Back in the day, financial planners would talk about the "three-legged stool" to fund retirement. The idea was to replace your working income with a roughly equal combination of Social Security, pension income, and distributions from personal savings. You can already see why retirees in the 21st century no longer sit on the three-legged stool -- because pensions have gone by the wayside. Given that Social Security only replaces about 40% of your working income, that puts the onus on you to turn your savings into two legs instead of one. Dividend income might be able to help.

Dividend income works for retirees because the cash flow can fund some or all of their retirement distributions. That reduces the reliance on liquidations, which lower future earnings power. Plus, dividend income is truly passive. There's no rent to collect or work to complete. The hardest part is choosing among the many dividend-paying options you have, which include dividend stocks, mutual funds, exchange-traded funds (ETFs), and Real Estate Investment Trusts (REITs). Here are three ways to filter down those options, along with a look at three funds that pay out monthly dividends.

Older woman holding cash with thumbs up.

Image source: Getty Images.

1. Diversification

For many retirees, mutual funds and ETFs are more appropriate than individual company stocks for regular income. A fund gives you instant diversification, which keeps you from being reliant on any one position to maintain its dividend, year in and year out. You could diversify on your own, of course, but you might find that portfolio tedious to manage over time. 

Mutual funds and ETFs also give you the option of diversifying into other asset classes, such as fixed income and real estate. Assuming you don't have a reason for sticking solely with dividend-paying equities for that $1,000 of monthly income, you could consider funds that hold fixed income positions as well as dividend-paying stocks. REITs and REIT ETFs are also worth exploring for retirement income. REITs own and manage real estate and legally must distribute 90% of their profits to shareholders.

2. Payout schedule

Most companies, funds, and REITs pay dividends quarterly or annually rather than monthly. You'll have to weigh the pros and cons here. If you are set on receiving monthly income, you'll have to accept a smaller number of investment options. If you're open to managing your living expenses with quarterly income, you'll have a broader set of investment options to consider. 

3. Yield

The table below estimates how much you'd need to invest at various yield levels to generate $1,000 in monthly retirement dividends.

Dividend Yield

Investment Amount Required for $1,000 in Monthly Dividends





















Table data source: Author calculations.

Looking at these numbers, it's tempting to conclude that higher yields are better. Mathematically, they are more efficient -- but they're also riskier. You can probably assume a fund yielding 4% or more is investing in something other than stable, large-cap companies. Always review the fund's portfolio and investment strategy to understand what's driving the high yield. The fund might use leverage or hold some asset type, like junk bonds or preferred stock, that's naturally volatile.

A look at three different funds can shed more light on the link between yield and risk. All three pay dividends monthly. First up is SPDR Dow Jones Industrial Average ETF Trust (NYSEMKT:DIA). This isn't a dividend fund per se; it's a fund that tracks the Dow Jones Industrial Average (DJIA) that happens to distribute to shareholders monthly. The portfolio consists of 30 of the country's largest and most stable companies. The distribution yield is about 2%, but shareholders can also benefit from share price appreciation over time. In 2020, DIA is down about 1.5% for the year.

The WisdomTree U.S. Total Dividend Fund (NYSEMKT:DTD) has a somewhat higher yield of 3.36%. The portfolio includes small- to large-cap companies, all based in the U.S. You'll recognize many of the names in the portfolio, including Apple, Microsoft, and AT&T. This fund's share price is down about 9% year to date.

Compare that to Global X SuperDividend ETF, which invests in high-yielding, dividend-paying stocks all over the world, including many companies you may not have heard of, like Kumba Iron Ore Limited and Nine Entertainment. This ETF has an impressive distribution yield of 10%, but its share price is down about 37% for the year.

At the end of the day, you have to decide how much volatility and risk you can handle. Most retirees don't want to see big swings in their portfolio balances. Also, it's always a good idea to steer clear of companies and asset types you don't understand.

4. Consistency

Don't forget to research a fund's historic distributions as well. You might see fairly consistent dividend payments from period to period, or you might not. Dividends for the WisdomTree Fund, for example, have ranged from $0.095 to $0.34 per share over the last 12 months. That might be far too much variation if these dividends are funding your living expenses retirement.

Investing for future dividends

Most investors are better off sticking with safer funds and lower dividend yields. Unfortunately, that means you need a larger pot of money on hand. If you don't have $600,000 today and you're still working, commit to saving and investing as much as you can afford.

And, since you don't need the monthly income right now, you don't have to limit yourself to a fund that distributes 12 times a year. A broad-based index fund might be more appropriate to grow your wealth until you retire. Later, when you're ready to leave the workforce, you can convert some of those assets into a dividend fund -- which hopefully props up your three-legged stool to last you through retirement. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.