The median weekly income for U.S. workers was $1,165 in the third quarter, which is roughly $60,500 per year, according to the Labor Department. That translates into after-tax income of roughly $45,000 per year even in the worst-case scenario. Financial advisors usually suggest saving 20% of after-tax income for retirement, which is $9,000 per year (or $750 per month) for the median worker.
However, workers can build a sizable investment portfolio that pays a significant amount of passive income by retirement with half that amount. To be clear, I am not suggesting that anyone should save less than 20% of their post-tax income, but rather pointing out that small sums invested regularly can build tremendous wealth over time.
Indeed, $375 invested monthly in the Vanguard High Dividend Yield ETF (VYM -0.55%) could build a $569,400 portfolio over 30 years, and that portfolio could pay about $17,200 in annual dividend income. Here are the important details.
The Vanguard High Dividend Yield ETF
The Vanguard High Dividend Yield ETF tracks 537 large U.S. companies that are forecast to pay above-average dividend yields. The index fund is most heavily weighted toward value stocks in three stock market sectors: financials (23%), industrials (13%), and healthcare (11%).
The 10 largest holdings are listed by weight:
- Broadcom: 3.9%
- JPMorgan Chase: 3.8%
- ExxonMobil: 2.8%
- Home Depot: 2.3%
- Procter & Gamble: 2.2%
- Walmart: 2.1%
- Johnson & Johnson: 2%
- AbbVie: 1.7%
- Bank of America: 1.7%
- Chevron: 1.4%
Three qualities make the Vanguard High Dividend Yield ETF an attractive option, particularly for risk-averse investors.
First, it has a low expense ratio of 0.06%. That means the annual fees will total $6 on every $10,000 invested in the fund. Comparatively, Morningstar says the average expense ratio for all U.S. index funds and mutual funds was 0.36% in 2023.
Second, while the Vanguard High Dividend Yield ETF is unlikely to beat the S&P 500 (^GSPC -1.11%) during bull markets, it did outperform by 8 percentage points during the last bear market. That's because the index fund tends to be less volatile. The Vanguard High Dividend Yield ETF has a three-year beta of 0.81, which means it moved 81 basis points for every 100-basis-point movement in the S&P 500 during the last three years.
Third, patient investors who regularly buy shares of the Vanguard High Dividend Yield ETF can build a sizable portfolio that pays a substantial amount of dividend income each year. I'll walk through a specific example in the next section.
Image source: Getty Images.
History says $375 invested monthly could create $17,200 in annual dividend income
The Vanguard High Dividend Yield ETF has achieved a total return of 349% since its inception in November 2006, which is equivalent to an annual return of 8.6%. That number may be skewed to the downside because the Great Recession started about a year later. Indeed, the Vanguard ETF returned 9.7% annually over the last decade.
However, I will assume the index fund returns 8.6% annually in the future to introduce a small margin of safety. At that pace, $375 invested monthly would be worth about $569,400 in 30 years, provided the dividends are reinvested. Investors can then stop reinvesting dividends to earn passive income in retirement.
The Vanguard High Dividend Yield ETF paid an average dividend yield of 3.03% during the last decade. At that rate, the $569,400 portfolio would generate a little more than $17,200 in annual dividend income. Additionally, that figure will actually increase if the underlying investment is left untouched.
For instance, the index fund has returned 5.2% annually since inception when dividends are excluded. At that pace, the $569,400 portfolio -- now paying about $17,200 per year in passive income -- would hit $733,600 in another five years. Assuming a dividend yield of 3.03%, the new portfolio would pay a little more than $22,200 in annual dividend income.
As a final thought, while the Vanguard High Dividend Yield ETF is a good choice for risk-averse investors, the risk-tolerant crowd should consider slightly more aggressive options. For instance, the S&P 500 has returned 510% since November 2006, outpacing the Vanguard High Dividend Yield ETF by 160 percentage points. That makes a compelling case for owning an S&P 500 index fund, and/or individual stocks for investors willing to do the research.
