Can Dividend ETFs Endure Fed Rate Hikes

Financial markets expect the Federal Reserve will raise interest rates at its meeting this week. The notion of higher interest rates could be cause for some concern among dividend investors, but there are dividend exchange traded funds that survive and thrive as U.S. monetary policy turns hawkish.

The Schwab US Dividend Equity ETF (NYSEArca: SCHD) is one dividend ETF that could be particularly well-suited for a rising rate environment, especially when considering the ETF uses a methodology that does not include focusing on high yields. Dividend ETFs that are weighted that way can expose investors to rate-sensitive sectors.

SCHD includes 100 stocks based on strong fundamentals, dividend yields and consistent dividend payouts for at least 10 consecutive years, and it has a trailing 12-month dividend yield that is above the yield on 10-year Treasuries. SCHD charges just 0.07%%, or $7 per $10,000 invested. Dividend growth as a means of trumping inflation could and arguably should serve to highlight the advantages of the ETFs that focus on dividend growth stocks. That group is comprised of well-established ETFs that emphasize dividend increase streaks as well as a new breed of funds that look for sectors chock full of stocks that have the potential to be future sources of dividend growth.

“If the Fed tries to push rates too high, too fast and recessionary concerns become more real, investors will likely flock towards conservative areas, such as utilities and consumer staples, that are traditionally more recession-proof. These companies also tend to pay above average dividends making them viable alternatives to Treasuries despite their rising rates. Income seekers may not want to lock up their money for 10 years or more in a Treasury note yielding only 2-3%. These stocks offer greater flexibility albeit at a slightly higher risk level,” according to ETF Daily News.

A dividend increase streak is useful for getting investors interested in a stock or ETF, but there has to be more meat on the bone to sustain that dividend growth. SCHD features that added meat by focusing on other quality factors such as return on equity, cash flow to debt ratios, dividend yield and five-year dividend growth.

Company stocks that issue high dividend yields can be masking their distressed books or may not be sustainable and are heading for dividend cuts. Consequently, these quality dividend ETFs try to limit the impact of these value traps by requiring a history of sustainable dividend growth.

“At just 0.07%, the U.S. Dividend Equity ETF is perhaps the cheapest of all the dividend equity ETFs. Combine that number with a portfolio that consists of companies with strong dividend growth histories, high yields, healthy balance sheets and loads of cash flow, this ETF is a core holding that you could put in your portfolio and hold forever,” adds ETF Daily News.

For more news and strategy on the Dividend ETF market, visit our Dividends category.

Tom Lydon’s clients own shares of SCHD.

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