Dividend growth investing can be a very profitable way to compound wealth over the long term. It brings with it numerous advantages, including:
- Focusing investors on what matters most: the fundamentals of the business. Even if the stock market gets volatile, if the company can continue to pay and even grow its dividends, then the compounding of intrinsic value continues unabated. As long as the company continues to grow its dividend, eventually, the market price will reflect that.
- It provides investors with a combination of current passive income and long-term capital appreciation. Over time, this can lead to a "best of both worlds" situation where the portfolio's passive income exceeds your living expenses and also grows faster than inflation while also still generating attractive appreciation, leading to the ability to retire off of dividends while also growing a meaningful estate to pass on to your heirs.
- Dividend growth stocks generally are great companies that are well-managed because companies can only pay out and consistently grow dividends if they are strong, profitable, and growing businesses and a company that makes that sort of consistent financial commitment to shareholders also has to be more disciplined with its capital allocation decisions since it is sending a considerable amount of its capital out the door to shareholders at regular intervals.
With this in mind, many investors choose to invest in diversified dividend growth ETFs to further reduce risk and set the dividend growth compounding process on autopilot. If I were to own a portfolio of four of these funds, these would be the ones I would invest in and why:
#1. Schwab U.S. Dividend Equity ETF (SCHD)
One reason why I like SCHD is that it has a minuscule expense ratio of just 0.06%. As a result, it passes on nearly all of its returns to shareholders with management only skimming a very small amount off the top.
Additionally, its dividend growth track record is very impressive, with a 10.87% 10-year dividend CAGR, an 11.80% five-year dividend CAGR, and an 8.56% three-year dividend CAGR.
Third, it has a very attractive trailing twelve-month dividend yield of 3.4% compared to other funds with similar dividend growth rates. Finally, it is among the best-diversified ETFs, with meaningful exposure to stocks in eight sectors, giving investors a very balanced allocation:
#2. Vanguard Dividend Appreciation Index Fund ETF Shares (VIG)
One reason why I like VIG is that - similar to SCHD - it has a very low expense ratio of just 0.06%, conservative shareholder total returns, and leading to superior performance over the long term. VIG's dividend growth track record is also quite strong, with a 10-year dividend CAGR of 8.49%, a five-year dividend CAGR of 8.46%, and a three-year CAGR of 11.39%.
While its trailing twelve-month dividend yield of 1.79% is pretty weak, this comes with the tradeoff of the fund having outsized exposure to technology stocks at nearly a quarter of its portfolio, including its top three holdings being AI-related tech giants Microsoft (MSFT), Apple (AAPL), and Broadcom (AVGO). This will expose dividend growth investors to one of the most dynamic sectors of the economy while still enjoying robust dividend growth.
#3. Vanguard High Dividend Yield Index Fund ETF (VYM)
VYM joins SCHD and VIG with its attractive 0.06% expense ratio and it stakes out a middle ground with its trailing twelve-month dividend yield of 2.88% which is much better than VIG's but is still well below SCHD's.
Meanwhile, its dividend growth track record is significantly worse than SCHD's and VIG's, but still inflation-beating with a 6.92% 10-year dividend CAGR, a 5.22% five-year dividend CAGR, and a 4.33% three-year dividend CAGR.
Finally, its portfolio is also pretty well diversified across eight sectors, giving investors better exposure to utilities than SCHD and VIG do, which also happens to be a sector that we are bullish on right now. Moreover, it gives investors outsized exposure to financials stocks, with ~22% of its portfolio allocated to them, providing us with better all-around diversification.
#4. iShares Core Dividend Growth ETF (DGRO)
One reason I like DGRO is that it has a very competitive expense ratio of just 0.08%. While slightly higher than SCHD's, VIG's, and VYM's, it is still quite low and does not impact total returns in a meaningful way.
Additionally, its dividend growth track record is strong, with a 9.70% five-year dividend CAGR and an 8.36% three-year dividend CAGR. Moreover, its trailing twelve-month dividend yield of 2.33% is not particularly high but is still more than 100 basis points above the S&P 500's (SPY) 1.30% trailing twelve-month dividend yield.
Finally, like the other ETFs in this article, it has strong diversification, with meaningful exposure to eight sectors. However, in contrast to SCHD and VYM, it has significant exposure to technology, paring nicely with VIG to ensure that dividend growth investors still get plenty of exposure to that dynamic sector while still generating a decent dividend yield and strong dividend growth.
Investor Takeaway
If I could only hold one dividend growth ETF, it would be SCHD due to its extremely low expense ratio, strong dividend growth track record, and attractive dividend yield. That being said, its sector allocation leaves it a bit light in both technology and utilities, so including these other three funds helps to round out its portfolio better while still pumping out dividend growth that easily beats inflation and a total dividend yield that is still well above that of SPY.
I personally want a higher dividend yield and have been able to significantly outperform these dividend growth ETFs (and SPY) by picking my own high-yield dividend stocks. As a result, I do not invest in these ETFs. However, if I were to revert to a completely passive investing approach and wanted to invest in dividend growth funds, these would be the four that I would own, likely weighting them as follows:
SCHD 50% DGRO 20% VIG 15% VYM 15%
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