👉 SCHD & SPYI: The Keys to Financial Independence

Happy Wednesday.

We’re excited to be sharing yet another wonderful analysis written by our friend Nicholas Bratto! If you’re like me and care about monthly income, this analysis does a wonderful job of explaining how SCHD and SPYI can be paired together to generate reliable income — while still optimizing for price appreciation.

As a disclaimer, the following analysis was conducted by Nicholas and the writing is in his own words. As always, none of this should be construed as financial advice. Also keep in mind that the charts here are from when he posted this piece last week.

If you enjoy Nicholas’ writing — feel free to check out his Substack and Linktree as well!

👉 Quick Reminder!

I encourage all of you to join me and Katie Stockton on Thursday (4/24) at 12:30p ET for an hour long deep dive into three stock picks!

I will share three of my favorite stocks right now (fundamentally speaking) and Katie will provide thoughts on where their prices could be heading (technically speaking). All GRIT subscribers are welcome to join us for this livestream! 

Summary:

• Investing in both dividend growth and income investment ETFs like SCHD and SPYI can help investors achieve financial independence faster with less capital while serving unique purposes in one's portfolio.

• SPYI’s 12% yield can cover my fixed expenses with just $200,000, compared to SCHD’s $700,000, offering peace of mind during the 25–55 age range when financial risk is highest.

• SPYI matches SCHD’s performance while adding a higher starting yield and volatility hedging, further diversifying your portfolio's income strategy.

⚡️ The Trenches of 25–55: Why Income Matters Now:

You can plan now or the day before you retire, but eventually, you will need to calculate what it takes for your income-producing assets to cover every one of your bills.

Starting to plan for this when you're 23-25 at your first job is better than getting laid off and scrambling at 50. The greatest financial risk begins around the age of 25: you're likely truly on your own facing student loans, new cars, weddings, homes, kids, and vacations with little invested and years of uncertainty ahead.

No one is coming to save you. There are no social safety nets and if you're relying on an inheritance, you're a long way off. Your retirement accounts are also of no help, as much as you want to hurt your future self by withdrawing from them. Retirement and Social Security don't offer safety nets starting until ages 55-60 and 62 respectively.

However, at age 40 — juggling the forever home, the car you need to upgrade, and a 9-5 job at risk of being laid off at any point — your vulnerability peaks.

All the while, fixed expenses like your subscriptions, car tabs, cellphone, water, internet, energy, insurances, fuel, property taxes, and grocery bills add up. They are essential, mandatory expenses that you will never stop paying. 9-5 jobs feel increasingly unstable, with AI and automation raising concerns about future labor needs, too.

As an educated professional recently laid off with a family, I can attest: owning as much of your income as possible, as soon as possible, is my top priority. 

Though a key mental barrier is balancing your net worth vs. cash flow. Backtesting hot stocks like NVIDIA Corporation (NVDA) or indices like Invesco QQQ Trust ETF (QQQ) might promise you $2,000,000 in a reasonable amount of time, but their yields: 0.04% and 0.64% respectively, fall short to providing meaningful income.

Even a diversified blended fund like SPDR S&P 500 ETF Trust's (SPY) 1.28% dividend yield falls short. Therefore, even if you had the money in these funds, you'd still have to convert a good portion to actually pay your bills. High-quality dividend growth funds like Schwab U.S. Dividend Equity ETF (SCHD) make it more achievable, but what if you’re short a million at retirement?

Working Americans are massively short on this goal, with average retirement savings ranging from $50,000 to $600,000 from 25-65. I invest heavily in dividend growth funds like SCHD, but the dividends are a long way off to delivering the financial security myself and many other Americans need. That’s why I also invest in income-focused investments like NEOS S&P 500 High Income ETF (SPYI) which has offered competitive performance to SCHD, a higher starting yield to cover fixed costs with less capital, and portfolio hedging for better risk management for all the markets and life will throw at you.

⚡️ Performance & Strategy:

Since its inception in late 2022, SPYI has actually outperformed SCHD, with about a 28% vs. 15% total return.

Income investors, don't get too excited, this is a pretty short time frame to hang your hat on. Normalizing both funds' performance since inception, SPYI has delivered an 11.27% annualized total return vs SCHD's 12.94% annualized total return since its inception in 2011. Thus far, the funds have performed on par with one another, while both offering tax-efficient distributions to shareholders: SCHD being qualified dividends and SPYI being mostly return of capital (ROC) which are essentially deferred long-term capital gains.

Both these classifications are taxed at the same federal tax rates of 15% or 20% depending on your tax bracket. For most people, it's 15%. I have several in-depth articles explaining SCHD's strategy and SPYI's strategy for more details if you’d like to read them. 

What's interesting is each fund's performance is derived from a fairly different set of holdings and an entirely different strategy: SCHD holds the top 100 quality US dividend stocks while SPYI holds the S&P 500 and sells laddered call options to generate a majority of their distribution, they pay out from the dividends of the underlying holdings similar to SCHD as well.

The two funds only overlap by 8% by weight (used SPY as a proxy).

⚡️ Portfolio Hedging:

The performance of these two funds are not as volatile or risky as the broader market either, signaling their diversification and strategy are providing a meaningful portfolio hedge. SCHD's beta is currently around 0.625 while SPYI's is 0.93. In my previous analysis, SPYI was more in the 0.5 range or half as volatile as the broader market, however with the recent market correction, we see a spike as SPYI did follow the broader market. In any case, these numbers fluctuate and I expect SPYI to come back down overtime as the option selling strategy converts the volatility into income.

SCHD and SPYI also have higher Sharpe ratios than SPY at 0.828 and 0.71 compared to 0.55 respectively. This supports that investors can achieve higher risk-adjusted returns on a total return basis.

Put differently, aside from the emotional and functional needs of income I outlined earlier, the advanced mathematical measurements support technical risk management is at play here. Overall, deriving income from assets in SCHD and SPYI which are not 100% correlated to the broader market using different strategies is a great way to hedge your portfolio and income risk.

⚡️ Fixed Income Needs & Yield on Cost:

I want to touch back on the fixed income needs and how I am using SPYI to address this in conjunction with my dividend growth holdings.

I currently need to make $2,000/month to pay my fixed expenses. Side note, variable costs like entertainment, new clothes, etc. and debt are not factored in because both are eliminable expenses. Debt is just a lot cheaper to pay off with active income rather than investment income.

To generate $2,000/month I would need about $700,000 invested in SCHD vs. $200,000 for SPYI based on each fund's average yield of 3.5% and 12% respectively. That's substantially less capital required to manage the same ongoing risk I outlined earlier.

One counter to this point is that dividend growth investors like myself are not buying SCHD for the 3.5% yield, but rather the 12%+ yield it will provide one day.

An excellent point, however, to get the same yield on your money it would take about 14 years to get there with SCHD, all the while a fund like SPYI may continue, and has, grown it's YOC to 14%+. Again, these are fixed expenses, so the cash flow and yield are what matter to service it. More importantly, this 14-year waiting period is about half the time I'm saying is the most risky time for your finances. You can manage this risk relatively inexpensively to bring peace of mind.

⚡️ Risk Analysis

The real risk with deploying this strategy is the distributions keeping up with inflation, as these "fixed" expenses will grow over time too. To study this, I ran a backtest of investing $200,000 in SPYI without reinvesting dividends not adjusting and adjusting for inflation as we are to assume we are paying bills with these.

Over the last few years, this strategy has kept pace with inflation.

The annual income actually exceeded our $24,000 / year requirement at $25,000 and $26,500 respectively and therefore saw a few thousand dollars of growth from 2023 to 2024. 2025 is on pace to distribute a similar level as 2024. I ran the same backtest on SCHD, which shows similar results using the $700,000 requirement during the same time period.

There have been slight dips, but this is normal even in a bond allocation strategy, which standard portfolio theory still stands at a whopping 40%.

Bonds fluctuate slightly in price too, don't grow their distributions, and have much lower yields than SPYI so from a purchasing power standpoint, much riskier than equities long term. You can replace a portion of this 40% required for fixed income with a fraction of the capital using SPYI and the rest with dividend growth ETFs. This allows you to invest a much larger sum of money into funds like SCHD, so the capital and dividends aren't wasted on fixed income needs.

Investors can also manage the risk of diminishing purchasing power by reinvesting a portion of the distributions, especially any unplanned excess as pointed out, to ensure your distributions keep growing.

Another way I'm hedging inflation and systemic risk with this strategy is diversifying with additional income funds like NEOS Nasdaq-100 High Income ETF (QQQI), NEOS Russell 2000 High Income ETF (IWMI), NEOS Bitcoin High Income ETF (BTCI), and NEOS Real Estate High Income ETF (IYRI) as these funds expand the strategy into other index volatility to generate consistent, sometimes higher monthly income.

⚡️ Portfolio Strategy Outlook:

As I hold substantial positions in SCHD, SPYI, and the S&P 500, I hope all three do well.

As of now, I prefer to view my SPYI and other income investments to exclusively service my fixed expenses and my dividend growth and broad market holdings be left for everything else on my path to financial independence. What's nice about this strategy is a small, say 10% allocation into income investments is only a fraction of my overall multi-million dollar portfolio strategy goal.

Overall, pairing SCHD with SPYI, and in general dividend growth and income, can provide excellent diversification, hedging, and financial security in your portfolio while you're in the trenches.

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