Latest / Dividend Investing with Fexingo: Income Stocks, Yield, and Long-Term Cash Flow Portfolios / How Dividend ETFs Absorb Rate Shocks in July 2026
Transcript
- Lucas: The 10-year Treasury hit 4.57 percent this week, and the yield curve — the spread between the 10-year and the 2-year — actually tightened, from 41 basis points down to 37. Normally that kind of move punishes dividend stocks. But if you look at SCHD, the Schwab US Dividend Equity ETF, it's up 1.1 percent in the last five days, while the S&P 500 is down almost 1 percent. So the question is: why are some dividend ETFs shrugging off the rate shock? Luna: And it's not just SCHD. DVY, the iShares Select Dividend ETF, is up 0.8 percent over the same period. VYM, Vanguard's High Dividend Yield ETF, is down 0.4 percent — so there's a divergence. What's driving that? Lucas: It comes down to what each fund owns. SCHD leans heavily into sectors like healthcare, consumer staples, and industrials — companies with strong free cash flow and a history of raising dividends. DVY tilts toward utilities and financials, which benefit from higher rates. VYM, by contrast, has a bigger weight in real estate and consumer discretionary — names that get squeezed when borrowing costs rise. Luna: Right, so it's not just about yield. It's about the quality of the dividend. A 4 percent yield from a company that can grow its payout is worth more than a 5 percent yield from one that's stretched. Lucas: Exactly. And this is where the payout ratio becomes critical. When rates rise, the discount rate used to value future cash flows goes up. That hits stocks with uncertain or stagnant dividends hardest. But companies with low payout ratios and strong cash flow — think of a company like Microsoft, which is a top holding in SCHD — they have the cushion to keep growing dividends even if the economy slows. Luna: And SCHD's methodology actually screens for dividend growth over the past decade, plus return on equity and free cash flow. So it's built to avoid the yield traps. Lucas: Right. Meanwhile, VYM just goes for the highest current yield. That sounds good in a low-rate environment, but when the 10-year is pushing 4.6 percent, a 3.5 percent yield from a risky REIT doesn't look as attractive. The market is rotating toward quality. Luna: And the Fed isn't helping. Dallas Fed President Logan came out this week and said rates need to go 'modestly' higher. The fed funds rate is at 3.63 percent, and the market is pricing in a potential hike. That reinforces the idea that we're not out of the tightening cycle yet. Lucas: Which means income investors need to be selective. The knee-jerk reaction when rates rise is to dump everything with a dividend. But if you look at the total return of SCHD over the past year, it's actually outperformed the S&P 500. Because these companies keep raising payouts, and the market rewards that consistency. Luna: Let's talk about a specific example. Realty Income, the triple-net lease REIT, ticker O, is up 2.4 percent in the last five days. That's counterintuitive — REITs usually get hammered when rates rise. Why is O bucking the trend? Lucas: Because Realty Income has a very long track record of dividend growth — over 600 consecutive monthly dividends. And its tenants are mostly investment-grade — Walgreens, Dollar Tree, 7-Eleven — so the cash flow is reliable. The market is looking past the rate headline and focusing on the underlying business quality. It's the same story with a stock like Procter and Gamble, up 1.1 percent this week. People still need toothpaste and detergent, regardless of what the yield curve does. Luna: So the takeaway might be that dividend ETFs aren't a monolith. You have to know what's inside them. And that's where a tool like Morningstar's X-Ray can help — you can see the sector breakdown and the dividend health metrics. Lucas: Absolutely. And one more thing: don't ignore international dividend ETFs. While the US yield curve is flattening, other markets — like Europe or Japan — have different rate dynamics. Some international dividend funds yield 4 to 5 percent with payout ratios under 50 percent. That's a diversifier that many us centric investors overlook. Luna: Before we wrap up, I want to touch on something that actually keeps these conversations going. We don't run ads on this show, and that's intentional. But it does mean the show relies on listeners who find value in it to help cover the costs — hosting, research, the data feeds we use to pull live numbers like we did today. Lucas: Yeah, and it's not about big contributions. A couple of dollars a month genuinely makes a difference. If our money conversations have helped you think about a decision differently, you can support the show at buy me a coffee dot com slash fexingo. That's it — no pressure, just if it's useful to you. Luna: And it helps us keep doing deep dives like this one, where we actually dig into the data rather than just repeating headlines. So, back to dividends: we talked about quality and yield, but there's one more metric I want to flag — the dividend coverage ratio. Lucas: Yes. That's essentially free cash flow divided by dividends paid. A coverage ratio above 1.5 means the company can easily afford the dividend. Below 1.0, and you're borrowing to pay shareholders — not sustainable. When you screen ETFs for coverage, you'll find that SCHD's holdings average a coverage ratio of about 2.0, while some high-yield funds dip below 1.2. That gap widens during rate shocks. Luna: So for someone building a dividend portfolio today, what's the one thing to check first? Lucas: The payout ratio relative to free cash flow. Not the reported earnings payout ratio, because earnings can be manipulated. Free cash flow is what actually pays the dividend. If that number is below 60 percent, you're in good shape. If it's above 80 percent, you're taking on more risk than the yield suggests. That's the filter I'd apply before even looking at the yield number. Luna: And that's the kind of detail that makes dividend investing work over the long term. It's not about chasing yield — it's about owning companies that can keep paying you through the cycle.