Retirement Passive Income: 4 Reasons To Forget VYM And Buy SCHD Instead (NYSEARCA:SCHD)

designer491Passive income investing is arguably the best way to save for and fund retirement because: It simplifies the retirement planning process. You determine what your retirement budget is likely going to be and what the annualized rate of inflation is likely to be over the long-term. Then you build a portfolio of dependable dividend stocks that provide a current yield that exceeds your living expenses and are likely to grow in aggregate at a pace that exceeds the expected rate of inflation. Rather than build a portfolio of low yield index funds and hope the markets cooperate enough for your funds to last you until you die, you can just relax and live off of the dividends. It also removes emotions from the investing equation. Rather than getting caught up on the emotional roller coaster ride that comes with obsessing over the ever-changing value of one’s portfolio, passive income focused investors instead measure their portfolio’s value according to the passive income stream that it generates. While markets rise and fall, dividends from quality companies tend to be much more stable and even grow consistently over time. Instead of panicking and selling during a market crash like many retail index fund investors do, passive income focused investors view the rising dividend yields on stocks during market downturns as an opportunity to buy more. They let market volatility serve them to accelerate their passive income growth rather than being mastered by it and panicking. Companies that pay out a substantial portion of their cash flow and still manage to consistently grow their dividends over a long period of time are generally truly great businesses. This is because it requires an exceptional management team and/or business model to be able to consistently suck a large and ever increasing amount of cash out of a business and yet still be able to sustain and grow its earnings power over the long-term. With rapid technological disruption, economic booms and busts, and black swan events wreaking havoc on businesses large and small, businesses that continue to grow their dividends through it all clearly have something special about them. For these reasons, dividend growth ETFs like the Vanguard High Dividend Yield Index Fund ETF Shares (NYSEARCA:VYM) and the Schwab U.S. Dividend Equity ETF (NYSEARCA:SCHD) are highly popular with passive income investors. They are particularly popular with those in or near retirement because: They pay out respectable current dividend yields to meet current living expenses. They have strong track records of growing shareholder principal over time, making them excellent long-term preservers of investor wealth for passing on to heirs. They have grown their dividends consistently through good times and bad at rates that significantly exceed the rate of inflation, meaning that retirees can actually raise their standard of living over time when depending on these funds for passive income. While both VYM and SCHD are good funds for retirees looking to live off of passive income, here are four reasons why SCHD is superior to VYM: Reason #1: Superior Total Returns While trailing total returns can be misleading and should not be the sole basis for any investment decision, SCHD’s material outperformance of VYM over time should get an investor’s attention: Data by YChartsClearly these two funds are closely correlated with each other as per the chart’s past behavior. However, SCHD has created reasonably strong separation in its total return performance from VYM over time, potentially indicating – though not proving – that its investment methodology yields better results over the long-term. Both funds charge identical expense ratios of 0.06%, so it is not a function of lower fees, but rather superior performance, that has been the difference maker in fund performance. Reason #2: Superior Dividend Growth Perhaps the biggest driver of this superior total return performance for SCHD relative to VYM is that it has generated massively superior dividend growth over time. Data by YChartsAgain, this seems to highlight the fact that SCHD manages to invest in much faster growing dividend stocks than VYM, making it a better compounder of capital over the long-term than VYM is. Reason #3: Superior Current Yield Perhaps surprisingly, SCHD’s current dividend yield is actually meaningfully higher than VYM’s as well, despite also boasting a much stronger growth track record. Based on the trailing twelve month dividend payout for each fund, VYM’s dividend yield is 3.0% relative to its current share price while SCHD’s is 3.5%. That means on a $1 million portfolio, SCHD investors could expect $35,000 in annual dividends whereas VYM investors could expect only $30,000 in annual dividends. When you are in retirement, every penny counts, so a 17% boost to annual passive income by switching to SCHD from VYM is substantial. When combined with the fact that SCHD grew its dividend at a 7.1% rate over the past twelve months and a 12.3% CAGR over the past three years compared to VYM growing its dividend at a 4.3% rate over the past twelve months and a 4.1% CAGR over the past three years, SCHD appears to be the clearly superior passive income machine. Reason #4: Superior Portfolio Composition How is SCHD able to seemingly have its cake and eat it too? It comes down to their portfolio composition. In particular, there are two key reasons why SCHD has been able to clearly beat VYM and will likely continue to do so over the long-term: SCHD’s portfolio strikes a better balance between concentration and diversification with 104 total holdings and 40.33% of the total portfolio invested in its top 10 holdings. In contrast, VYM is overdiversified across 465 stocks and only hold 25.08% of their portfolio in their top 10 holdings, resulting in them inevitably holding a lot of capital in underperforming stocks and slower dividend growers. SCHD’s portfolio is also more concentrated in growthier, more dynamic sectors such as technology, industrials, consumer cyclical stocks, and health care. In contrast, VYM has a greater concentration in slower growing sectors like financials, consumer defensive, and utilities. While these may perform better during economic recessions, they generally generate lower returns on invested capital, resulting in long-term underperformance, especially when diversified so broadly in a manner that largely ignores valuation. Investor Takeaway SCHD and VYM are both useful engines for funding a retirement that is based on passive income investing principles. However, given its superior total return and dividend growth track record, meaningfully higher current dividend yield, and greater concentration in individual stocks and higher returning/higher growth industries, SCHD appears to be the clearly superior pick relative to VYM.If you want full access to our Portfolio and all our current Top Picks, feel free to join us at High Yield Investor for a 2-week free trialWe are the #1-rated high-yield investor community on Seeking Alpha with 1,500+ members on board and a perfect 5/5 rating from 150+ reviews:You won’t be charged a penny during the free trial, so you have nothing to lose and everything to gain.

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