Today’s topic will make you think, so put on your exploration hats. I have never seen a subject like this before, so we are charting new territory and hunting some sacred cows. Let’s begin.
Typical index fund retirement. The standard index fund retirement involves savers (not investors) piling their money into various index funds. Most savers use vehicles like 401Ks, TSP, and Roth IRAs to hoard as much cash as possible over 30-40 years in the workforce.
When your company offers mutual funds, they may look different from index funds on the stock market. However, they follow the same indices as my top four index funds. My top four funds are Total Stock Market (VTI), S&P 500 (SPY), Dow Jones Industrial Average (DIA), and NASDAQ 100 (QQQ).
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We will invest our index funds in a brokerage account for today’s experiment, not a retirement fund. The reason is that the government locks retirement accounts from receiving dividends until retirement age (59 ½). Additionally, many of these mutual funds do not pay dividends; they reinvest directly into more of their shares.
Build your own retirement. You may consider withdrawing a portion of your 401K or TSP stockpile, paying taxes, and investing in index funds via a brokerage account if you hit retirement age. Talk to your tax professionals or financial advisor to run the numbers. I’ll explain my thought process below.
Why blind index fund investing is dangerous. I love index funds because they are simple ways to gain massive returns. 99% of investors cannot beat the annual returns of an S&P 500 index fund over 2-10 years periods. So, if you can’t beat them, join them.
The problem with index funds is how you have to fund your retirement from them. Let’s go on a quick detour.
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Let’s say Josh started investing in index funds at age 25. He invested 50% of his salary into the four index funds for 40 years, thus amassing a portfolio worth $2 million.
At age 65, he now wants to start living off of his nest egg—this is where things become complicated. He spent 40 years blindly saving in stock market index funds and not learning how to invest.
However, withdrawing your cash from your account is more important than putting it in. Now, you need to make your money last for 20-40+ years. Inflation, interest rates, and recessions all factor into your withdrawal strategy.
By the way, these are all things Josh avoided while saving money in his index funds. Josh is now terrified of spending money and living on his nest egg.
The typical retiree. Because the typical retiree knows nothing about investing, they turn to financial advisors to assist them. Things can go downhill quickly from here.
Most financial advisors will manage your money for a 1-3% fee. That’s money off your top line, as they take their cut first. These fees will torpedo your returns for the rest of your life.
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Also, financial advisors will recommend things like annuities, reverse mortgages, and insurance to help you feel secure. Financial advisors aren’t bad people; they are just feeding off of your ignorance.
Enter dividends. If Josh knew about dividends, he could formulate a plan where he could live entirely on them. Instead of hiring a financial advisor, Josh could take the dividends from his index funds, add social security and maybe house hacking, and be comfortable.
He could keep all of his returns for himself, except for taxes (of course). But how does living on index fund dividends look?
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Index Funds pay dividends. My top four index funds pay dividends; however, they are minuscule. These numbers fluctuate, but historically these are the dividend yields of my index funds.
- Total Stock Market (VTI) 1.5%. March, June, September, December.
- Dow Jones Industrial Average (DIA) 2%. Monthly.
- S&P 500 (SPY) 1.5%. January, April, July, October.
- NASDAQ 100 (QQQ) 0.5%. January, April, July, October.
It will be challenging to live off a 2% dividend yield, but you can always supplement your index fund dividends with additional revenue streams.
Run the numbers. Let’s run the numbers for living on VTI at 1.5%. How much money do we need to invest to earn a living wage?
As you can see, you’ll need around $5 million invested to earn a livable wage ($75,000/year). Yes, that sounds like a lot, but it is highly achievable with determination and grit.
Advantages of index fund dividends. Yes, you’ll get more income from dividend growth investing and income investing; one massive advantage of index fund investing is safety.
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Index funds capture the gains of the entire stock market. Whether growth stocks (QQQ) or value stocks (DIA) are leading the charge, you are part of the bull run. If there is a recession, simply keep investing in your index funds until the next bull market.
You can sleep well at night knowing you’re capturing one of the best long-term strategies in investment history, the US stock market. You don’t have singular exposure to one company or sector. You have broad diversity and market-proven results.
You’re everywhere but nowhere. You don’t have to worry if McDonald’s cuts the dividend or your closed-end fund will reduce its payout.
Combine index funds with another strategy. Because of the low yield, index fund dividends will serve you best as a supplement to other systems.
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Reaching $500,000 in your index fund portfolio can be done in 4-6 years if you take it seriously. That $625 will be huge in retirement. If you combine index funds with social security, some rental income, and maybe a small business, you’ll be good to go.
You can also reinvent your index fund dividends into higher-yielding products like closed-end funds and preferred shares.
If you could invest your $625/month into AGNC mortgage REIT at 10%, you would create an entirely different income stream from your index fund profits. Yes, it is that simple to create wealth.
Another example. You saved $500,000 in index funds by age 40. You then use the index fund dividends to fund an income portfolio from age 40 to 50. You keep your index funds growing in the background.
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Over ten years, you would receive $75,000 in index fund dividends, not counting dividend growth. If you invested that cash into AGNC at 10%, you would have a $7,500/year or $625/month income stream.
By age 50, your index funds would grow to roughly $1.2 million. You would receive $18,000/year in index fund dividends and $7,500 in AGNC dividends.
It may be a lot of math, but that’s because it’s a lot of money. The idea is to keep your money growing. You could keep this going into perpetuity.
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Conclusion. Don’t be scared of the stock market. Index funds are safe and can change your life. But you have to understand how to leverage their dividends to your advantage.
Saving money is excellent, but you need to learn to multiply your money. The stock market does all the heavy lifting with index funds until you need to make withdrawals. At that point, you’ll need to understand the math.
If you don’t learn how to invest and use dividends, you’ll have to pay someone else to do it for you. And it will be very costly to yourself and the generational wealth you hope to build.
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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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