Index funds are like ready-made portfolios that track a specific financial index, sector, or industry. They spread your funds across dozens, hundreds, or even thousands of different stocks, giving you diversified market exposure without the hassle of researching each stock individually.
Income investors should consider the following: Vanguard High Dividend Yield ETF (VYM -0.06%). Index funds can turn small contributions into large sums of money and generate significant dividend income. For example, his $500 monthly investment could grow to $915,300 over 30 years, giving him a total of $27,000 in annual dividend income.
Here's what investors need to know.
Vanguard High Dividend Yield ETF
The Vanguard High Dividend Yield ETF tracks 450 of the largest U.S. companies with above-average dividend yields. The company is comprised entirely of value stocks, so its constituents tend to be mature, low-growth companies. The ETF spreads its money across 10 of 11 market sectors, with the highest weightings being in financials, consumer staples, industrials, and healthcare.
Here are the Vanguard High Dividend Yield ETF's 10 largest holdings.
- Broadcom: 3.6%
- JPMorgan Chase: 3.6%
- ExxonMobil: 2.9%
- Johnson & Johnson: 2.7%
- Procter & Gamble: 2.6%
- Home Depot: 2.5%
- Merck: 2.2%
- AbbVie: 2.1%
- Chevron: 1.7%
- Walmart: 1.7%
One of the reasons the Vanguard High Dividend Yield ETF is so attractive is its ultra-low expense ratio of 0.06%. That means a $10,000 portfolio will only cost you $6 in annual fees. Similar funds have an average expense ratio of 0.9%. So a $10,000 portfolio would have an annual fee of $90.
How $500 per month generates $27,000 in annual dividend income
The Vanguard High Dividend Yield ETF returned 158% over the past 10 years, compounding 9.9% annually. To introduce a margin of safety, we assume a more conservative future rate of return of 9% per year. $500 invested each month at this rate will be worth $915,300 after 30 years, assuming all dividends are reinvested.
After 30 years, investors can stop reinvesting their dividends to earn passive income. The Vanguard High Dividend Yield ETF has delivered an average dividend yield of 3.02% over the past 10 years. At that rate, a $915,300 portfolio would generate $27,600 in annual dividend income. However, the principal and dividends continue to increase over time.
To elaborate, if dividends were not reinvested, the Vanguard High Dividend Yield ETF would have returned 6.5% annually over the past 10 years. Assuming a more conservative annual return of 6%, his $915,300 portfolio (currently paying $27,600 in annual dividends) would be worth him $1.2 million in five years. . This $1.2 million portfolio would pay out $36,200 in annual dividend income, assuming a dividend yield of 3.02%.
How $500 per month generates $30,000 in annual dividend income
Alternatively, investors can use two index funds. One maximizes his first 30-year return, and the other maximizes subsequent dividend payments. for example, S&P500 (SNPINDEX: ^GSPC) It has returned 10.3% annually over the past 30 years. At this rate, a $500 monthly investment in an S&P 500 index fund would grow to $1.2 million over the next 30 years.
Investors can then sell the S&P 500 index fund and reinvest the proceeds into the Vanguard High Dividend Yield ETF. Long-term capital gains taxes will eat up some of the profits, leaving investors with about $996,000. However, assuming a dividend yield of 3.02%, this amount would still provide you with $30,000 in dividend income per year.
Vanguard High Dividend Yield ETF Can Complement a Portfolio of Individual Stocks
The Vanguard High Dividend Yield ETF is a proven earner that consistently pays above-average dividends. These characteristics make them an attractive addition to a portfolio of individual stocks. Investors know that index funds have returned 9.9% annually over the past 10 years, and it's no wonder they believe they can generate similar returns in the future. This makes the fund a kind of safety net.
Specifically, investors can invest their time and energy into researching and managing a small number of individual stocks while investing regularly in Vanguard High Dividend Yield ETFs. If individual stocks outperform funds, investors will be ahead of the curve. But even if these stocks underperform, investors should still be okay because index funds should dampen the downside.
JPMorgan Chase is an advertising partner of The Motley Fool's Ascent. Trevor Jennewine has no position in any stocks mentioned. The Motley Fool has positions in and recommends Chevron, 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.
