A more subdued narrative has been developing somewhere between the cacophony of meme stocks and the never-ending discussion about AI valuations. The majority of the expensive, talkative competition has been consistently outperformed by a small group of index funds, the kind your father most likely owns and seldom checks. Not by chance. And not due to a single outstanding trade.
The Schwab U.S. Dividend Equity ETF, ticker SCHD, is the fund that I consistently return to. The annual fee is 0.06 percent. Six dollars for every ten thousand dollars invested. That is not as much as you would tip for a sandwich. Nevertheless, perusing its holdings is more akin to reading a meticulous shortlist than it is to perusing an index. Ten-year dividend records, cash flow stability, and return on equity are used to screen companies. It’s an index fund with standards, which is an odd but true statement.
Long-term investors feel that something has changed. It used to be believed that index funds just replicated the market, buying whatever the herd produced. However, SCHD and other rules-based funds are taking a more covert approach. They are filtering. silently keeping out the speculative, the unprofitable, and the indebted. Additionally, that kind of discipline appears to be more important than it once was in a market where the Shiller P/E ratio is higher than 30.
Future returns suffer when you pay too much for earnings, according to Robert Shiller, the Yale economist who has spent decades cautioning about high valuations. It is difficult to refute his data. The following 20 years tended to be disappointing whenever the CAPE ratio rose above 25. Today’s market feels uncomfortably familiar because of that history. late 1920s. late 1990s. In both instances, the conclusions were harsh.
In light of this, the allure of a fund that overlooks the most expensive areas of the market becomes clear. Tesla is not owned by SCHD. Netflix is not owned by it. Unglamorous businesses like Texas Instruments, Coca-Cola, and Verizon are among its biggest holdings. names that appear infrequently in headlines but frequently in retirement accounts. However, in recent periods, the fund has either matched or outperformed the overall S&P 500 while offering a yield above 3.5 percent, which is more than twice that of the index.
Of course, this outperformance could be fleeting. Anyone who confuses a few prosperous years with a long-term advantage faces cruelty from markets. There is a lengthy history of tactics that were successful until they failed. Value investing suffered for ten years before making a comeback. For years, small caps have lagged. There are no guarantees.
However, there is something instructive about the construction of SCHD. The process is open. The costs are very low. There is little turnover. An analyst in a Manhattan tower calling executives at midnight is not necessary. A screen and a rebalance schedule are necessary. That’s all.
Forward returns are equal to dividend yield plus earnings growth plus or minus changes in valuation, according to John Bogle, the man who created the index fund and dedicated his life to promoting low costs. According to that calculation, a fund with a 3.5 percent yield and businesses that are expanding their profits at a reasonable rate begins with a substantial buffer. Not a promise. a soft spot.
As you watch this develop, you begin to notice how infrequently funds like this are covered by the financial press. They’re not thrilling. A chart with a sharp, abrupt line does not work well with them. They simply function as compound interest is meant to, albeit slowly.
Investors appear to be realizing this. Over the last few years, SCHD has made billions, and its asset base now reaches tens of billions. It’s unclear if that growth will eventually lessen its impact. Overly large funds occasionally lose their advantage. However, the formula is valid for the time being.
And that has a subtle lesson. The steady performer was sitting there the entire time in a market that was fixated on the newest, loudest, and most disruptive. charging very little. picking with care. Compounding is an unglamorous task.
