Building a portfolio of great stocks that can pay out enough in dividends to cover most of your major expenses in 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 not only pay a reasonably high yield today, but will also grow their payouts over time.
Finding those stocks means you’ll likely receive an annual pay raise every year as long as you remain diversified. You might not ever have to sell a single stock to fund your retirement if you can find the right portfolio of dividend payers.
The great 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. Consistently investing in an exchange-traded fund (ETF) every month and reinvesting the dividends during your career can result in a massive portfolio paying a substantial sum in annual income over time.
One simple Vanguard ETF, the Vanguard High Dividend Yield ETF (VYM), has the potential to turn a consistent investment of $500 per month 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 forecast to pay above-average dividend yields. Some might find the stock selection for the index to be too simple, but higher-paying dividend stocks historically provide above-average total returns as a group over the long run, according to research conducted by Hartford Funds.
In other words, it historically pays off in the long run to simply buy every stock in the market with an above-average dividend yield. The top holdings in the Vanguard High Dividend Yield ETF (and their yields) are:
- Broadcom (1.3% dividend yield)
- JPMorgan Chase (2.2%)
- ExxonMobil (3.3%)
- Procter & Gamble (2.3%)
- Johnson & Johnson (3%)
- Home Depot (2.4%)
- AbbVie (3.2%)
- Walmart (1.1%)
- Merck (2.6%)
- Coca-Cola (2.7%)
As you can see, the biggest holdings in the ETF aren’t super-high-yield stocks you might associate with some funds. But they do, for the most part, offer yields well above the S&P 500’s average of 1.3%. The fund’s 2.8% yield is still over twice the S&P 500’s.
Importantly, the fund contains 551 stocks, with just 24.8% of the fund held in the top 10 stocks, making it more diversified than the S&P 500 as well. That can provide extra downside protection if one company or industry suffers. That way, no single investment will bring down the value of the fund or the dividend it pays.
What’s more, you get the benefit of a super-low expense ratio. Vanguard charges just 0.06% of assets to invest in its index fund.
How $500 per month could generate $50,000 in annual dividends
The Vanguard High Dividend Yield ETF has produced 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 tilts toward will fluctuate over time, the historical return can help us estimate the growth of a consistent investment in the future.
Keep in mind that the total return includes reinvesting dividends. It’s a smart idea to automatically reinvest while accumulating assets, but eventually, you’ll want to start living off those dividends.
If the only thing you ever did was buy $500 worth of the Vanguard ETF at the start of every month and reinvest your dividends, you would be able to build a sizable portfolio over time. Here’s what your account balance might look like based on the historical returns and current yield.
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 you could collect from the portfolio without ever touching the principal investment. As such, you should expect the income stream to keep growing as the companies in the fund raise their dividends over time.
At the same time, you should see the total value of your portfolio continue to climb over time, even when you stop adding to your portfolio or reinvesting dividends. That could result in a substantial inheritance for your heirs.
There are a few important considerations for investors. First, future returns aren’t guaranteed to look like past returns. While the Vanguard fund has a long track record of good returns and dividend stocks historically perform well, there’s a chance they don’t continue to perform as they have in the past.
Moreover, investors shouldn’t expect steadily consistent returns month in and month out. The above table assumes a constant rate of return, but investors should expect volatility. The longer you invest, the more likely your returns will end with similar results to the table above, but the path to get there could be filled with 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 aren’t nearly as high as they were 40 years ago, and they could fall further. On the other hand, they could increase in the future. You might find your dividend income doesn’t match the expectations as a result.
Lastly, it’s important to remember that $50,000 won’t be able to buy as much in 40 years as it does today. So be sure your long-term plan accounts for inflation if you’re aiming to replace your income with a steady stream of dividend payments.
If you keep those things in mind, the Vanguard High Dividend Yield ETF is one of the best options for building a strong portfolio of dividend stocks without the effort of evaluating individual stocks and businesses.
— Adam Levy
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Source: The Motley Fool