How $200 Per Month Can Create $25,000 in Annual Dividend Income

Building a portfolio full of high-quality dividend stocks that pay enough to cover your essential living expenses in retirement is a big goal for many investors.

Quality dividend payers also tend to raise their dividend each year, more than offsetting inflation most of the time. That means if you can build an annual income big enough to retire on using dividends alone, you may be able to avoid selling any of your shares. Your heirs will certainly thank you for a very generous income-generating portfolio when you eventually pass it on to them.

Fortunately, you don't have to spend hours researching dividend stocks to pick out one or two quality companies to buy each month. Consistently investing in a simple exchange-traded fund (ETF) and reinvesting the dividends could result in a massive portfolio over time that pays you tens of thousands of dollars each year. This simple strategy could turn a $200 monthly investment into $25,000 in annual dividend income for patient investors.

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The best dividend ETF you can buy

Great dividend stocks have a relatively long track record of payment, consistently raise their dividend, and have the financial wherewithal to keep raising it for years to come. That's why the Schwab U.S. Dividend Equity ETF (SCHD 0.22%) is such an attractive fund for investors looking for dividend growth stocks.

The fund tracks the Dow Jones U.S. Dividend 100 Index, which selects 100 stocks issued by U.S. companies with a 10-year track record of paying dividends. On top of that, each company produces strong cash flow that more than covers debt and payments to shareholders, ensuring they can continue raising payments. Those criteria differentiate it from other dividend ETFs, which might select stocks based purely on yield or dividend growth without concern for potential payout cuts in the near future.

The Schwab U.S. Dividend Equity ETF is full of great companies. Its top 10 holdings (and their forward dividend yields) are:

1. Pfizer (6.4%)
2. Abbvie (3.6%)
3. Coca-Cola (3.2%)
4. Cisco Systems (2.7%)
5. BlackRock (2%)
6. Bristol Myers Squibb (4.4%)
7. Texas Instruments (2.8%)
8. Verizon Communications (6.8%)
9. Amgen (3.7%)
10. PepsiCo (3.7%)

A few high-yield dividend stocks make it into the ETF's top holdings, but yield is far from the most important metric for weighting in the fund. Most of the top holdings have yields well below what you could get from Treasury bonds, but they hold a lot of potential to raise those payments over time. A great dividend growth stock could pay off much more in the long run than simply selecting investments with the highest yield today.

The Schwab fund has an expense ratio of just 0.06%, making it one of the simplest and most cost-effective ways to invest in a variety of great dividend growth stocks.

Data by YCharts.

How to turn $200 per month into $25,000 in annual dividends

If you consistently buy $200 worth of the Schwab U.S. Dividend Equity ETF each month, you'll eventually have a sizable portfolio. And if you automatically reinvest the dividends until you're ready to start living off your portfolio, you should see excellent returns.

The ETF has a 13.6% annual return since its inception in 2011. That's unlikely to continue; the last 13 years have been some of the best in stock market history.

The S&P 500 historically returns around 10% per year. Big mature dividend-paying stocks might return slightly less, on average. Investors will also have to account for the above-average tax drag on dividend stocks, so the fund might grow about 9% per year (when reinvesting dividends).

The ETF also has a 3.3% distribution yield over the trailing 12 months. That, too, may come down over time. That's because the Federal Reserve is currently looking to lower interest rates over the next few years, which could carry over to dividend yields (as a result of more investors moving capital to stocks and sending share prices higher). A 3% dividend yield may be a conservative long-term estimate.

Investing $200 per month based on the assumptions noted above (including the reinvestment of dividends) will lead to the following theoretical returns over time:

Calculations by author.

The above table is merely hypothetical. Anyone with even a little bit of experience with stocks knows they don't go up in a straight line every month. As a result, actual returns will look much different from the above table. That said, the longer your investment horizon is, the more likely real-world results will look similar to theoretical results.

Another consideration is that $25,000 won't be worth nearly as much in 40 years as it's worth today. Inflation will eat into the value of the dollar over time.

Even with a modest 2% average annual inflation, $25,000 in 40 years won't be worth half as much as it's worth today. If your goal is $25,000 in today's dollars, you'll need to double your investment.

You'll find those challenges in any long-term investment planning exercise. It's important to remain flexible and adjust your strategy over time to ensure you reach your goals.

But by starting today, you can build a strong foundation for massive dividend payments in the future by consistently investing in the Schwab U.S. Dividend Equity ETF each month.