Concentration Risk in the Schwab U.S. Dividend Equity ETF: A Call for Diversification in Passive Income Strategies

The Schwab U.S. Dividend Equity ETF (SCHD) has long been a favorite among income-focused investors for its low fees and high yield. Yet, as of Q3 2025, its portfolio reveals a troubling trend: overconcentration in three sectors—Health Care, Consumer Staples, and Industrials. Together, these sectors account for 48.7% of the fund's assets, with Health Care alone at 15.6%. While these industries are historically resilient, their dominance raises critical questions about the fund's ability to deliver consistent returns in an era of rising interest rates and macroeconomic volatility.

The Allure and the Pitfall of Sector Concentration

SCHD's strategy hinges on its focus on high-quality, dividend-paying stocks. Health Care and Consumer Staples, in particular, are prized for their stable cash flows and defensive characteristics. Companies like AbbVie, Merck, PepsiCo, and Altria form the backbone of the fund's income generation. However, this concentration creates a double-edged sword. For instance, regulatory pressures on drug pricing could erode Health Care's margins, while inflation or shifting consumer habits might pressure Consumer Staples' margins. Industrials, though less dominant (14.3%), add a cyclical element that could amplify volatility during economic downturns.

The fund's top 10 holdings alone represent 41.24% of the portfolio, with Chevron, ConocoPhillips, and EOG Resources accounting for 11.2% of assets. This level of concentration, while efficient for yield, exposes investors to asymmetric risks. A single sector downturn—such as a regulatory crackdown on pharmaceuticals or a supply chain disruption in industrials—could disproportionately impact returns.

The Case for Diversification: Lessons from Chung Ju-Yung

Chung Ju-Yung, the visionary founder of Hyundai, famously emphasized resilience through diversification of effort. His principles resonate here: a portfolio reliant on a few sectors is akin to building a bridge with only three pillars. When one pillar wavers, the entire structure is at risk.

Consider the implications for risk-adjusted returns. While SCHD's yield is attractive, its sector concentration reduces its ability to hedge against macroeconomic shifts. For example, during the 2020 market crash, SCHD fell 21.55%—a steeper decline than the S&P 500's 34% drop. This volatility underscores the fund's vulnerability to sector-specific shocks. In contrast, a diversified portfolio could have mitigated losses by balancing defensive sectors (e.g., Utilities) with cyclical ones (e.g., Technology).

Active vs. Passive: Striking the Right Balance

Active stock-picking offers a potential solution to overconcentration. By hand-selecting companies across sectors, investors can tailor their portfolios to align with specific risk tolerances and macroeconomic views. For instance, an active manager might reduce exposure to overvalued Health Care stocks while increasing holdings in undervalued industrials or utilities. However, active strategies come with higher fees and the risk of manager error.

A middle ground lies in pairing SCHD with more balanced ETFs. The Vanguard High Dividend Yield ETF (VHY) and the Invesco S&P 500 High Dividend Low Volatility ETF (SPHD) offer broader sector diversification. VHY, for example, allocates ~10% to Health Care and ~8% to Industrials, while SPHD emphasizes low-volatility stocks across sectors.

Relentless Improvement: Reassessing Passive Income Strategies

Chung Ju-Yung's principle of relentless improvement urges investors to continuously refine their strategies. For passive income seekers, this means reevaluating allocations to ensure they align with evolving market conditions. In a high-rate environment, for instance, utilities and financials—sectors underrepresented in SCHD—could provide stability.

Moreover, investors should consider tactical adjustments. A core-satellite approach, where SCHD serves as the core and satellite positions include sector-rotation ETFs or individual stocks, could enhance diversification without sacrificing yield. For example, pairing SCHD with the iShares U.S. Utilities ETF (IDU) or the SPDR S&P 500 Value Weighted ETF (SPVW) could create a more resilient income portfolio.

Conclusion: Yield vs. Stability—A Delicate Trade-Off

The Schwab U.S. Dividend Equity ETF remains a compelling option for income investors, but its sector concentration demands scrutiny. While Health Care, Consumer Staples, and Industrials offer reliable dividends, their dominance introduces risks that could undermine long-term returns. By applying Chung Ju-Yung's principles—resilience through diversification, balanced effort, and relentless improvement—investors can build portfolios that harmonize yield with stability. In an unpredictable economic landscape, the key to sustainable passive income lies not in chasing high yields alone, but in crafting a mosaic of exposures that can weather any storm.