3 ETFs That Work Better Together for Dividend Investors

When people try to construct a portfolio, a lot of them end up instead building a collection of recent high-performing funds.

The problem with that is that there's often a high overlap across holdings that defeats the purpose of diversifying. Right now, that's a big problem for anyone who owns an S&P 500 ETF, a growth ETF, and a tech ETF. Look at the top 10 holdings in those funds. They're mostly the same.

The same principle applies to dividend ETFs. You don't just want a bunch of high-yield funds, nor do you want a collection of just the best performers. You want to use ETFs that build off of each other's strengths and give you all the benefits of their respective strategies while minimizing downside risk.

If you want to build a diversified dividend ETF portfolio today, here are the three funds I would consider using together.

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High yield: State Street SPDR Portfolio S&P 500 High Dividend ETF

High-yield dividend strategies don't get any more pure than the State Street SPDR Portfolio S&P 500 High Dividend ETF (NYSEMKT: SPYD). Its security selection process is simple -- it targets the 80 highest-yielding stocks from the S&P 500 and then equal-weights them.

Its current yield of 4.4% is one of the highest rates you'll find from a diversified large-cap equity ETF without venturing too far out on the risk spectrum. But it is very rate-sensitive. Roughly 25% of the portfolio is invested in real estate investment trusts (REITs), with another 15% in consumer staples, 14% in financials, and 10% in utilities. If interest rates move, as they are currently, the State Street SPDR Portfolio S&P 500 High Dividend ETF will be affected.

High quality: Schwab U.S. Dividend Equity ETF

The Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) is where we begin focusing more on balance sheet strength and durability. It actually considers a stock's dividend history and yield as well as several fundamental metrics when building its portfolio. It's one of the few dividend ETFs that consider aspects of quality, dividend growth, and yield in a single strategy.

This, too, is a more defensively positioned ETF with a combined 41% of assets getting invested in healthcare and consumer staples. The most attractive aspect of this fund, in my opinion, is that considering multiple aspects of a stock's dividend profile helps create a cross-check. A vulnerable high yield, for example, may get screened out because the company doesn't demonstrate the balance-sheet health to sustain it. The Schwab U.S. Dividend Equity ETF has a current yield of 3.2%.

Dividend growth: iShares Core Dividend Growth ETF

The iShares Core Dividend Growth ETF (NYSEMKT: DGRO) doesn't apply a pure dividend growth strategy, but it's not far off. It requires only a modest five-year track record of consecutive annual dividend increases and adds a payout ratio screen to help ensure sustainability. It's not the strictest selection process there is, but it does create a reasonably good end product.

The iShares Core Dividend Growth ETF includes nearly 400 stocks, so you get both long-term and emerging dividend growers. Like many stocks in this category, the fund doesn't offer a big yield. Its 1.9% dividend yield is well above that of the S&P 500 but below that of many of its peers.

Three ETFs, three strategies, one dividend portfolio

Combining these three ETFs together is where you begin to see real benefits. The Schwab U.S. Dividend Equity ETF has only around a 20% overlap with the other two funds. The iShares Core Dividend Growth ETF and the State Street SPDR Portfolio S&P 500 High Dividend ETF only have roughly a 5% overlap.

Not only do you combine three different strategies, but you also build true diversification and risk management. An investment split equally into each fund would still produce a 3.1% yield overall.

While this three-ETF portfolio would give you something very distinct from the S&P 500, it does come with some unique risks. I mentioned the rate sensitivity problem earlier: This group could become especially vulnerable to rising interest rates. You would also collectively have much less tech sector exposure. If the artificial intelligence (AI) trade were to continue, there's a good chance this dividend ETF portfolio would lag.

But the balance sheet health, yield, and durability factors are its biggest advantages. Dividend growth, dividend quality, and high-yield strategies focus on different things. But they fit together remarkably well.

David Dierking has positions in Schwab U.S. Dividend Equity ETF. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.