Should Passive Income Investors Be Concerned That 54% of the High-Yield Schwab U.S. Dividend Equity ETF Is in Just 3 Stock Market Sectors?

Key Points

• Since launching in 2011, the Schwab U.S. Dividend Equity ETF has become a go-to choice for income investors.

• The fund achieves its high yield by underweighting growth-focused sectors like tech, communications, and consumer discretionary.

• The Schwab U.S. Dividend Equity ETF has more than doubled over the last decade without even factoring in dividends.

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With $69 billion in net assets and a mere 0.06% expense ratio, the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) is a popular tool for investors to get exposure to around 100 dividend-paying stocks without racking up high fees.

The exchange-traded fund (ETF) sports a 3.7% 30-day SEC yield, which is roughly three times higher than the 1.2% yield that investors can get from an S&P 500 (SNPINDEX: ^GSPC) index fund.

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However, the fund is highly concentrated in just a handful of sectors. Here are the pros and cons of the sector concentration and if the ETF is a good buy for income investors.

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Betting big on high-yield sectors

The Dividend Equity ETF achieves its high yield by investing in companies in traditionally stodgy, dividend-paying sectors. Companies in these sectors typically reward shareholders by passing along a portion of profits, rather than reinvesting the bulk of excess earnings to drive growth.

Compared to the S&P 500, the ETF is overweighted with energy, consumer staples, healthcare, and industrials. Energy, consumer staples, and healthcare alone make up 54% of the ETF.

Energy is 19.2% of the Dividend Equity ETF, compared to just 3% of the S&P 500. Similarly, consumer staples is 18.8% of the Dividend Equity ETF and just 5.2% of the S&P 500.

A portfolio built around dividend quality and quantity

Some investors may be concerned with the ETF's high concentration in the energy sector, given the volatility of oil and gas prices. However, the fund does a good job of betting on some of the best companies in the sector.

The ETF's top holding, Chevron (NYSE: CVX), makes up 4.4% of the fund. Chevron has a rock-solid balance sheet, diversified business, and 38 consecutive years of boosting its payout.

ConocoPhillips (NYSE: COP) is the fifth-largest holding in the fund with a 4.2% weighting. ConocoPhillips is one of the best exploration and production companies, with a low cost of production, high free cash flow, and an affordable dividend.

EOG Resources (NYSE: EOG), which is 2.6% of the fund, is another E&P with a solid production portfolio and high free cash flow.

Combined, these three holdings make up 11.2% of the ETF and the majority of its energy sector position. The energy emphasis is grounded in logic, rather than betting on risky companies that depend on high oil and gas prices to grow their payouts.

Similarly, the ETF's concentration in the consumer staples sector is also built around quality. The ETF has 4.3% stakes in PepsiCo (NASDAQ: PEP) and Altria (NYSE: MO) -- both of which are Dividend Kings with over 50 consecutive years of boosting their payouts. While Pepsi and Altria aren't necessarily high-growth companies, their track records for boosting their payouts and industry leadership make them ideally suited for income investors.

The fund's top healthcare positions are AbbVie (NYSE: ABBV) at 4.3% and Merck (NYSE: MRK) at 4.1% -- two massive drug manufacturers. Like Pepsi and Altria, AbbVie is a Dividend King.

A simple way to generate passive income from stocks

The Schwab U.S. Dividend Equity ETF won't light up a growth stock investor's radar screen. Rather, the best reason to buy the fund is that it offers a way for investors to collect significantly more passive income than the S&P 500, or even many value-focused funds, without having to cap upside potential or invest in a different vehicle like bonds or Treasury bills (T-bills).

As the name "dividend equity" implies, the fund is ideally suited for investors who want to center their passive income stream around equities. The 10-year Treasury rate is 4.2%, which is only slightly higher than the 3.7% from the Dividend Equity ETF. But investing in T-bills doesn't have upside potential, although it is far less risky than investing in the stock market.

Over the last decade, the Schwab U.S. Dividend Equity ETF has gained 129% in capital gains, but has produced a 217.4% total return, which factors in dividends. It may surprise investors to learn that the gains from the equity, rather than the high yield, have driven the majorly of the return over those 10 years.

All told, the Dividend Equity ETF's concentration in energy, consumer staples, and healthcare is a strength, not a weakness. The fund is a great buy for income investors looking for a straightforward way to invest in high-yield stocks.

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Charles Schwab is an advertising partner of Motley Fool Money. Daniel Foelber has positions in Schwab U.S. Dividend Equity ETF. The Motley Fool has positions in and recommends AbbVie, Chevron, and Merck. The Motley Fool recommends Charles Schwab and EOG Resources and recommends the following options: short September 2025 $92.50 calls on Charles Schwab. The Motley Fool has a disclosure policy.