This is My Favorite ETF to Buy Right Now. (Hint: It's Not From Vanguard)

I primarily invest in individual stocks. However, I have a small and growing portion of my portfolio in exchange-traded funds (ETFs). I find them to be very complementary to my investment strategy, which is to generate growing streams of passive income. My goal is to eventually generate enough passive income to cover my basic living expenses and become financially independent.

While Vanguard offers several income-focused funds, my favorite ETF is from another fund sponsor. Here's why I prefer the Schwab U.S. Dividend Equity ETF (SCHD +0.16%) to Vanguard's dividend ETFs.

Focused on the top dividend stocks

The Schwab U.S. Dividend Equity ETF has a straightforward investment strategy. It aims to track the Dow Jones U.S. Dividend 100 Index, which measures the performance of high-yielding U.S. dividend stocks with a consistent dividend record. It screens companies based on several dividend quality characteristics, including current yield, five-year dividend growth rate, and financial strength.

The fund holds about 100 high-quality, high-yielding dividend stocks. It has a roughly 3.3% current yield based on its dividend distributions over the last 12 months, which is about three times the S&P 500's yield. SCHD's holdings have increased their dividend by more than 9% annualized over the last five years. That dividend growth provides investors with a steadily rising income stream:

SCHD Dividend data by YCharts

The fund's combination of yield and growth has enabled it to generate strong total returns for investors over the years. It has delivered a double-digit annualized return over the last one-, three-, and 10-year periods as well as since its inception in 2011 (13.3%).

To top it all off, the Schwab U.S. Dividend Equity ETF has a Vanguard-like ETF expense ratio of 0.06%, enabling investors to keep more of the dividend income generated by its holdings.

How SCHD compares to Vanguard's dividend ETF options

I'm always on the hunt for new sources of passive income. That's led me to evaluate both of Vanguard's dividend ETFs: Vanguard High Dividend Yield ETF (VYM 0.26%) and Vanguard Dividend Appreciation ETF (VIG 0.48%).

The Vanguard High Dividend Yield ETF shares many similarities with the Schwab U.S. Dividend Equity ETF. It also tracks an index (FTSE High Dividend Yield Index) focused on higher-yielding dividend stocks. However, that index takes a much broader approach, investing in any company that has a high dividend yield (excluding REITs). As a result, it holds a lot more stocks (currently over 600). These stocks have a lower average yield (currently around 2.2%). Overall, the fund has delivered strong returns for investors (double-digit annualized over the past decade and 9.4% since its inception in 2006). It also has a very low expense ratio of 0.04%.

Whereas VYM focuses on yield, the Vanguard Dividend Appreciation ETF concentrates on dividend growth. This ETF tracks the S&P U.S. Dividend Growers Index, which follows companies that have increased their payouts for at least 10 consecutive years. However, it excludes the top 25% highest-yielding dividend stocks. As a result, the fund has a lower current yield (around 1.5%) from its roughly 330 holdings. This ETF also has a strong performance track record (double-digit returns over the past decade and 10.2% annualized since its inception in 2006) and a low 0.04% expense ratio.

The best of both funds

The Schwab U.S. Dividend Equity ETF has a higher current yield than VYM while still offering the dividend-growth potential of VIG. That's why I like it over those Vanguard options. SCHD can provide me with more income now, while also supplying income growth and strong total return potential. These features put me in a better position to achieve my long-term goal of reaching financial freedom.