Building a portfolio of great stocks that can pay enough dividends to cover most of your major expenses during retirement is a big goal for many investors. Experts and amateurs alike spend a lot of time and effort searching for great dividend stocks that will not only provide a reasonably high yield today, but will also grow their payouts over time. Finding those stocks means you’ll likely receive an annual raise every year as long as you stay diversified. You may never have to sell a single stock to fund your retirement if you can find the right portfolio of dividend payers.
The good news for investors is that building a portfolio of dividend stocks that can pay out tens of thousands of dollars each year doesn’t have to be complicated. By investing consistently in an exchange-traded fund (ETF) each month and reinvesting the dividends over the course of your career, you can build a massive portfolio that can generate a significant amount of annual income over time.
One simple Vanguard ETF, the Vanguard High Dividend Yield ETF (NYSEMKT: VYM)has the potential to turn a consistent $500 per month investment into a $50,000 annual dividend machine.
The Only ETF You Need to Build a Diversified Dividend Portfolio
The Vanguard High Dividend Yield ETF tracks the performance of the FTSE High Dividend Yield index, which includes stocks that are predicted to have above-average dividend yields. Some may find the stock selection for the index too simplistic, but stocks with higher dividend yields have historically delivered above-average total returns as a group over the long term, according to research conducted by Hartford Funds.
In other words, it has historically paid off in the long run to simply buy every stock on the market with an above-average dividend yield. The top holdings in the Vanguard High Dividend Yield ETF (and their yields) are:
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Broadcom (1.3% dividend yield)
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JPMorgan Chase (2.2%)
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ExxonMobil (3.3%)
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Procter & Gamble (2.3%)
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Johnson & Johnson (3%)
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Home Depot (2.4%)
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AbbVie (3.2%)
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Walmart (1.1%)
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Merck (2.6%)
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Coca Cola (2.7%)
As you can see, the largest holdings in the ETF aren’t the super high-yield stocks you might associate with some funds. But they do generally offer returns well above the S&P 500‘s average of 1.3%. The fund’s 2.8% return is still more than twice the S&P 500.
Importantly, the fund holds 551 stocks, with just 24.8% of the fund in the top 10 stocks, making it more diversified than the S&P 500. That can provide additional protection against downside risk if one company or sector struggles. That way, no single investment will drag down the value of the fund or the dividend it pays.
Plus, you benefit from a super low expense ratio. Vanguard charges just 0.06% of assets to invest in its index fund.
How $500 a Month Can Generate $50,000 in Annual Dividends
The Vanguard High Dividend Yield ETF has delivered an average compound total return of 8.7% since its inception in late 2006. While the returns of dividend stocks and the large-cap value stocks that the fund is biased toward will fluctuate over time, historical performance can help us gauge the future growth of a consistent investment.
Keep in mind that total return includes reinvesting dividends. It’s a smart idea to automatically reinvest as you accumulate assets, but eventually you’ll want to live off those dividends.
If all you ever did was buy $500 of the Vanguard ETF at the beginning of every month and reinvested your dividends, you could build a decent portfolio over time. Here’s what your account balance might look like based on historical returns and current yield.
|
Holding period in years |
Portfolio value |
Annual dividend income |
|---|---|---|
|
1 |
$6,279 |
€176 |
|
5 |
$37,336 |
$1,045 |
|
10 |
$93,944 |
$2,630 |
|
15 |
$179,772 |
$5,034 |
|
20 |
$309,901 |
$8,677 |
|
25 |
$507,199 |
$14,202 |
|
30 |
$806,337 |
$22,577 |
|
35 |
$1,259,881 |
$35,277 |
|
40 |
$1,947,532 |
$54,531 |
Calculations by author. Figures are based on $500 invested monthly in the Vanguard High Dividend Yield ETF, with interest calculated on a compound basis.
As illustrated above, consistently investing $500 per month for 40 years results in a portfolio that pays out $54,531 per year based on the current dividend yield. That’s the amount of money you could take out of the portfolio without ever touching the principal investment. Therefore, you can expect the income stream to continue to grow as the companies in the fund increase their dividends over time.
At the same time, you should see the total value of your portfolio continue to increase over time, even when you stop adding to your portfolio or reinvesting dividends. That could result in a significant inheritance for your heirs.
There are a few important considerations for investors. First, there is no guarantee that future returns will resemble past returns. While the Vanguard fund has a long track record of good returns and dividend stocks have historically performed well, there is a chance that they will not continue to perform as they have in the past.
Additionally, investors should not expect to earn a consistent return each month. The table above assumes a consistent return, but investors should consider volatility. The longer you invest, the more likely it is that your returns will end up with results similar to the table above, but the path to get there can be full of ups and downs.
Second, the dividend yield for the Vanguard fund (and the stock market as a whole) could decline over the next 40 years. Yields are not nearly as high as they were 40 years ago, and they could decline further. On the other hand, they could rise in the future. You could find that your dividend income is not meeting expectations.
Finally, it’s important to remember that $50,000 won’t buy as much in 40 years as it does today. So make sure your long-term plan accounts for inflation if you want to replace your income with a steady stream of dividend payments.
With these things in mind, the Vanguard High Dividend Yield ETF is one of the best options for building a strong portfolio of dividend stocks without having to evaluate individual stocks and companies.
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JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Adam Levy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Home Depot, JPMorgan Chase, Merck, Vanguard Whitehall Funds-Vanguard High Dividend Yield ETF, and Walmart. The Motley Fool recommends Broadcom and Johnson & Johnson. The Motley Fool has a disclosure policy.
1 Simple Vanguard ETF Can Turn $500 a Month Into $50,000 in Annual Dividend Income was originally published by The Motley Fool
