2 Dividend ETFs to Buy Hand Over Fist and 1 to Avoid

Key Points

• Schwab’s U.S. Dividend Equity ETF requires fundamental business strength beyond a mere dividend.

• The Vanguard Dividend Appreciation ETF delivers despite what might look and feel like a subpar dividend yield.

• The Vanguard High Dividend Yield ETF isn’t offering newcomers enough in the way of actual dividends.

• 10 stocks we like better than Schwab U.S. Dividend Equity ETF ›

Do you need immediate and reliable investment income that grows over time? Dividend stocks are the obvious answer, although buying and holding individual dividend payers may be more hassle than many investors want. Baskets of dividend-paying stocks -- in the form of exchange-traded funds, or ETFs -- are an even simpler solution that will likely work just as well.

Contrary to a common assumption though, not all dividend ETFs are the same. Most of the major ones have their own unique approach to picking their holdings, in fact, which can and does impact their performance. More to the point, some are better suited for you than others.

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With that as the backdrop, here's a closer look at two dividend-oriented exchange-traded funds that are solid buys for income-minded investors right now, and a look at one dividend ETF you might want to avoid for the time being.

Buy the Schwab U.S. Dividend Equity ETF

With a trailing yield of just under 3.8%, the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) checks off at least one hugely important box for a lot of income-minded investors. You can find higher yields. You won't find much higher yields with stocks or ETFs of comparable quality though. Chevron, drugmaker AbbVie, tobacco giant Altria, and PepsiCo are some of this ETF's biggest positions at this time, although being based on the partially equal-weighted Dow Jones U.S. Dividend 100 Index, the fund's biggest holdings can and do regularly change during its quarterly rebalancing.

It's a curious index to build an ETF around. Most funds are still cap-weighted (for better or worse), and while this index's core requirement is reliable dividend payments, dividend growth isn't the only criteria for inclusion. Dow Jones parent Standard & Poor's also rates and ranks eligible equities based on that company's cash flow and return on equity.

The thing is, this approach works! The end result is a bunch of value stocks that don't necessarily produce a great deal of revenue of earnings growth, but you still get solid growth stemming from the sheer quality of the names this index and fund owns. (In many cases, for instance, generous stock-buyback programs do quite a bit of heavy lifting.) That's how this Schwab fund is up 45% for the past five years, and more than 130% higher for the past 10.

And that's without reinvesting dividends paid along the way. Factoring in these dividend payments adds another 60% to 70% to this performance. This still trails the S&P 500's for these time frames. Given the value nature of this fund and the minimal amount of risk you're taking with it, however, the trade-off is well worth it to income investors seeking relative safety.

Buy the Vanguard Dividend Appreciation ETF

With roughly $100 billion dollars' worth of investor money invested in the fund, the Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) is at least in one regard the market's favorite dividend-oriented ETF.

It's not difficult to figure out why either. Based on the S&P U.S. Dividend Growers, this fund holds some of the market's most reliable dividend growers. Broadcom, Microsoft, and JPMorgan are among this ETF's biggest holdings right now, and its quarterly payment has nearly doubled in size over the course of the past 10 years. It is performing as promised.

It's producing some respectable capital gains as well, with the ETF's price up 186% during this same stretch of time. That's the upside of holding several of the market's few dividend-paying technology stocks that have benefited from the rise of cloud computing and then artificial intelligence.

Now, there is one arguable downside with VIG. That is, the yield itself is subpar compared to alternatives. The ETF's trialing 30-day dividend yield is just a little over 1.6%, and hasn't been much above 2% for very long since 2018, when interest rates slipped to multi-year low levels. You can certainly find better.

This weak yield is largely the result of the way Standard & Poor's selects the holdings for the S&P U.S. Dividend Growers Index. Although it requires a minimum of 10 consecutive years of yearly payment increases, it excludes the top 25% highest-yielding stocks on worries that these high yields are a hint that the market sees limited growth potential or even outright trouble ahead. And it's a healthy criteria to apply.

It can still matter to investors, though. While this fund produces above-average long-term capital gains, it's not exactly the most productive cash cow you could buy into. It's really more for growth-minded blue chip investors who don't mind a little taxable income along the way, but don't actually need this income right way to pay any bills.

Avoid the Vanguard High Dividend Yield ETF

On the flipside, if you're seeking recurring investment income you might not want to take on a stake in the Vanguard High Dividend Yield ETF (NYSEMKT: VYM) -- not now, or anytime soon.

It's ironic, but this Vanguard fund mostly fails to offer the one thing it's supposed to offer above all else: a high dividend yield. Its average 30-day yield is a fairly modest 2.5%. You could easily do better (like the aforementioned Schwab U.S. Dividend Equity ETF) even though Schwab's fund mostly just seeks out quality companies that just so happen to dish out dividends.

Just don't read too much into the current ho-hum trailing yield. It's a bit unusual. Prior to last year the ETF's trailing yield was typically in the ballpark of 2.7% to 3.3%. It's been dragged considerably lower since late-2023 when some of its biggest holdings like Broadcom, JPMorgan, and Walmart started to soar with the rest of the broad market -- its constituents' dividend growth just couldn't keep up.

Being a cap-weighted index didn't exactly help either; a handful of some of the market's biggest companies with the best-performing stocks has done most of the bullish work here.

None of this is to suggest the Vanguard High Dividend Yield ETF will never be worth owning again, to be clear. The underlying FTSE High Dividend Yield Index it's meant to mirror is sound enough in its premise as well as its execution. It's just that the unusual market action since late 2023 has overinflated the fund's price, undermining its yield. It could take a while to fully correct the problem, and there are too many other compelling dividend-paying options out there in the meantime to wait on this one.

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JPMorgan Chase is an advertising partner of Motley Fool Money. James Brumley has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends AbbVie, Chevron, JPMorgan Chase, Microsoft, Vanguard Dividend Appreciation ETF, Vanguard Whitehall Funds-Vanguard High Dividend Yield ETF, and Walmart. The Motley Fool recommends Broadcom and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.