation over a non-volatile investment that has little chance of keeping up with inflation. And I like the idea of owning productive businesses rather than debt.

So most of my portfolio is now in dividend stock ETFs, and most of that is SCHD. Does this sound risky? Maybe. But looking back over my past investments, risky would have paid off nicely.

If stocks totally collapse, I have Social Security to keep me going. But if stocks totally collapse, I doubt that Social Security will be far behind.

For dividend stock ETFs look at SCHD, SPYD, VYM, DGRO, VIG, and there are many more.

BEWARE (2024-07-15) - 

ETFs such as SCHD, and those listed above, that own dividend paying stocks and distribute only those dividends, will not lose stock shares (although the value of the shares may drop). This is critical to my analysis of risk and keeping up with inflation.

Some dividend ETFs pay out more than the dividends of the stocks that are in the ETF. This can be done by selling shares or using derivatives - either way you risk losing shares. This can be useful for increasing your income, but it risks principal and growth of principal. For long term, passive income that keeps up with inflation, I would stay away from these.