The S&P 500 (SNP INDEX: ^GSPC) outperformed nearly every other asset class over the past decade, including bonds, global equities, precious metals and real estate. The index also outperformed 85% of large-cap funds, meaning that S&P 500 index funds often outperform professional money managers.
Investors can use that information to build a portfolio that generates large amounts of passive income. For example, $400 invested monthly in an S&P 500 index fund could grow to $789,500 over three decades. That amount could then be reinvested (minus capital gains taxes) in a high dividend-yielding index fund to generate $16,800 in passive income annually.
Here are the important details.
Step 1: Invest $400 per month in the Vanguard S&P 500 ETF
The Vanguard S&P 500 ETF (NYSEMKT: VOO) is a low-cost S&P 500 index fund. It measures the performance of 500 U.S. companies, covering approximately 80% of domestic stocks and more than 50% of global stocks by market capitalization. In other words, it lets investors spread capital across many of the world’s most influential companies.
The five largest holdings in the Vanguard S&P 500 ETF are shown below by weight:
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Apple: 6.9%
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Microsoft: 6.5%
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Nvidia: 6.2%
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Alphabet: 3.7%
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Amazon: 3.4%
The S&P 500 has returned 2,000% over the past three decades, or 10.6% per year. I round up to 10% to include a margin of safety. At that rate of return, $400 per month invested in the Vanguard S&P 500 ETF would be worth $789,500 after three decades. Investors could then sell the index fund and reinvest the proceeds in another fund.
Depending on the account type, investors may have to pay capital gains taxes when they sell the Vanguard S&P 500 ETF. Federal taxes on that amount would total about $100,000, but state taxes would vary. So I round the total tax burden to $150,000, leaving $639,500 to reinvest in another high-dividend index fund.
Step 2: Invest $639,500 in the Vanguard High Dividend Yield ETF
The Vanguard High Dividend Yield ETF (NYSEMKT: VYM) measures the performance of 550 U.S. companies that are forecast to pay above-average dividends. While the Vanguard S&P 500 ETF includes value and growth stocks, this index fund leans heavily toward value stocks. The five largest holdings are listed below by weight:
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Broadcom: 4.2%
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JPMorgan Chase: 3.6%
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ExxonMobil: 3%
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Procter & Gamble: 2.3%
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Johnson & Johnson: 2.2%
The Vanguard High Dividend Yield ETF currently pays a dividend yield of 2.63%. At that rate, the $639,500 from the previous section would generate about $16,800 in annual dividend income. And the payout should grow over time.
The Vanguard High Dividend Yield ETF has returned 88% over the past decade. At that rate, the total amount invested in the index fund would be $1.2 million in 10 years, and that total would generate about $31,600 in annual dividend income.
Most people should save more than $400 per month
According to the Census Bureau, the average American worker will earn $69,240 in net income in 2023. Financial planners generally recommend saving 20% of net income for retirement. That means the average worker should save $13,848 per year, or $1,154 per month.
In that context, $400 per month is a reasonable goal for most people. It would also leave the average worker with $754 per month in additional savings, which could be invested in stocks or other index funds. Either way, the end result should be a sizable nest egg that generates five figures of passive income annually by the time he retires.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Trevor Jennewine has positions in Amazon, Nvidia, and Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, JPMorgan Chase, Microsoft, Nvidia, Vanguard S&P 500 ETF, and Vanguard Whitehall Funds-Vanguard High Dividend Yield ETF. The Motley Fool recommends Broadcom and Johnson & Johnson and recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
2 Vanguard Index Funds Can Turn $400 a Month Into $16,800 in Annual Dividend Income by Retirement was originally published by The Motley Fool
