The 4 Biggest Risks to SCHD’s 3.7% Dividend Yield

Dividend growth investing has proved to be one of the best strategies for accumulating wealth over time. Numerous studies have found that stocks that initiate a dividend and grow them over time have outperformed all other classes of stocks.

The Schwab U.S. Dividend Equity ETF (NYSEARCA:SCHD | SCHD Price Prediction) has been one of the most popular choices for dividend-focused investors since its launch in 2011. It tracks the Dow Jones U.S. Dividend 100 Index with a focus on high-yield, fundamentally strong U.S. companies and over the past decade has increased its payout at a compound annual growth rate of 12%. 

However, its dividend, which currently yields around 3.7% annually, faces several risks that could impact its consistency or growth. Below are four key risks to consider.

1. Economic downturns and corporate earnings pressure

The ETF targets companies with strong balance sheets and consistent dividends, but an economic downturn could still threaten its 3.5% yield. A recession triggered by slowing consumer spending or manufacturing declines, for example, might slash corporate earnings across its 100 holdings. 

Financials and consumer staples comprise one-third of the ETF’s portfolio and are vulnerable if loan defaults rise or discretionary spending drops. During the 2008 crisis, even stalwarts like GE cut dividends. 

SCHD’s focus on quality, such as requiring a 10-year dividend growth history, offers some protection, but it’s not foolproof. Over the past few years, Dividend Aristocrats including Walgreens Boots Alliance (NASDAQ:WBA), 3M (NYSE:MMM), AT&T (NYSE:T), and Leggett & Platt (NYSE:LEG) all slashed their payouts by half or more. Cash-strapped firms might prioritize survival over payouts, and if enough holdings falter, SCHD’s yield could shrink.

2. Sector concentration and interest rate sensitivity

SCHD’s heavy weighting in financials — around 19% of its portfolio — ties its fate to interest rate swings, risking its dividend stability. 

Rising rates can boost bank profits short-term, supporting dividends, but if rates climb too high or too fast, loan demand could dry up, hitting earnings. Conversely, rate cuts might compress net interest margins, and as recessionary pressure builds, the Federal Reserve plans to cut interest rates further. 

This sector tilt exceeds the Russell 1000 Value Index’s diversification, amplifying its risk. And potentially dragging SCHD’s yield below its historical average.

3. Annual reconstitution and dividend dilution

The ETF just completed its annual reconstitution, and while it refreshes its lineup as it drops stocks with faltering dividend metrics for higher-yield options the newest additions averaged yields of 4.75% versus the 5% those that were removed yielded. It is a hint at a subtle dilution trend. 

If replacements like a struggling industrial firm face cash flow issues and cut dividends, the ETF’s overall yield could dip. The methodology prioritizes fundamentals, such as debt-to-equity ratios, but it’s not immune to picking unsustainable payers in a weakening economy. A focus on yield over growth could sacrifice long-term stability as a few missteps in this rebalancing act could erode SCHD’s edge, especially if market conditions sour. That would challenge its reputation for consistency.

4. Inflation and rising costs outpacing dividend growth

Inflation eased to 2.8% in February, according to the Bureau of Labor Statistics, but President Trump’s tariffs will feed its growth going forward. It also gnaws at SCHD’s real yield if dividend growth lags. 

Major holdings like Chevron (NYSE:CVX) or Verizon (NYSE:VZ) have historically raised payouts, but rising costs could stall this. Energy firms face higher drilling expenses and while they comprise less than 12% of the portfolio, ConocoPhillips (NYSE:COP) and Chevron are SCHD’s two largest holdings.  

Telecoms are still grappling with 5G rollout bills and Verizon is its third-largest stock. If these pressures outpace revenue, dividend hikes might slow, leaving the 3.5% nominal yield less potent against inflation. 

In 2022, real yields turned negative for many funds as inflation hit a historical high of 9%. A repeat could hit SCHD hard as without robust earnings growth, its companies might prioritize capex over shareholders. That would shrink purchasing power for investors reliant on that income stream.

Key takeaways

The Schwab U.S. Dividend Equity ETF has proved itself an investor favorite because of its growth and resilience, and management has deftly navigated the pitfalls outlined above. However, investors should still understand the risks they potentially face before buying any stock even if they seem distant possibilities.