Rethinking Income Investing: Why Dividend ETFs Like SCHD May No Longer Be the Best Bet for Growth and Stability

In the evolving landscape of income investing, traditional dividend ETFs such as the Schwab U.S. Dividend Equity ETF (SCHD) are facing challenges in delivering the growth and stability investors once expected. A closer look at recent performance data reveals a growing preference for sector-specific ETFs like the Energy Select Sector SPDR Fund (XLE) and Utilities Select Sector SPDR Fund (XLU), particularly in a rising rate environment. This shift underscores the need for investors to reassess their income strategies.

SCHD's Underperformance: A Wake-Up Call

SCHD, which tracks the Dow Jones U.S. Dividend 100 Index, has struggled to keep pace with sector-focused ETFs over the past year.

. In 2024, XLE and XLU both delivered 5.56% returns, while SCHD lagged at 3.48%. In 2025 YTD, XLU surged to an 8.97% return, far outpacing SCHD's -1.58% and XLE's modest 0.57%.

This divergence highlights a critical flaw in SCHD's approach: its diversified, quality-focused portfolio may lack the sector-specific exposure needed to capitalize on cyclical opportunities. While SCHD prioritizes dividend sustainability and financial health, its broad allocation—spanning healthcare, industrials, and consumer goods—has left it vulnerable to sector rotation.

Why Energy and Utilities Are Dominating

Sector ETFs like XLE and XLU are benefiting from structural tailwinds:

1. Energy (XLE): Rising geopolitical tensions and the transition to renewables have boosted demand for traditional energy stocks. Additionally, energy companies often reinvest profits into dividends, offering a high yield (3.34% TTM) and capital appreciation potential.
   

2. Utilities (XLU): Utilities are classic “defensive” plays, with regulated cash flows and high dividend payouts (2.80% TTM). In a rising rate environment, utilities have historically outperformed due to their bond-like characteristics. Their 8.97% YTD return in 2025 reflects this stability.

Both sectors also offer superior risk-adjusted returns. XLU's Sharpe Ratio of 1.26 dwarfs SCHD's 0.39, meaning it generates more return per unit of risk.

The Rising Rate Environment: A Double-Edged Sword

Central banks' aggressive rate hikes have reshaped income investing dynamics:

• Pressure on High-Priced Dividend Stocks: SCHD's holdings, many of which are mature companies with limited growth, face valuation headwinds. Rising rates reduce the present value of future dividends, squeezing multiples.
• Sector-Specific Opportunities: Energy and utilities benefit from inflation-linked pricing and demand resilience. For example, utilities' regulated rate hikes offset rising costs, while energy firms leverage higher commodity prices.

Investment Implications: Rethink, Rebalance, and Diversify

Investors should consider three strategies to align with this shift:

1. Sector Rotation: Allocate a portion of income portfolios to sector-specific ETFs like XLE and XLU. Their high yields and growth potential can offset SCHD's stagnation.
   

2. Blend Stability with Growth: Pair low-risk utilities (XLU) with cyclical energy (XLE) to capture both income and growth. This reduces reliance on SCHD's mediocre returns.

3. Leverage Rate Expectations: Monitor central bank policies. If rates peak soon, utilities may outperform; if energy demand remains robust, XLE could sustain gains.

Backtest the performance of XLE, XLU, and SCHD when buying on dates of U.S. Federal Reserve rate decisions from 2020 to 2025, and holding for 30 trading days.

Final Thoughts: The Future of Income Investing

SCHD's underperformance is a symptom of a broader trend: income investors can no longer rely on one-size-fits-all strategies. Sector-specific ETFs like XLE and XLU offer higher yields, better risk-adjusted returns, and growth potential in today's environment. While SCHD still provides steady dividends, it is no longer the “best bet” for those seeking balanced growth and stability.

Investors must embrace a more dynamic approach—sector allocation, rate-sensitive decision-making, and diversification—to navigate the evolving income landscape. The era of passive dividend ETFs may be ending, but opportunities abound for those willing to adapt.