1 Rock-Solid Index Fund Could Turn $400 per Month into $15,700 in Annual Dividend Income

Index funds are a great option for investors who prefer to spend very little time managing their savings. Think of them as prebuilt portfolios that can reduce risk by spreading money across a broad range of stocks. But index funds come in many shapes and sizes, so investors still need to do research.

With that in mind, the Vanguard Dividend Appreciation ETF (VIG 0.10%) is a compelling option for passive income investors. If it follows past performance, the index fund could turn $400 per month into an $825,100 portfolio over three decades, and that portfolio could then generate $15,700 in annual dividend income while continuing to grow.

Here's what investors should know.

A rock-solid index fund that pays a reliable dividend

The Vanguard Dividend Appreciation ETF tracks 315 U.S. companies that have increased their dividend payments for at least 10 consecutive years. The index fund counts value stocks and growth stocks among its holdings. However, it excludes the top 25% highest-yielding companies because excessive payouts tend to coincide with limited potential for stock price appreciation.

In other words, the Vanguard Dividend Appreciation ETF spreads capital across hundreds of companies with rock-solid financials, and it simultaneously offers reliable passive income and reasonable total returns. The top 10 holdings are listed below:

1. Microsoft: 4.9%
2. Apple: 4.3%
3. ExxonMobil: 3.4%
4. UnitedHealth Group: 3.4%
5. JPMorgan Chase: 3.1%
6. Johnson & Johnson: 2.7%
7. Visa: 2.6%
8. Procter & Gamble: 2.5%
9. Broadcom: 2.4%

The Vanguard Dividend Appreciation ETF also bears a below-average expense ratio of 0.06%, meaning investors would pay only $6 in annual fees for every $10,000 invested.

How $400 invested monthly could create $15,700 in annual dividend income

The Vanguard Dividend Appreciation ETF returned 188% over the last decade, compounding at 11.1% annually, if all dividends were reinvested. That falls below the 221% return in the S&P 500, but the Vanguard Dividend Appreciation ETF came with added bonus of being less volatile. Specifically, it carries a 10-year beta of 0.87, meaning it moved 87 basis points for every 100-basis-point movement in the S&P 500.

For this article, I will assume a more conservative total return of 10% annually to introduce a margin of safety. At that rate, $400 invested monthly in the Vanguard Dividend Appreciation ETF would grow into $79,900 in one decade, $287,300 in two decades, and $825,100 in three decades, provided all dividends are reinvested.

After three decades, Investors could stop reinvesting dividends to earn passive income in retirement. Assuming the dividend yield aligns with the 10-year average of 1.91%, the $825,100 portfolio would generate $15,700 in annual dividend income. Better yet, that passive income stream would actually get bigger over time.

Without reinvested dividends, the Vanguard Dividend Appreciation ETF returned 135% over the last decade, compounding by 8.9% annually. That would turn $825,100 into $1.2 million in another five years, and that new sum would generate about $24,000 in annual dividend income.

Some investors may have fewer than 30 years until retirement, so the table below illustrates how $400 invested monthly would grow over different holding periods. It also shows much annual dividend income the portfolio would generate at the end of each period. The table maintains the same assumptions I made above.

Table by author. Note: The table assumes the Vanguard Dividend Appreciation ETF will return 10% annually and pay a dividend yield of 1.91%. All dollar amounts have been rounded down to the nearest $100.

Dividend investors don't have to choose between index funds and stocks

Index funds are a good choice for investors who prefer to minimize time spent on portfolio management. However, investors who enjoy learning about companies and reading financial reports should consider a blended approach, meaning a portfolio that combines one or more index funds with a manageable number of individual stocks.

That strategy has two advantages. First, it allows the investor to build a diversified portfolio while only researching the companies they find interesting. Second, it allows the investor to beat their index funds if their stocks outperform, but the index funds will act as ballast to limit the downside if their stocks underperform.

For passive income investors, the Vanguard Dividend Appreciation ETF is a great source of ballast given its total return of 11.1% annually over the last decade.