If you are looking to create a portfolio that can provide you with a lifetime of passive income, then you need to look closely at exchange-traded funds (ETFs). They are simple to buy and sell and, more importantly, provide instant diversification.
When it comes to generating income, you should probably start with Schwab U.S. Dividend Equity ETF (SCHD 0.75%) and Vanguard Dividend Appreciation ETF (VIG 0.73%) on the equity side of the equation. For bonds, it's best to go simple and buy an ETF like Vanguard Intermediate-Term Bond ETF (BIV 0.14%). Here's a look at each of these reliable income generators.
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Schwab U.S. Dividend Equity ETF does what you would do
Schwab U.S. Dividend Equity ETF is fairly complex. It tracks the Dow Jones U.S. Dividend 100 Index. That index is created by first screening for companies that have increased their dividends annually for at least 10 years. It excludes real estate investment trusts (REITs) from consideration. After it creates this pool of stocks, it generates a composite score for each remaining company, selecting the 100 top-scoring stocks for the portfolio.
The magic is in the composite score, which factors in metrics like cash flow to total debt, return on equity, dividend yield, and a company's five-year dividend growth rate. Without getting too deep into the details, the score is effectively trying to find good businesses that are growing and offer attractive yield backed by growing dividends. That's pretty much what you would be looking for if you built your own portfolio from scratch.
Over time, Schwab U.S. Dividend Equity's dividend has trended generally higher, and so has its share price. And all you have to pay is a very modest 0.06% for the work being done. The trailing dividend yield is an attractive 3.8%.
Vanguard Dividend Appreciation ETF adds dividend growth flare
Compared to the Schwab U.S. Dividend Equity ETF, the Vanguard Dividend Appreciation ETF is pretty simple. It tracks the S&P U.S. Dividend Growers Index. First, the index identifies all the U.S. stocks that have increased their dividends annually for at least 10 years. And then it lops off the highest-yielding 25% of the stocks, buying the rest. The expense ratio is a shockingly low 0.05%.
The key here is that the Vanguard Dividend Appreciation ETF is really focused on buying growing businesses. But that comes along with a growing dividend, which helps income investors stave off the detrimental impact of inflation over time. While the yield is modest at 1.6%, the dividend has increased over time, and the price of the ETF has performed more strongly than that of the Schwab U.S. Dividend Equity ETF. All in, that's resulted in a better total return for the Vanguard ETF, which assumes dividend reinvestment.
Vanguard Intermediate-Term Bond ETF provides balance
You could just stop with the two equity exchange-traded funds featured above if you wanted, but your portfolio would likely be exposed to more volatility than you might expect. This is why it would be a good idea to add some bonds into the mix, which tend to provide stability to a portfolio. A great option is Vanguard Intermediate-Term Bond ETF.
There's nothing particularly special here. The ETF simply buys high-quality bonds with maturities that fall between five and 10 years. It tracks the Bloomberg U.S. 5–10 Year Government/Credit Float Adjusted Index. The expense ratio is very low at 0.03%, and the yield is currently around 3.9%. The key is that intermediate-term bonds tend to offer higher yields than cash or short-term bonds, while exposing investors to much less risk than long-term bonds.
Adding the Vanguard Intermediate-Term Bond ETF is a diversification play that tries to find a good balance between risk and reward. How much you own will really depend on how much equity risk you are willing to take on, noting that you'll want to lean toward equities to ensure your income stream and capital keep growing over time.
Working together as a team
Schwab U.S. Dividend Equity ETF, Vanguard Dividend Appreciation ETF, and Vanguard Intermediate-Term Bond ETF could all be bought alone. But the real benefit comes from owning all of them if you are trying to build a lifetime of reliable passive income. Together, they provide income, capital appreciation, and diversification, with your own preferences on allocation dictating the amount of risk you take on and the yield you generate.
