If you are looking for a domestic stock portfolio that spans multiple capitalization sizes, there are a number of choices. Many advisors go with one of the low-cost leaders -- say, the Vanguard Total Stock Market ETF (VTI), with an expense ratio of 0.05%; Schwab U.S. Broad Market ETF (SCHB), which costs 0.04%; or iShares Core S&P Total U.S. Stock Market ETF (ITOT), at 0.07%.
All three are based on capitalization-weighted indexes: the CRSP U.S. Total Market Index, the Dow Jones U.S. Broad Stock Market Index, and the S&P 1500 Index, respectively.
But another alternative is the WisdomTree Total Dividend Fund (DTD). This ETF, based on a proprietary WisdomTree index, includes dividend-paying stocks at all cap levels -- but weights those holdings by cash dividends rather than by market capitalization. The total cash dividend of each issue is divided by the total aggregate cash dividend of all stocks in the index to arrive at the weighting.
In theory, this should provide some protection against the speculative bubbles that periodically appear in stock markets. Because a stock's weighting in the WisdomTree fund is tied to the company's actual cash dividend, that stock can't dominate the portfolio simply because it has become Wall Street's flavor of the month.
HIGHER COST
The downside: DTD has an expense ratio of 0.28%. Is it worth the extra cost?
VTI owns almost 3,800 stocks and SCHB has more than 2,000. ITOT, at 1,500 holdings, is closest in portfolio size to DTD, so we'll use it for comparison.
Figuring out DTD's holdings can be confusing. WisdomTree's website notes that the ETF currently owns 963 stocks (although a quick look at the weightings shows that the bottom six holdings in the fund have weightings of 0.0% each, so that brings it to 957). By contrast, the WisdomTree Dividend Index had 1,448 components on the same date.
Why the difference? The index holds all U.S. stocks that pay a dividend, no matter how small that payment really is. Yet, if the total dividend contributed by the bottom third of payers doesn't really move the index, there's no point to owning the stocks in the ETF. The same type of sampling is common in funds based on cap-weighted indexes.
As of Jan. 30, ITOT's top sectors were information technology (19.20%) and financial services (16.83%), while DTD's were financial services (18.56%) and information technology (13.22%). Since the tech sector is increasing its dividend payments rapidly, expect to see its share of DTD rise over time.
Three of the five largest stock holdings in each portfolio are the same, though with different weightings. And the 30-day SEC yield of DTD on Jan. 30 was 60 basis points better that the yield of ITOT.
PERFORMANCE OVER TIME
Those 60 basis points won't make much difference to investors seeking income, but what about performance differences over time? Total return data from Morningstar show that DTD outperformed over the year ended Jan. 30, but that ITOT outpaced it over the three-year period. DTD did better than ITOT over five years, but only by 24 basis points annually.
When you look at recent performance data, the choice between the two ETFs might be a tossup for many advisors. But one other statistic from Morningstar is worth considering.
In the dismal year 2008, how did the performance of the two portfolios compare? The dividend-weighted ETF declined 34.64% that year, while the cap-weighted fund fell 36.48%.
No one would argue that a drop of almost 35% is desirable, but in the context of 2008, it was good for an index fund. The 184-basis point advantage of DTD that year is another reminder that, in difficult market conditions, dividend-paying stocks tend to hold up better than non-payers.
Read more:
Which Sectors Are Best for Dividend Investors? Dividend Investing: Time to Consider Oil Stocks? Biggest Buybacks: What Your Clients Need to Know
