Building a steady dividend income can go a long way toward ensuring a good standard of living in retirement. Not only can you live off your annual dividends, but you can also avoid selling your stocks indefinitely.
Over time, you can expect your dividends to grow (usually faster than inflation) so that you have enough money to cover your annual expenses. Combined with inflation-protected Social Security benefits, an extra $1,000 in dividend income per month can go a long way.
Fortunately, building a dividend portfolio that can pay out up to $14,000 in annual income doesn’t require extensive analysis of multiple companies’ financials. You can buy a simple exchange-traded fund (ETF) that does the hard work for you while giving you the protection of diversification. And you can build a sizable dividend income stream with an investment of just $100 per month.
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The best dividend ETF you can buy
Not all dividend-focused ETFs are the same. Some focus on dividend growth, while others focus on dividend yield. Investors who want to build a portfolio that will continue to provide them with a decent income for several years to come will choose high-yielding stocks that also have a high potential to continue to grow their distributions each year.
The fund that probably offers the greatest mix of high-quality and high-yielding dividend payers is the Schwab US Dividend Equity ETF (WKN: A2JW4T).
The fund pursues the Dow Jones US Dividend 100 Index that selects 100 stocks of U.S. companies with a strong track record of paying consistent dividends. It also screens these stocks for strong fundamentals to ensure they have the ability to continue paying and increasing those dividends over time.
This makes the Schwab ETF more attractive than some competing ETFs, such as the Vanguard High Dividend Yield ETF (WKN: A2JW4T)The Vanguard ETF tracks an index with a single selection criterion: the stock pays an above-average dividend yield. It then weights these stocks according to market capitalization.
There is no fundamental test to determine a company’s cash flow record or the likelihood that it can maintain that dividend. The result is lower overall performance over time as the quality of the stocks in the Schwab ETF shines through.
The quality of the stocks in the Schwab US Dividend Equity ETF is also evident in comparison to the Vanguard Dividend Appreciation ETF (WKN: A2JW4T)It tracks an index of stocks that have increased their dividends every year for the past decade, but excludes the top 25% of companies that earn the most. This depresses the ETF’s yield but does not appear to offer significant upside potential.
Since its launch in 2011, the Schwab ETF has delivered slightly higher total returns than the Vanguard Dividend Appreciation ETF. In addition, it has demonstrated better downside protection.
Data from YCharts,
How $100 a month can turn into $14,000 in dividend income a year
If you consistently invest $100 each month in the Schwab US Dividend Equity ETF, you will eventually build up a sizeable portfolio. However, one of the keys is to constantly reinvest the dividends the ETF pays out each quarter. This way, you will accumulate more and more shares each quarter, in addition to your monthly investments. You can eventually stop reinvesting the dividends when you are ready to use them for your retirement savings.
The ETF has produced an average annual total return of 13.3% since its inception in 2011. However, investors have seen particularly strong returns over the past 15 years. Returns are unlikely to stay that high. Over history, the S&P 500 index has produced an average annual return of about 10%. Conservatively, investors could expect an annual total return of 8.5% for a large-cap value stock ETF like the Schwab fund.
Even with conservative return estimates, the results of investing $100 per month add up over time. While the trailing 12-month return is about 3.5%, investors can look forward to dividend increases on the stock holdings that yield a future return of nearly 3.8%. Using these assumptions, the following hypothetical investment results emerge over time.
|
End of the year |
Portfolio value |
Annual dividends |
|---|---|---|
|
1 |
$1,247 |
$47 |
|
5 |
7,385 USD |
$281 |
|
10 |
$18,488 |
$703 |
|
15 |
35,183 USD |
1,337 USD |
|
20 |
60,286 USD |
2,291 USD |
|
25 |
98,033 USD |
3,725 USD |
|
30 |
154,791 USD |
$5,882 |
|
35 |
$240,136 |
9,125 USD |
|
40 |
368,465 USD |
14,002 USD |
Calculations by the author.
There are a few important points to consider. As most investors can attest, the stock market doesn’t produce consistent returns month after month. The constant inconsistency of market returns means your results won’t look exactly like those above. You might do a little better or a little worse. The longer your time horizon, the more likely it is that things will even out in the end.
Second, the calculations above don’t take into account an important factor: inflation. That $14,000 in annual dividend income won’t be worth nearly as much in 40 years as it is today. Be sure to take that into account when deciding how much to invest for your future.
Finally, the stock market could fundamentally change over time, favoring stocks with lower or higher dividend yields. A change in the average dividend yield could affect the Schwab ETF’s total return, resulting in higher or lower dividend income if you are willing to collect payments rather than reinvest them. Therefore, you may need to supplement your dividend income by selling stocks.
Importantly, these challenges aren’t unique to investing in this ETF or other securities. It’s important to stay true to your plan, but be flexible enough to change it if you find you’re not quite on track to reach your goals. Starting with a steady investment in the Schwab US Dividend Equity ETF is a great way to build a nice dividend income for retirement.
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Adam Levy does not own any stocks mentioned. The Motley Fool owns and recommends Vanguard Specialized Funds – Vanguard Dividend Appreciation ETF and Vanguard Whitehall Funds – Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.
