If you are reading this, then chances are that you haven’t started your journey into stock market investing yet, correct? I say that because index funds are some of the very first ways to head down the path towards building wealth.
Passive Index Fund investing is the third pillar of my overall investing strategy. The first pillar is dividend growth investing, and the second pillar is income investing. Finally, the last pillar is passive index fund investing.
Using these three pillars together can lead to stable, consistent gains, as well as a portfolio that produces you a livable income. When we retire, we want to have a high-income level, but we also want our portfolio to grow along with the stock market; that’s why we use index funds.
The Average Millionaire has 7 Streams of Income
Why do I use the word passive? I like to add “passive” in front of index fund investing. It is passive because the index fund does all the work. First, you pick your platform—I recommend STASH.
Next, you choose your index funds. My favorite index fund is the Vanguard Total Stock Market or VTI. Also, I wrote an article outlining my top 4 index funds, which are the S&P 500 (SPY), Dow Jones Industrial Average (DIA), and the NASDAQ 100 (QQQ).
Finally, you decide how much you want to dollar-cost average into your index funds. You can do daily, weekly, or monthly. I use STASH to drop roughly $30/week into VTI.
And that’s really all it takes. I could end the article right here, and you have enough to become a millionaire. But’s let’s look at the magic of passive income fund investing and why that’s also its biggest downfall.
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The Magic. The magic of passive index fund investing is that it is passive. To become quite wealthy, you don’t have to know much about the stock market. You honestly just need to dollar-cost average into VTI, and you will be good.
The passivity comes at a price, which ends up being the biggest pitfall with this type of investing—there is no need to learn how to invest.
Investing in education is crucial. Building your investing knowledge is vital to your long-term wealth and viability. Index fund investing uses the method of “The 4% rule” at its core.
The 4% rule. The 4% rule states that you can withdraw 4% of your nest egg annually and last over 30 years before running out of money. You also are adjusting your withdrawals for inflation as you continue along the years.
Many index fund millionaires tucked as much money into index funds and retired early (the Financial Independence Retire Early (FIRE) movement comes to mind). Here’s the rub, it’s much faster to build a $1 million with index investing than with dividend growth investing. That’s why many people prefer this way to acquire wealth.
New Year’s Passive Income Resolution 2022
However, the 4% rule has some serious flaws. I discuss more 4% rule in my article “Stocks vs. Bonds: Is 60/40 Still Effective?” One of the flaws is that you are 100% dependent on how much the stock market returns.
The Sequence of Return Risk. Say you had $1 million in VTI on January 1st, 2020, and you decided to retire. Perfect, everything is good to go, the world is quiet. Then March 2020 hits, and your portfolio immediately goes to $600,000.
However, you still need to eat, so you withdraw $40,000 at the bottom of the market. Even if the market bounces back, your returns over the lifetime will have diminished because of that one major shock. This is the sequence of returns risk.
In January 2020, if you had a $1 million dividend growth portfolio consisting of primarily blue-chip dividend-paying companies, you would have faired much better. Yes, your dividend income might have dropped by 25%, but you didn’t have to sell shares of any stocks to eat.
The Dividend Debit Card
My preference. That is why I prefer to build income and dividend growth portfolios. You don’t have to sell your nest egg to eat; the nest egg pays you.
Look at it this way. If you had a $1 million chicken, would you want to sell it at the start of your retirement or have it produce $40,000 of golden eggs every year?
My advice for passive index fund investing. My advice for passive index fund investing is to get started immediately. It is tough to go wrong with my four top index funds. As long as the US economy grows, the stock market will also grow. You truly can’t lose.
But you can’t stop there. You still need to learn how to invest in dividend-paying companies, or you can choose dividend ETFs as an alternative investment.
Can you live on index dividends? A final approach would be to live off the index funds’ dividends. Currently, VTI has a dividend yield of roughly 1.5%. For reference, I aim for a 4% yield with my dividend growth and an 8% yield with my income portfolio.
Preferred Shares 101: Getting Started with Preferred Shares
If you want to earn $40,000/year of dividends from VTI, you would need a nest egg of $2.6 million. Compare that to $1 million for a dividend growth portfolio and $500,000 for an income portfolio. So, it’s possible, but you can save a lot of time by learning how to invest in dividends.
Conclusion. Passive index fund investing is truly passive. Books like “I Will Teach You to be Rich” and “Smart Couples Finish Rich” go more in-depth in this simple form of investing. It is a great way to keep your money growing along with the economy.
However, I still like to use all three pillars in my investing strategy. This is how I see them: Index Investing (all Growth), Income investing (all Income), and Dividend Growth Investing (50% growth and 50% Income).
Dividends vs. Royalties 2
I am using all three methods, which allow me to sleep well at night. My Index funds can cover some of my weak DGI stocks and closed-end funds. And my closed-end funds pay me well while my DGI and Index funds continue to grow.
So I can eat today and grow my wealth for tomorrow. Last month, my wife and I had $900 in dividend income. Life is good. If you are new to the stock market, index fund investing is the perfect place to start.
As you learn about dollar-cost averaging and see your gains, add blue-chip stocks like McDonald’s (MCD) or Starbucks (SBUX)—you can learn as you go. I recommend my book “Dividend Investing: Back to Basics” as a great place to continue your dividend journey. Good luck!
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Disclosure: I am not a financial advisor or money manager, and any knowledge is given as guidance and not direct actionable investment advice. I am an Amazon Affiliate. Please research any investment vehicles that are being considered. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. All Right Reserved Military Family Investing
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