I Boosted My SCHD Position by 50%. Here’s What I Checked First.

I'm currently renovating my retirement accounts. I recently did a thorough analysis and discovered an uncomfortable truth. I'm sitting on way too much cash and short-term Treasury investments, waiting for a market downturn that might never come. That's leading me to revamp my approach to focus on making more investments that can deliver attractive returns over the next five to 10 years, even if there's a near-term market correction.

Schwab U.S. Dividend Equity ETF (NYSEMKT:SCHD) was near the top of the list due to its attractive dividend yield (3.2% over the last 12 months) and strong historical returns. However, before buying even more shares of the top ETF, I ran it through three questions that matter whether I owned 1 share or 1,000. The answer to these questions led me to boost my position by 50%.

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Is the dividend built to last?

An investment's dividend yield is worthless if it isn't sustainable. The Schwab U.S. Dividend Equity ETF tracks an index (Dow Jones U.S. Dividend 100 Index) focused on dividend quality and sustainability. Rather than simply grabbing the highest yields, it screens companies for a 10-year dividend history, cash flow relative to debt, return on equity, and dividend growth. The result is about 100 high-quality businesses, including Texas Instruments, Chevron, Procter & Gamble, and Coca-Cola, with a proven record of paying durable dividends.

Quality screens aren't a safety net, though. Companies can cut their dividends. So, I checked how quickly SCHD's payouts are actually growing. Using SCHD's distribution history, annual dividends per share rose from a split-adjusted $0.68 in 2020 to $1.05 over the last 12 months, or roughly 7.5% a year. However, I did notice that its dividend growth rate has slowed considerably over the past year (2%). That slowdown is worth watching.

Is the price reasonable?

An investment can deliver lackluster returns if you pay too much for it at the beginning. SCHD reports on its website that its holdings currently have an average price-to-earnings ratio of 18.2 times and trade at 10.7 times cash flow. That's a solid starting point -- the S&P 500 currently trades at over 23 times earnings -- not a screaming bargain. SCHD has rallied nearly 28% this year, compared to a 13% rise in the S&P 500.

I'm not expecting a repeat of those returns over the next year. However, I don't need that level of return either. My return math is simple. Long-term returns come from the starting yield, growth in earnings and dividends, and any change in the valuation multiple. With its yield currently over 3%, SCHD would need to deliver around 7% annualized earnings-per-share growth and a steady valuation multiple to deliver 10% annualized returns over the next five to 10 years. That seems very reasonable, as SCHD's current holdings have grown their dividends at an average annualized rate of more than 9% over the last five years.

Does it improve my portfolio?

Diversification is more than owning many stocks; you need to own companies with different economic income streams. I already own SCHD and some of its holdings directly, including Procter & Gamble, Coca-Cola, and Verizon, so adding to my position in the ETF raises my exposure to those names.

However, when I look at my portfolio broadly, I'm heavily invested in technology stocks and other companies benefiting from the growth in AI infrastructure. That's where boosting my position in SCHD can help diversify my portfolio. Its top two sector weightings are consumer staples (20% of the portfolio) and healthcare (over 19%). Meanwhile, tech is only about 12%. That defensive tilt helps balance my growth-heavy holdings, which is an improvement.

An ideal portfolio fit

I'm not betting that SCHD will outperform the S&P 500 every year or that it's unusually cheap. I like the mix of income, business quality, and sector diversification. That's why I felt comfortable boosting my position by 50% to around 3% of this particular retirement account. I'm comfortable adding gradually, with a long-term target allocation of 6%-7% in this account. From here, I'll watch whether dividend growth picks up from its recent snail's pace, whether the price-to-earnings ratio drifts higher, and how much overlap it has with stocks I already own.

Matt DiLallo has positions in Chevron, Coca-Cola, Procter & Gamble, Schwab U.S. Dividend Equity ETF, and Verizon Communications. The Motley Fool has positions in and recommends Chevron and Texas Instruments. The Motley Fool recommends Verizon Communications. The Motley Fool has a disclosure policy.