1 Simple Vanguard ETF Can Turn $500 a Month into $50,000 in Annual Dividend Income

Building a portfolio of great stocks that can pay enough 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 looking for great dividend stocks that not only pay a reasonably high yield today, but will also grow their payouts over time. Finding these stocks means you’ll likely get an annual pay 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 dividend-paying portfolio.

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) each month and reinvesting the dividends during your career can lead to a massive portfolio that pays a substantial amount in annual income over time.

A simple Vanguard ETF, the ETF Vanguard High Dividend Yield (VYM -0.17%)has the potential to turn a consistent $500 per month investment into a $50,000 annual dividend machine.

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The only ETF you need to build a diversified dividend portfolio

The Vanguard High Dividend Yield ETF tracks performance High FTSE Dividend Yield index, which includes stocks expected to pay above-average dividend yields. Some might think that selecting stocks for the index is too simple, but higher-paying dividend stocks historically provide above-average total returns as a group over the long term, according to research by Hartford Funds.

In other words, historically, it pays in the long run to simply buy every stock in the market with an above-average dividend yield. The main holdings in the Vanguard High Dividend Yield ETF (and their returns) are:

1. Broadcom (1.3% dividend yield)
2. JPMorgan Chase (2.2%)
3. ExxonMobil (3.3%)
4. Procter & Gamble (2.3%)
5. Johnson & Johnson (3%)
6. Home Depot (2.4%)
7. AbbVie (3.2%)
8. Walmart (1.1%)
9. Merck (2.6%)
10. Coca cola (2.7%)

As you can see, the largest holdings in the ETF are not very high-yielding stocks that you might associate with some funds. But, for the most part, it delivers returns far above S&P 500his average of 1.3%. The fund’s 2.8% return is still more than twice that of the S&P 500.

Importantly, the fund contains 551 stocks, with only 24.8% of the fund held in the top 10 stocks, making it even more diversified than the S&P 500. This can provide additional downside protection if a company or industry has to suffer. That way, no investment will reduce the value of the fund or the dividend it pays.

What’s more, 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 could generate $50,000 in annual dividends

The Vanguard High Dividend Yield ETF has produced an average compounded total return of 8.7% since its inception in late 2006. While the returns on dividend stocks and the high-value stocks the fund leans toward will fluctuate over time, historical performance can help us estimate the growth of a consistent investment in the future.

Note that the total return includes the reinvestment of dividends. It’s a smart idea to automatically reinvest as you accumulate assets, but eventually you’ll want to start living off those dividends.

If all you ever did was buy $500 of the Vanguard ETF at the beginning of each month and reinvest your dividends, you could build a sizable portfolio over time. Here’s what your account balance might look like based on historical returns and current return.

Calculations by author. Figures are based on $500 invested monthly in the Vanguard High Dividend Yield ETF, with interest calculated on a compounding basis.

As illustrated above, steadily investing $500 per month for 40 years results in a portfolio that pays $54,531 per year based on the current dividend yield. This is the amount you could collect from the portfolio without ever touching the principal investment. As such, you should expect the income stream to continue to grow 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 grow over time, even when you stop adding to your portfolio or reinvesting dividends. That could lead to a substantial inheritance for your heirs.

There are some important considerations for investors. First, future returns are not guaranteed to look like past returns. While the Vanguard fund has a long history of good returns and dividend stocks have historically performed well, there’s a chance they won’t continue to perform as they have in the past.

Moreover, investors should not expect constant consistent returns month after month. The table above assumes a constant rate of return, but investors should expect volatility. The more you invest, the more likely your returns will end up with results similar to the table above, but the path to get there could 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 as high as they were 40 years ago, and could fall further. On the other hand, they could increase in the future. You may find that your dividend income doesn’t match expectations as a result.

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 takes inflation into account if you want to replace your income with a steady stream of dividend payments.

If you keep 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 the effort of valuing individual stocks and companies.