Everyone should strive to have a passive income stream because it allows you to make money without lifting a finger. Ideally, you'd have multiple, but one is by far better than none. There are many forms of passive income, ranging from rental properties to royalties to licensing, and in the case of the stock market, dividends.
Now, what if I told you that receiving $11,000 in dividends each year could be possible with relatively small monthly investments? It won't happen overnight or in a few years in most cases. However, it's very possible with the help of a dividend ETF like the Vanguard High Dividend Yield ETF (VYM +0.65%).
Image source: Getty Images.
What you're getting when you invest in VYM
VYM tracks the FTSE High Dividend Yield Index, which focuses on U.S. companies with above-average dividend yields. For a company to be included in the index, it must have a history of stable, reliable dividends and meet specific financial and size requirements. This ensures the companies within it are established, cash-generating businesses rather than higher-risk, speculative businesses.
Unlike many of the mainstream U.S. indexes, like the S&P 500 and Nasdaq Composite, which have become extremely tech-heavy, VYM is much more diversified by sector:
- Financials: 21.1%
- Technology: 14.1%
- Industrials: 13.5%
- Healthcare: 12.3%
- Consumer Discretionary: 9.8%
- Consumer Staples: 8.9%
- Energy: 8.4%
- Utilities: 6.4%
- Telecommunications: 3.6%
- Basic Materials: 1.9%
Within these sectors are well-known blue chip stocks like JPMorgan Chase, ExxonMobil, Johnson & Johnson, Walmart, AbbVie, Bank of America, Procter & Gamble, UnitedHealth Group, and many others. VYM currently has 566 holdings.
NYSEMKT: VYM
Key Data Points
How VYM could generate $11,000 in annual dividends
With a dividend ETF, it's important to focus on total returns, since dividends often account for a large share of its gains. Over the past decade, VYM has averaged 10.7% annual total returns. Past results don't guarantee future performance, but let's just assume this average holds up over time.
Below is how much a $500 monthly investment could grow to in different numbers of years, maintaining that average:
| Years | Investment Total |
|---|---|
| 10 | $98,600 |
| 15 | $200,500 |
| 20 | $369,600 |
| 25 | $649,900 |
| 30 | $1.11 million |
Table by author. Values are calculated based on VYM's 0.06% expense ratio and rounded down to the nearest hundred.
In that time, VYM's average dividend yield has been 3%. Dividend yields inevitably fluctuate with stock prices, but if we're assuming it stays constant for the sake of illustration, here is how much the above totals would pay out annually.
| Years | Investment Total | Annual Dividend Payout |
|---|---|---|
| 10 | $98,600 | $2,958 |
| 15 | $200,500 | $6,015 |
| 20 | $369,600 | $11,088 |
| 25 | $649,900 | $19,497 |
| 30 | $1.11 million | $33,300 |
Calculations by author.
More important than the actual numbers -- though they are important, they will inevitably vary based on returns and dividend yield -- is how time and compound earnings play a significant role in building your investment up to the point where you receive five-figure dividend payouts.
Focus on reinvesting dividends
The most efficient way to maximize your long-term returns is to reinvest your dividends initially rather than taking them in cash. Most major brokerage platforms offer a dividend reinvestment plan (DRIP), which automatically reinvests the dividends you receive into the ETF or stock that paid them out.
By reinvesting your dividends to buy more shares, you accelerate the compounding of your earnings. This works out better in your favor because initial cash payouts won't be very meaningful while you only have a relatively small amount invested in the ETF. For instance, $1,000 invested in VYM with a 3% yield pays out just $30 annually. In most cases, it's better to buy $30 more worth of VYM shares.
With a bit of patience, you'd be surprised by how powerful using a DRIP can be for your total returns.
