With Rising Rates Ahead, Stick With High Quality Dividend Growers

Rising interest rates are supposed to draw investors away from equities and into the bond market but so far that hasn’t really happened. Despite the interest rate on the 10 year Treasury note increasing from 1.9% to 2.6% since the election, the S&P 500 has still managed to post an 11% gain during that time. The Federal Reserve is widely expected to raise rates again this week putting dividend-paying equities squarely back in focus.

The Schwab U.S. Dividend Equity ETF (SCHD) has been one of my favorite large-cap dividend payers for some time. Using the Dow Jones U.S. Dividend 100 Index as its benchmark, the fund invests in companies that have both a long history of growing their dividends and demonstrating solid fundamentals such as high returns on equity and cash flow to debt ratios.

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.

Fortunately, this fund is loaded with these high yielders. Consumer staples, which makes up nearly a quarter of the portfolio, is the top sector holding in the fund. Procter & Gamble (PG), with and its broadly diversified product line and 3% dividend yield, has been a top holding of this fund for a while. Dueling beverage makers Coca-Cola (KO) and PepsiCo (PEP) are also in the top 10 but face an uncertain business environment going forward. Philadelphia recently passed a soda tax which has resulted in sales slumps of 30-50% in that market. Chicago and San Francisco are looking to pass similar measures this year.

Sticking with the theme of broadly diversified product lines, Pfizer (PFE) and Johnson & Johnson (JNJ) account for nearly 10% of the portfolio. The healthcare sector was a bottom performer in 2016 and has continued to lag the broader market since the election. Concerns over drug pricing continue to weigh, but both of these companies generate more than $10 billion in free cash flow annually making them solid dividend growth candidates. Other big names such as Microsoft (MSFT), Intel (INTC), IBM (IBM) and Chevron (CVX), all with dividend yields well above the S&P 500, are also among the fund’s top 10 holdings.

This fund has a lot of the characteristics I like in a core dividend holding. One of the best features of the fund is its rock bottom expense ratio. 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.

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