If You Buy the Schwab U.S. Dividend Equity ETF, You Might Want to Add This Dividend ETF Too

The Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) is offering an attractive dividend yield today of around 4% or so. It is also very well-designed, mixing income, company quality, and growth into one exchange-traded fund (ETF) option. But it misses out on some key dividend-focused sectors, which is why you might want to add this one simple dividend ETF to your portfolio if you own the Schwab U.S. Dividend Equity ETF.

What does the Schwab U.S. Dividend Equity ETF do?

Getting right into the meat of it, the Schwab U.S. Dividend Equity ETF only looks at companies that have increased their dividends for at least a decade. It then eliminates real estate investment trusts (REITs) from the list. For all the stocks that remain, it creates a composite score looking at cash flow to total debt, return on equity, dividend yield, and a company's five-year dividend growth rate.

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The 100 companies with the highest composite scores are included in the Schwab U.S. Dividend Equity ETF. The stocks are market cap-weighted, so the largest companies have the greatest impact on performance. Every year, the list is updated and the portfolio rebalanced. The cost for all of this is a very modest 0.06% expense ratio.

Effectively, the Schwab U.S. Dividend Equity ETF is buying well-run companies that have attractive yields and proven track records of growth. It is likely buying many of the same companies that a dividend investor would be looking at if they invested in individual stocks. It's a solid core holding.

There are glaring holes in the Schwab U.S. Dividend Equity ETF's approach

Although the Schwab U.S. Dividend Equity ETF's approach is good, it isn't perfect. (No investment is perfect -- they all come with trade-offs.)

For example, REITs are excluded from consideration, even though they are designed to pass income on to investors in a tax-advantaged manner (REITs avoid corporate-level taxes if they distribute at least 90% of taxable earnings as dividends). The screening process for the Schwab U.S. Dividend Equity ETF, meanwhile, will generally leave it underweight in areas like utilities and finance; sectors that are also known for paying dividends. And turnaround stocks, which often have high yields, will likely fail the screens, too.

SCHD data by YCharts

So buying the Schwab U.S. Dividend Equity ETF is a good idea, but you might want to consider pairing it with another dividend-focused ETF if you want a widely diversified dividend portfolio. A strong candidate is SPDR Portfolio S&P 500 High Dividend ETF (NYSEMKT: SPYD).

By comparison, it is an incredibly simple ETF. It basically buys the 80 highest-yielding stocks in the S&P 500 (SNPINDEX: ^GSPC). That's it. But that's actually a near-perfect compliment for the Schwab U.S. Dividend Equity ETF, though its expense ratio is a touch higher at 0.07%.

The highest-yielding stocks in the S&P 500 are generally focused on the REIT, utility, and finance sectors (with a smattering of turnaround stories thrown in). That's where the SPDR Portfolio S&P 500 High Dividend ETF has some of its largest allocations. There's a bit of an overlap in the consumer staples niche between the two ETFs, but that's probably not a bad thing, given that this sector tends to be fairly resilient during economic downturns.

SPYD data by YCharts

All in, with these two ETFs, you get exposure to the most important dividend sectors and some of the strongest-performing dividend-paying companies. The SPDR Portfolio S&P 500 High Dividend ETF's dividend yield is slightly higher, at 4.5%, too, so its inclusion in your portfolio will also help you generate a little more income.

If you buy one, consider the other

The truth is, this story could go the other way, too. If you buy either one of these ETFs, you are missing out on an important dividend approach. The Schwab U.S. Dividend Equity ETF highlights dividend growth and high-quality companies. The SPDR Portfolio S&P 500 High Dividend ETF's approach is focused simply on high-yield stocks, though that's within the confines of the S&P 500's selection criteria. The differences between the two ETFs is a little subtle, but in the end, they work well together to create a balanced income portfolio.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.